Private Benefit Ruled to Become Inurement Because of Board Service

Published date01 October 2017
Date01 October 2017
Bruce R. Hopkins’ Nonprofit Counsel DOI:10.1002/npc
purposes of the self-dealing rules (IRC § 4941). One way
for an act of self-dealing to occur is by reason of a direct
or indirect transfer to, or use by or for the benefit of, a
disqualified person (IRC § 4946) of the income or assets
of a private foundation (IRC § 4941(d)(1)(E)). The exercis-
ing of a power to substitute trust assets in this context
may result in an act of self-dealing.
An act of self-dealing generally involves a transaction
or arrangement between a disqualified person and a
private foundation. Here, the substitutor is not a family
member with respect to the grantor because siblings are
not treated as members of a family for purposes of the
definition of disqualified person (IRC § 4946(d)). There-
fore, the IRS concluded, the conversion of the trust will
not be an act of self-dealing inasmuch as disqualified
persons are not involved. [12.2(d), 12.4(a)]
Note: The IRS further ruled that conversion of the trust will
not result in an income tax charitable contribution deduc-
tion to the grantor in the year of conversion because con-
version of a trust from a nongrantor one to a grantor one
is not a transfer of property for income tax purposes.
A small rural hospital facility has been operating,
from a tax-exemption standpoint, as a dual-status entity,
in that it had a determination from the IRS that it was
an exempt charitable (IRC § 501(c)(3)) organization
and qualifies as a governmental unit or an affiliate of a
governmental unit. This hospital is a critical care access
facility for Medicare billing purposes.
The hospital conducted a community health needs
assessment as required by the Medicare program. The
IRS concluded, however, that this CHNA did not comply
with the exemption requirements for charitable hospitals
(IRC § 501(r)) in that it did not complete and adopt an
implementation strategy (required by IRC § 501(r)(3)(A)
(ii)) and did not make the CHNA report widely available
to the public (IRC § 501(r)(3)(B)(ii)). These failures were
found by the IRS to be egregious.
During the IRS examination, the hospital’s adminis-
trators made it clear to the IRS agent that the facility
had, in the words of this ruling, “neither the will, the
financial resources, nor the staff to follow through with
the CHNA process” on a triannual basis. They stated that
they did not want or need charitable exempt status, and
that that status sometimes prevented the hospital from
becoming involved in various Medicare reimbursement
or payment arrangements. The IRS retroactively revoked
the charitable exempt status of this hospital (Priv. Ltr. Rul.
201731014). [7.6(b)(ii)]
An organization operating a market for the sale of
local farm products to the public was granted recog-
nition of exempt status by means of the streamlined
application process. It was thereafter selected for audit.
The IRS ruled that this entity is not entitled to exemption
because any charitable or educational programming is
incidental and it is operated in a commercial manner
(Priv. Ltr. Rul. 201731012). Private benefit was found
to be flowing to the vendors, in that the organization
is providing an outlet for product sales and marketing
services, which are services for which the vendors would
otherwise have to pay for themselves. Because the
members of this entity’s board of directors are vendors,
this private benefit was converted by the IRS to private
inurement. [4.11(d), 20.5(n), 20.12(a)]
Commentary: This contention that private benefit is
converted to private inurement because of the composi-
tion of the organization’s board (apparently never before
made) appears flawed. Suppose a trade association’s
board adopts a policy (e.g., a lobbying initiative) favoring
businesses in the field represented by the association.
Perhaps incidental private benefit, at the most. As is
common, all of the board members are owners of busi-
nesses in this line of business. Is unwarranted private
benefit inuring to the board members? From here, the
answer is no, but this ruling suggests otherwise. (The
view of the IRS is that there is no such thing as inci-
dental, thus permissible, private inurement.) There have
been denials of recognition of exemption recently for
farmers’ market groups, with this position not raised.
A nonprofit organization was established to provide col-
leges and universities with the ability to engage in science
and engineering studies and research in the submarine envi-
ronment, offering “advice and consulting services” to these
institutions. It has a “highly skilled multidisciplinary support
team” that has over two decades of experience in a wide
variety of scientific missions. The IRS denied recognition of
exemption as a charitable entity because it failed the opera-
tional test (Priv. Ltr. Rul. 201729022). The IRS did not explain
the basis for this failure, other than to note that this entity
uses third-party contractors to provide most of the services.
The fact that the organization provides consulting services,
charges fees that include coverage of administrative and
overhead costs, markets its services, and does not receive

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