Various 501(c)(3) organizations may pursue charitable activities or operate to pursue altruistic purposes. However, what if such activities or purposes do not fall within the Internal Revenue Code’s requirements for charitable organizations? Besides jeopardizing the ability of donor taxpayers to deduct contributions, the organizations may find that they are taxable and have certain filing requirements other than annual Form 990 filings. In a recent Private Letter Ruling, the Internal Revenue Service highlighted that “charitable” organizations, such as hockey organizations, that ultimately take care of their own members may not be so charitable for tax purposes.
501(c)(3) Organizations, Generally
Generally, charitable organizations must meet certain requirements to be exempt for federal tax purposes. First, the organization must operate for limited purposes (e.g., religious, charitable, scientific, testing for public safety, literary, or educational purposes). Second, individuals must not privately benefit from the net earnings of the organization. Finally, the organization must not engage in substantial propaganda or lobbying activities, and the organization must not participate in (or intervene in) any political campaign for or against a political candidate.
Specifically, Section 1.501(c)(3)-1(a) notes that an organization must meet the “organization test” and “operational test” to be an exempt organization under Section 501(c)(3):
(1) In order to be exempt as an organization described in section 501(c)(3), an organization must be both organized and operated exclusively for one or more of the purposes specified in such section. If an organization fails to meet either the organizational test or the operational test, it is not exempt.
(2) The term exempt purpose or purposes, as used in this section, means any purpose or purposes specified in section 501(c)(3), as defined and elaborated in paragraph (d) of this section.
Section 1.501(c)(3)-1(b) defines the “organizational test,” and Section 1.501(c)(3)-1(c) defines the “operational test.” The “operational test” provides, in part:
(c) Operational test –
(1) Primary activities. An organization will be regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in section 501(c)(3). An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.
(2) Distribution of earnings. An organization is not operated exclusively for one or more exempt purposes if its net earnings inure in whole or in part to the benefit of private shareholders or individuals. For the definition of the words private shareholder or individual, see paragraph (c) of § 1.501(a)-1.
Further, Section 1.501(c)(3)-1(d)(1)(ii) specifically assigns the burden of proof to an applicant organization to show that it serves a public rather than a private interest and specifically that it is not organized or operated for the benefit of private interests, such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests.
Moreover, previous revenue rulings have explicitly excluded certain organizations from being tax-exempt under Section 501(c)(3) based on their purposes and operations. In Rev. Rul. 69-175, parents of pupils attending a private school formed a nonprofit organization to provide bus transportation for certain school children. The Internal Revenue Service held that the organization was not tax-exempt under Section 501(c)(3)—“[w]hen a group of individuals associate to provide a cooperative service for themselves, they are serving a private interest.” Further, in Rev. Rul. 61-170, a charitable organization was established for the general purpose of organizing private duty and practical nurses for their mutual benefit (i.e., affording greater employment opportunities for its members). The Internal Revenue Service held that the organization did not meet the requirements of Section 501(c)(3), as the organization incorporated substantial private considerations in its operation.
Private Letter Ruling 202101008
On January 8, 2021, the IRS issued a Private Letter Ruling (“PLR”) related to a taxpayer’s request for a ruling under Section 501(c)(3). The PLR states in part:
Said organization is organized . . . to associate and organize ice hockey officials registered with F, to facilitate registration, training, and development of those officials for the overall improvement of the quality of amateur ice hockey officiating. The Association shall provide a forum for discussion and a medium for dissemination of information on ice hockey rules and interpretations to insure uniformity of rules interpretation and application; to develop more efficient and effective officials; to maintain the highest standards of officiating; and to create a better understanding between officials, coaches and players.as not limited to such a situation.
. . .
Membership in you is restricted to persons who have (1) paid all fees, dues and assessments as prescribed by the Board of Directors (2) has met the F registration requirements and are currently registered as an F on-ice official at any level or is an off-ice official registered with F as an affiliated (non-skating) official. . . . all your revenue is from league payments for officiating services. . . . Nearly all of your expenses are for the remuneration of members for their officiating services.
Based on the taxpayer’s purpose and operations, the Internal Revenue Service determined that the character of the organization’s activities was essentially commercial, not charitable. In essence, the taxpayer was like the nurses’ association in Rev. Rul. 61-170 and the school cooperative in Rev. Rul. 69-175. Accordingly, the IRS held that the taxpayer did not qualify for exemption under Section 501(c)(3) for failing the operational test under Section 1.501(c)(3)-1(c).
Charitable organizations should be careful that their purposes and activities squarely satisfy the organizational and operational tests. In the instant case, private inurement and serving the interests of a small, private group of members will more than likely endanger the 501(c)(3) status of an organization. Taking care of an organization’s members may generally seem charitable, but organizations should examine whether their purposes and activities truly serve the public.
 See I.R.C. § 501(c)(3).
 Treas. Reg. § 1.501(c)(3)-1(a).
 Treas. Reg. § 1.501(c)(3)-1(c)(1)-(2).
 See Rev. Rul. 69-175, 1969-1 CB 149.
 See Rev. Rul. 61-170, 1961-2 CB 112.
 I.R.S. Priv. Ltr. Rul. 202101008 (Jan. 8, 2021).