Originally published on Forbes.com.
Got a run-down old house that needs some spiffing up? Here is an idea. Get it designated a historic landmark. Then you can form a not-for-profit and get grants to do some renovations. Since it is a historic landmark, you’ll have to let people see it sometimes. Have them call you to make an appointment. When it is convenient. For you. After all, it is still your house. The proposition reminded me just a bit of the Seinfeld episode in which Kramer convinced NYU to provide him with an intern.
Reilly’s Thirteenth Law of Tax Planning. When an idea makes you think of a Seinfeld episode, it is not going to end well.
The Plan
And it did not end well for the organization (Let’s call it This Really Old House (TROH))) that was the subject of Private Letter Ruling 201648020. Private letter rulings are redacted, so to follow along you have to remember that the founder of TROH is B and the actual property is C. And as we noted, B owns C.
Once you establish your exempt status, you project all revenue to come in the form of donations and grants. You have not provided a detailed breakdown of your expenses, but they are all related to the restoration and maintenance of C and the property that surrounds it. C and the property surrounding it will continue to be owned by B. B will interview and select all workers that will perform the restoration of C as well as supervise all work. B’s permission is needed for anyone to view the property and appointments to do so are encouraged. You wrote you may be interested in inviting school groups for educational field trips and plan to eventually provide an educational program on site.
Why It Is Not Exempt
The Articles of Incorporation had not been amended to include the required language. Presumably, that can be fixed, but there are other issues that prevent the organization from being exempt. Let us count the ways,
You do not meet the provisions of Treas. Reg. Section 1.501(c)(3)-1(c)(1) because more than an insubstantial part of your activities is not in furtherance of an exempt purpose. You are operating to obtain grant funding to pay restoration costs of property owned by B, your incorporator and director. These facts show you were formed to further private purposes not public.
You are not described in Treas. Reg. Section 1.501(c)(3)-1(c)(2) because your net earnings inure to the benefit of B who is your incorporator and director. This is illustrated by the fact you are funding the renovation of property owned by her, which she is supervising and overseeing. In addition, C can only be viewed with B’s permission. Appointments are arranged with her.
You are not described in Treas. Reg. Section 1.501(c)(3)-1(d)(ii) because you are serving the private interests of B. You were formed to obtain grants to pay for the restoration of property in which B owns and resides. She is controlling all aspects of the restoration which also indicates her private interests are being served.
You are not similar to the organization described in Revenue Ruling 75-470. Unlike that organization, your primary purpose is to restore the property owned by your incorporator, and director. This results in inurement. Any public benefit is secondary and incidental to your primary purpose of furthering the interests of B.
Love That 501(c)(3) Status
Reading between the lines, I’m thinking that TROH might not have been angling for 501(c)(3) status, because of its own tax issues, or even those of B, who, granted, might have been able to start deducting the money that was going into renovating her house. The motivation to qualify for 501(c)(3) may have been to have a wider availability of grants.
For better or worse, 501(c) status has significance beyond federal income tax.It can be relevant for property tax and sales tax exemptions and be a requirement for an organization to be able to serve liquor or run gambling operations in some jurisdictions. And then there is the, in my view, extra dose of credibility that 501(c) organizations have along with the ability to access certain types of grants.
All this means that it is not only people of good will seeking 501(c) status. There are more than a few scoundrels or to be a little kinder to B and those that form non-profits to pay for their own kids’ activities, people whose goals are a bit too self-centered to qualify as charitable.
And the gatekeeper sorting the wheat from the chaff is the IRS Tax Exempt and Government Entities Division sometimes referred to as EO. There are also state agencies of greater or less ferocity, usually the Attorney General rooting out phony charities, but mainly we seem to rely on IRS EO to prevent the charitable sector from being overrun by the less than charitable. The reliance was probably never that reasonable, but the developments over the last few years have made things much worse.
The Interminable Scandal
At its very heart, the interminable IRS scandal, now on Day 1312 by TaxProf count was about exempt status applications. Applications from Tea Party and similar organizations were held up and applicants were asked intrusive questions. Here is the thing, I am the last agnostic on the IRS scandal. Was it bureaucratic bumbling or targeting of conservatives? I never found the targeting argument persuasive, but both Joe Kristan and George Will did, which gives me pause.Regardless of whether it was bumbling or targeting, the end result has not been good for the integrity of the charitable sector. The IRS has streamlined the process and now many, possibly most applications are receiving no scrutiny thanks to the new Form 1023-EZ. You can find commentary to the effect that the corrupt IRS is still persecuting the Tea Party. I really think the only way out of the mess is to turn the vetting of exempt status over to a different agency. In the states supervision of not for profits generally falls under the Attorney General, not the revenue department. Maybe they are on to something.
The targeting believers will never accept that the IRS has been punished enough or that enough will be done to protect against future targeting, so taking the job away from the IRS might be the only way out of a downward spiral.
Other Coverage
Paul Streckfus reproduced the ruling in EO Tax Journal 2016-231 with the comment:
This is an example of the cases that worry me under the current little or no review standards of the EO Division. This application is an easy denial, but how many cases like it have been approved without the IRS realizing the applicant is not a (c)(3), no way, no how?
A week later in EO Tax Journal 2016-238, he quoted a remark by Marc Owens at the Western Conference on Tax-Exempt Organizations.
I forecast that will be a problem for the next five or six years for the IRS as it begins to find out what’s hiding under that rock. I think every practitioner I’ve ever spoken to privately have their own little anecdotes about things they’ve seen.