SUMMARY: A change in function of a Section 501(c)(3) organization results in the IRS revoking its exemption.
To receive Section 501(c)(3) status, exempt organizations apply for exemption from the IRS. The exemption application provides details on what the organization intends to do, and the IRS confirms that it is an appropriate activity for a Section 501(c)(3) organization.
Many times, as organizations evolve they move into other areas and functions. Such organizations must monitor their functions and determine that the new functions are exempt functions under Code Section 501(c)(3).
In a recent Taxpayer Assistance Memorandum, an exempt organization and public charity was formed to operate a private school. Over time, its function drifted to the purchase or lease of school buildings that it then renovated, leased, and subleased to nonexempt charter schools. The IRS determined that such landlord functions were not an exempt purpose under Code Section 501(c)(3), and it revoked the exempt status of the organization.
The TAM is interesting for a number of reasons, including:
1. It is a warning to exempt organizations that the IRS will not tolerate mission creep away from the original exempt purposes of the organization. Organizations undergoing a change in purpose and function should advise the IRS of these changes prospectively and confirm that such changes do not jeopardize exempt status.
2. Leasing real estate is generally a nonexempt trade or business carried on for profit.
3. At times, a business can be regarded as exempt if it is an integral part of the exempt activity of a related exempt entity. Counsel for Bibliographic and Information Technology, T.C. Memo. 1992-364. In the TAM, the lessees, while they were schools, were not exempt entities.
4. Further, an organization may conduct a business in a charitable manner to promote the exempt purpose of an unrelated exempt organization. For example, the provision of leased space at rents well below market the levels can be exempt. Rev.Rul. 69-572. This was not helpful in the TAM because again, the lessees were not exempt organizations. Further, while the exempt organization did reduce the rents below market values, the reduction was not low enough since the exempt organization recovered its costs and also accumulated a surplus.
5. That an organization conducts some exempt activities along with its non-exempt activities may not act to save the exemption. Here, the organization conducted an educational summer program. The TAM concluded that this constituted only a minor portion of its time and resources, and thus the activity could not be considered a substantial purpose or basis for exemption. The TAM cited the U.S. Supreme Court in Better Bus. Bureau of Washington, D.C. v. U.S., 326 U.S. 279,283 (1945) which provided "that the presence of a single non-educational [exempt] purpose, if substantial in nature, will destroy the exemption [under § 501(c)(3)] regardless of the number or importance of truly educational [or other exempt] purposes."