TAXATION OF NONPROFIT ORGANIZATIONS · C. The Unrelated Business Income Tax: History and Policy 360 D. The Nature of an Unrelated Trade or Business 372 E. Exclusions From Unrelated

CASES AND MATERIALS

TAXATION OFNONPROFITORGANIZATIONS

THIRD EDITION

by

JAMES J. FISHMANProfessor of Law,Pace University School of Law

STEPHEN SCHWARZProfessor of Law Emeritus,University of California, Hastings College of the Law

FOUNDATION PRESS **&?;.•2010 THOMSON REUTERS"

SUMMARY OF CONTENTS

PREFACE , v

ACKNOWLEDGEMENTS - ix

TABLE OF CASES xxiiiTABLE OF STATUTES xxviiTABLE OF TREASURY REGULATIONS xli

TABLE OF REVENUE RULINGS. v xlviiTABLE OF MISCELLANEOUS RULINGS '.' xlixTABLE OF AUTHORITIES - li

PART ONE Introduction 1

CHAPTER 1 An Overview of the Nonprofit Sector 2

A. Introduction 2B. Dimensions of the Nonprofit Sector - 12C. Charity, Philanthropy and Nonprofit Organizations: A Historical

Introduction 19D. Rationales for the Nonprofit Sector 26E. The Legal Framework: Organization and Governance 34

PART TWO Charitable Organizations 55

CHAPTER 2 Qualification for Tax Exemption 56

A. Introduction 56B. The Rationale for Charitable Tax Exemptions ~~, 59C. Affirmative Requirements for Charitable Tax Exemption ----- 77D. Inurement, Private Benefit and Intermediate Sanctions 207E. Limitations on Lobbying and Political Campaign Activities 243F. Procedural Issues- - 315CHAPTER 3 Commercial Activities and Unrelated Business

Income - - 336

A. Introduction 336B. Impact of Commercial Activities on Exempt Status 339C. The Unrelated Business Income Tax: History and Policy 360D. The Nature of an Unrelated Trade or Business 372E. Exclusions From Unrelated Business Taxable Income 404F. Computation of Unrelated Business Taxable Income 411G. Unrelated Debt-Financed Income - 420H. Complex Structures and Other Special Problems 432I. Proposals for Reform - 465

X I

Xll SUMMARY OF CONTENTS

CHAPTER 4 Private Foundations — 472

A. The Universe of Private Foundations---- 472B. Private Foundations vs. Public Charities: An Overview 490C. Avoiding Private Foundation Status: The Details 508D. Private Foundation Excise Taxes 534E. Termination of Private Foundation Status 573

PART THREE Charitable Giving 593

CHAPTER 5 Charitable Contributions 594

A. Introduction 594

B. Charitable Contributions: Basic Principles — 615C. Noncash Contributions 654D. Planned Giving Techniques---- 677PART FOUR Mutual Benefit Organizations —— 687

CHAPTER 6 Tax Exemption: Mutual Benefit and Other Non-charitable Organizations \ 688

A. The Rationale for Tax Exemption 688B. Social Welfare Organizations 698C. Labor, Agricultural and Horticultural Organizations 699D. Trade Associations and Other Business Leagues - - 704E. Social Clubs and Fraternal Organizations 719F. Other Mutual Benefit Organizations 739

INDEX — 743

TABLE OF CONTENTS

PREFACE v

ACKNOWLEDGEMENTS ix

TABLE OF CASES —- -- xxiiiTABLE OF STATUTES xxviiTABLE OF TREASURY REGULATIONS xli

TABLE OF REVENUE RULINGS — ~ - - xlviiTABLE OF MISCELLANEOUS RULINGS '-'-'-'- xlixTABLE OF AUTHORITIES li

PART ONE Introduction - - 1

CHAPTER 1 An Overview of the Nonprofit Sector 2

A. Introduction 2John W. Gardner, The Independent Sector 4Note: The Underside of the Nonprofit Sector 6

B. Dimensions of the Nonprofit Sector 12Note: Where the Money Comes From—Sources of Funding of the

Charitable Sector 13\Lester M. Salamon, The Rise of the Nonprofit Sector 14Note: Restrictions on NGOs in New Democracies - 16Note: International Charities and Terrorist Activity 17Notes 17

C. Charity, Philanthropy and Nonprofit Organizations: A HistoricalIntroduction 19

Preamble to the Statute of Charitable Uses - 19Note: The Statute of Charitable Uses and the Meaning of Charity 20Note: The Development of Nonprofit Law in the United States 21Note: Social Enterprise Organizations 24

D. Rationales for the Nonprofit Sector 26Lester M. Salamon, America's Nonprofit Sector: A Primer 27Henry Hansmann, Reforming Nonprofit Corporation Law 29Notes and Questions 32

E. The Legal Framework: Organization and Governance 341. Introduction 342. Choice of the Legal Form of a Nonprofit Organization 35

a. In General - - -~ 35b. Unincorporated Associations 36c. Charitable Trusts - 37d. Nonprofit Corporations - 38

3. Nonprofit Corporations: A Closer Look 40a. In General - 40b. Public Benefit v. Mutual Benefit 42

Lizabeth A. Moody, Foreword to the Model Nonprofit Corpo-ration Act (Third Edition) 43

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XIV TABLE OF CONTENTS

Note: Criticism of the Model Nonprofit Corporation Act(Third Edition) 47

c. Forming a Nonprofit Corporation 474. Taxation 49

John Simon, Harvey Dale & Laura Chisolm, The Federal TaxTreatment of Charitable Organizations 50

5. An Introductory Problem T 54Problem-- 54

PART TWO Charitable Organizations 55

CHAPTER 2 Qualification for Tax Exemption 56

A. Introduction -*. 56

Notes -- - 57B. The Rationale for Charitable Tax Exemptions 59

1. Traditional Public Benefit Subsidy Theories 60Chauncey Belknap, The Federal Income Tax Exemption of

Charitable Organizations: Its History and Underlying Policy 61Notes and Questions 62

2. Income Measurement Theory -•- - 64Boris I. Bittker and George K. Rahdert, The Exemption of

Nonprofit Organizations from Federal Income Taxation 64Questions 69

3. Capital Subsidy Theory 70Henry Hansmann, The Rationale for Exempting Nonprofit Or-

ganizations from Corporate Income Taxation 71Notes and Questions 73

4. Property Tax Exemptions 75C. Affirmative Requirements for Charitable Tax Exemption 77

1. Organizational and Operational Tests — - 772. Application for § 501(c)(3) Exemption 793. The Meaning and Scope of Charity 81

a. Introduction 81Excerpt from Historical Development and Present Law of the

Federal Tax Exemption for Charitable and Other Tax-Exempt Organizations 82

Notes and Questions 84b. Hospitals and Other Health Care Organizations - - - - 85

Revenue Ruling 69-545 86Notes and Questions 88IHC Health Plans, Inc. v. Commissioner 91Notes 99Problems 105

c. Public Interest Law Firms and Other Legal Services- 106Revenue Ruling 75-74 106Revenue Procedure 92-59 108Problems- 112

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d. Community Development and Low-Income Housing 113Revenue Ruling 74-587 - 113Revenue Ruling 70-585 115Notes 118Problems - 119

e. Protection of the Environment 119Revenue Ruling 76-204 —- 120Revenue Ruling 78-384 - - 122Notes 123Problems—- — 124

f. Disaster Relief- - —I.— 124Problems— 129

g. Credit Counseling Organizations 1304. The Public Policy Limitation 131

Bob Jones University v. United States 132Notes and Questions 151Problems 159

5. Educational Organizations 160Revenue Ruling 75-384 160Revenue Ruling 78-305 162Big Mama Rag v. United States 163Revenue Procedure 86-43 — 171Notes — 174Problems-- 176'

6. Religious Organizations 177Holy Spirit Association v. Tax Commission 178General Counsel Memorandum 36993 - 183Notes and Questions 189Problems 192

7. Other Charitable Purposes 193Hutchinson Baseball Enterprises, Inc. v. Commissioner 194Notes 199Problems--- - 201

8. State and Local Tax Exemptions 202D. Inurement, Private Benefit and Intermediate Sanctions 207

1. Inurement of Private Gain 207Church of Scientology of California v. Commissioner — 208Notes and Questions 215Note: Executive and Trustee Compensation 216Notes and Questions- r 218

2. Private Benefit 221United Cancer Council, Inc. v. Commissioner — 222Notes and Questions--- — 229

3. Intermediate Sanctions on Excess Benefit Transactions - 230Problems 240

E. Limitations on Lobbying and Political Campaign Activities 2431. Background < 2432. The Lobbying Limitation: No Substantial Part Test 245

Christian Echoes National Ministry, Inc. v. United States 247Notes and Questions —- 254

3. Constitutional Issues 257Regan v. Taxation With Representation of Washington 258Notes and Questions 265

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4. The§ 501(h) Expenditure Test Election '. — 266a. Introduction 1. 266b. Spending Limits and Penalties 267c. Lobbying Expenditures 269d. Excepted Communications 271e. Reporting Requirements 274f. To Elect or Not to Elect 274

Problem- — 2755. Political Campaign Limitations - 277

Revenue Ruling 2007-41- 277Branch Ministries v. Rossotti 289Note: Churches and Political Campaign Activity 295Notes-— - 299

6. The§ 501(c)(4) Alternative 301Revenue Ruling 71-530 301Notes 302Problem 305

7. Section 527 Political Organizations: Reporting and DisclosureRequirements 306

8. Other Regulation of Political Activities of Nonprofit Organiza-tions- — 308

9. Policy Issues: Use and Abuse of Nonprofit Organizations forPartisan Political Activities---- — 312

Notes and Questions 313Problem —- 314

F. Procedural Issues 3151. Judicial Determinations of Exempt Status - 3152. Information Return and Disclosure Requirements 3173. Standing by Third Parties to Challenge Exempt Status— - 320

In re United States Catholic Conference 321Notes and Questions 335

CHAPTER 3 Commercial Activities and Unrelated BusinessIncome 336

A. Introduction 336Burton A. Weisbrod, The Nonprofit Mission and Its Financing:

Growing Links Between Nonprofits and the Rest of the Economy 337B. Impact of Commercial Activities on Exempt Status 339

1. Introduction ,. - 3392. The Commerciality Doctrine 342

Goldsboro Art League v. Commissioner 342Presbyterian and Reformed Publishing Co. v. Commissioner 346Revenue Ruling 67-4 353Note and Questions - 354

3. The-Commensurate-in-Scope Doctrine 355Revenue Ruling 64-182 355Notes and Questions 355Problems 359

C. The Unrelated Business Income Tax: History and Policy 3601. Historical Background 361

Notes and Questions 364

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2. Policy Considerations: Fairness, Efficiency and Public Rela-tions 365

Statement of Joseph O'Neil, Chairman, Business Coalition forFair Competition, at Hearings Before the Subcommittee onOversight, House Ways and Means Committee — 365

Notes and Questions 370D. The Nature of an Unrelated Trade or Business - 372

1. Imposition and Rates of Tax —- 3722. Taxable and Excepted Activities —- 373

a. Advertising - - 374United States v. American College of Physicians 374

b. Intercollegiate Athletics 382Revenue Ruling 80-296 — 382National Collegiate Athletic Ass'n v. Commissioner 384Notes 392

c. Museum Gift Shops 393Revenue Ruling 73-104 393Revenue Ruling 73-105 395

d. Corporate Sponsorship Activities —- 396Notes and Questions 400Problems- - 402

E. Exclusions From Unrelated Business Taxable Income 4041. Passive Investment Income - 4042. Rents — 4053. Royalties 406

Notes and Questions —- 4084. Research Income — —- 4085. A Monogrammed Exclusion — 409

Problems - 410F. Computation of Unrelated Business Taxable Income 411

1. Allocation of Expenses 411Rensselaer Polytechnic Institute v. Commissioner 412

2. Other Computation Issues - 418Problems-— 419

G. Unrelated Debt-Financed Income — 420Bartels Trust v. United States 422Notes and Questions —- - 428Problem — —- - 431

H. Complex Structures and Other Special Problems--- 4321. The Use of Controlled Subsidiaries —- 432

a. Planning Considerations — - 432b. Payments from Controlled Organizations 433

Notes and Questions 4362. Joint Ventures - - - 436

a. Introduction 436b. Whole Hospital Joint Ventures: The Control Test- 442

Revenue Ruling 98-15 442Notes 450

c. Ancillary Joint Ventures 453Revenue Ruling 2004-51 —- 454Problem 458

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3. Partnerships and S Corporations 459Service Bolt & Nut Co. v. Commissioner 459Notes and Questions 461

4. Social Clubs 464I. Proposals for Reform-- 465

Subcommittee on Oversight of House Ways and Means Committee,Draft Report Describing Recommendations on the UnrelatedBusiness Income Tax 465

Notes — 470

CHAPTER 4 Private Foundations — — 472

A. The Universe of Private Foundations 4721. Introduction 472

David F. Freeman, The Handbook on Private Foundations 473Note: Dimensions of the Foundation Community 480

2. The Distinction Between Private Foundations and PublicCharities: Historical Origins 481

Notes and Questions- 4843. Community Foundations 484

John A. Edie, First Steps in Starting a Foundation 485Notes —- : 488

4. Other Private Foundation Alternatives — 4885. The Present (and Future) of Private Foundations 489

B. Private Foundations vs. Public Charities: An Overview 4901. The Tax Definition of a Private Foundation 490

John A. Edie, First Steps in Starting a Foundation - 4912. Private Operating Foundations : 4963. Private Foundation Excise Taxes 4974. Donor-Advised Funds - - 499

a. Introduction —— 499b. Definition of Donor-Advised Fund - 501c. Taxable Distributions and Prohibited Benefits 502d. Other Sanctions and Penalties-- 503e. Reporting and Disclosure -— 504f. Lingering Policy Questions 504

5. Pass-Through Foundations and Pooled Common Funds 505Problem —- 7 , 506

C. Avoiding Private Foundation Status: The Details 5081. The Disqualified Person Rules 5082. Traditional Public Charities: § 509(a)(l) - 511

a. Organizations Engaging in Inherently Public Activities 511b. Publicly Supported Organizations 513

3. "Gross Receipts" and Membership Organizations: § 509(a)(2)-- 517Problem 519

4. Supporting Organizations: § 509(a)(3) 520a. Introduction 520b. Permissible Relationships 521c. Organizational and Operational Tests 524

TABLE OF CONTENTS X I X

d. Control Test 526Revenue Ruling 80-207 —- 526

e. Other Operational Rules and Sanctions---- 527Problem —- - 530

5. Private Operating Foundations -- 5326. Information Reporting and Disclosure Requirements- 533

D. Private Foundation Excise Taxes 5341. Tax on Net Investment Income: § 4940 - 535

Problem - 5372. Self-Dealing: § 4941 '..'.'. 538

a. Acts of Self-Dealing — 538b. The Tax Cost of Self-Dealing 541

Madden v. Commissioner... 542Problems 549

3. Charitable Distribution Requirements: § 4942 550a. Introduction 550b. Operation of § 4942 551c. Policy Issues: Adjusting the Payout Rate 554

Problem —- .-. 5564. Excess Business Holdings: § 4943 - 558

a. Introduction 558b. Operation of § 4943 558c. Application of Excess Business Holdings Rules to Donor-

Advised Funds and Certain Supporting Organizations 560d. Transitional Rules 561

Problem —- —- 5625. Jeopardy Investments: § 4944 - 563

Problems - 5646. Taxable Expenditures: § 4945 — 564

a. Introduction .— 564b. Types of Taxable Expenditures 565c. Expenditure Responsibility 568

John A. Edie, Expenditure Responsibility: "It's Easier ThanYou Think" — 568

Problems-— v —- 572E. Termination of Private Foundation Status - 573

1. Involuntary Termination - 5732. Voluntary Termination 574

Revenue Ruling 2002-28 - 575Revenue Ruling 2003-13 - 586

PART THREE Charitable Giving 593

CHAPTER 5 Charitable Contributions — 594

A. Introduction .— 594

1. Historical Origins- —- 594

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2. Policy Issues- 595Giving in America: Toward a Stronger Voluntary Sector 596William D. Andrews, Personal Deductions in an Ideal Income

Tax 599Teresa Odendahl, Charity Begins at Home: Generosity and Self

Interest Among the Philanthropic Elite 604Note: Policy Aspects of the Estate Tax Charitable Deduction.--- 610Notes and Questions 611

B. Charitable Contributions: Basic Principles 6151. Qualified Donees ~~~..'. 6 1 5

a. In General 615b. International Giving 616

Revenue Ruling 63-252 616Notes 619

c. Fiscal Sponsors 6212. Form and Timing 622

Notes 6223. What is a Charitable Gift? 624

a. Return Benefits: In General 624Revenue Ruling 67-246 624Notes , -- 630

b. Intangible Religious Benefits - 632Sklar v. Commissioner 632Notes and Questions —- 643

4. Percentage Limitations and Carryovers — 6455. Substantiation and Compliance Rules 648

Problems r 652C. Noncash Contributions 654

1. Capital Gain Property 654Blake v. Commissioner 655

2. Ordinary Income Property '. 659Revenue Ruling 79-256 660Notes 662

3. Tangible Personal Property 6634. Bargain Sales 6675. Partial Interests (Not in Trust) 6686. Qualified Conservation Contributions 6697. Valuation and Appraisal Requirements 671

Notes and Questions 673Problems- 675

D. Planned Giving Techniques 6771. Introduction 6772. Charitable Remainder Trusts 6783. Pooled Income Funds 6814. Remainder Interest in Personal Residence or Farm 6825. Charitable Gift Annuities 6826. Charitable Lead Trusts - 683

Problems 684

TABLE OF CONTENTS XXI

PART FOUR Mutual Benefit Organizations - 687

CHAPTER 6 Tax Exemption: Mutual Benefit and Other Non-charitable Organizations 688

A. The Rationale for Tax Exemption.-- 688Boris I. Bittker and George K. Rahdert, The Exemption of Non-

profit Organizations From Federal Income Taxation 689Notes and Questions —— — - 695Excerpt From Joint Committee on Taxation, Description of Reve-

nue Provisions Contained in the President's Fiscal Year 2000Budget Proposal —- — 695

Notes and Questions — —- — 697B. Social Welfare Organizations- 698C. Labor, Agricultural and Horticultural Organizations---- 699

Stichting Pensioenfonds Voor de Gezondheid v. United States 699Notes —- 703

D. Trade Associations and Other Business Leagues 7041. The Line of Business Requirement - 705

Guide International Corporation v. United States 705Note - 707

2. No Conduct of Business for Profit Requirement - - - - 708Associated Master Barbers & Beauticians of America v. Com-

missioner — -- 708.Notes - - - 713

3. Lobbying and Other Political Activities - —- 714Problems —- -— - 718

E. Social Clubs and Fraternal Organizations 7191. Introduction 719

Zeta Beta Tau Fraternity, Inc. v. Commissioner —. 7202. Discrimination —- 727

McGlotten v. Connally — 727Notes —- 734

3. Nonmember Activities--- - 737Problems —- —- —- 738

F. Other Mutual Benefit Organizations 7391. Veterans Organizations - 7392. Political Organizations---- 7403. Title Holding Companies - 7414. Other Exempt Organizations 742

INDEX — 743