Based on a recent decision by both the U.S. Tax Court and the IRS that focused on the requirements for an organization to qualify for a tax exemption under Sec. 501(c)(3), a non-profit organization must operate exclusively for charitable purposes. Under this section, an organization will be regarded as operating exclusively for one or more exempt purposes only if it “engages primarily in activities that accomplish one or more of the exempt purposes” specified therein. It is important to note that the organization bears the burden of proving that it meets the requirements, and that a statute creating an exemption “must be strictly construed.”
By definition, a “charitable purpose” includes “Relief of the poor and distressed or of the underprivileged; advancement of religion; advancement of education or science; erection or maintenance of public buildings, monuments, or works; lessening of the burdens of government; and promotion of social welfare by organization designed to accomplish any of the above purposes, or (i) to lessen neighborhood tensions; (ii) to eliminate prejudice and discrimination; (iii) to defend human and civil rights secured by law; or (iv) to combat community deterioration and juvenile delinquency.”
However, a single, substantial nonexempt purpose will disqualify an organization despite the importance of its exempt purpose. Although a charity’s mission may be to benefit the community, and they may not profit from the services they offer, tax-exempt status can still be denied. Also, if an organization serves private rather than public interests, it will not qualify for exemption status.
Specifically, the court focused on how an organization that offers a recreational activity to achieve a charitable purpose can qualify as a charitable organization. It’s possible for a single activity to have more than one purpose, and after all, the purpose of the activity, not the nature of it, is the determining factor. Therefore, the Court focused on whether an organization’s primary purpose for engaging in its sole activity was an exempt purpose or whether there was another substantial nonexempt purpose.
One example of such a situation was when an organization called GameHearts, a non-profit organization in Montana, said it was committed to “providing alternative forms of entertainment” including “free and low cost tabletop gaming activities in a supervised non-alcoholic, sober environment” in its Application for Recognition of Exemption. This organization also stated that it was working toward the betterment of the region by attracting participants to attend its activities “during evening hours, as opposed to frequenting bars and casinos in the area, as well as to inspire decision making and problem solving abilities by teaching and promoting educational and strategic games and activities …” Although the court recognized that recreational therapy could be a way to achieve a charitable purpose, GameHearts did not show that it was “operated exclusively” for one or more exempt purposes. Although promoting sober gaming may benefit the community, the IRS argued that a substantial part of GameHearts’ activities furthered “nonexempt social and recreational interests” because GameHearts offered gaming to anyone who was over 18 years old and sober. The IRS’s positions were that gaming is recreational, and that GameHearts did not limit its services to a charitable class. Therefore, GameHearts, and any other charitable organization that does not operate exclusively for charitable purposes, is ineligible for tax-exempt status.
This is just an example of how straying from a strict exempt purpose can cause an exemption to be denied. However, it can be easy to stray. Is your nonprofit engaged in activities that could threaten its exemption? It may be time for a review.
Please note that the information contained in this blog, including comments posted by visitors, is provided for informational purposes only. It should not be construed as financial, tax or other advice on any subject matter. It is not intended to be a substitute for obtaining accounting, tax, or other financial advice from an appropriate professional adviser. The reader is advised to consult with their own tax adviser for guidance on anything contained herein.