Yeah, Science! IRS Issues Guidance Section 501(c)(3) Scientific Organizations

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Cory D. Halliburton

Cory D. Halliburton

Attorney

214.984.3658
challiburton@freemanlaw.com

Cory Halliburton serves as general counsel and business adviser to a nationwide nonprofit / tax-exempt client base, as well as for multi-state professional service companies. He is a results-oriented attorney, with executive-level strategy and an understanding of the intersection of law and business judgment. With a practical upbringing, he pushes for process-driven results in internal governance, strategy and compliance with employment law, and complex or unique contracts and business relationships.

He dedicated the first ten years of his practice to mainly commercial litigation matters in West Texas and the Dallas-Fort Worth Metroplex. During that experience, Mr. Halliburton transitioned his practice to a more general counsel role, with an emphasis on nonprofit and tax-exempt organizations, advising those organizations through formation, dissolution, litigation, governance, leadership succession, employment law, contracts, intellectual property, tax exemption issues, policy creation, mergers and other. He has served as borrower’s counsel for tax-exempt bond and loan transactions near $100 million aggregate; some with complex pre-issue construction, debt payoff and other debt financing challenges.

Mr. Halliburton also serves as outside legal and business advisor for executive professionals in multi-state engineering firms, with a focus on drafting and counsel on significant service agreements, employment law matters, and protection of trade secrets.

In the Netflix series, Breaking Bad, character Jesse Pinkman exclaimed, “Yeah, Science!!” as his meth-lab mentor, Walter White, displayed how chemistry can be used to hone their joint venture. While the activity in which they were engaged may have been “scientific,” I doubt that activity would qualify as “scientific” as that term is used in section 501(c)(3), Title 26 of the Internal Revenue Code.

Under section 501(a) of the Code, an organization described in subsection 501(c) shall be exempt from federal income taxation. Organizations qualified under section 501(c)(3) include organizations organized and operated exclusively for, among other listed things, religious, charitable, educational, and scientific purposes.

The Treasury Regulations (26 C.F.R. § 1.501(c)(3)-1(d)(5)) provides a lengthy definition and explanation of the term “scientific” as used and intended in section 501(c)(3). In a nutshell, a scientific organization must be organized and operated in the public interest. Research, for example, must be for the public interest and not the type ordinarily carried on as an incident to commercial or industrial operations. Research may qualify under section 501(c)(3) if: (a) the results are made available to the public on a nondiscriminatory basis; (b) the research is performed for the United States, or any of its agencies or instrumentalities, or for a State or political subdivision thereof; or (c) the research is directed toward benefiting the public.

The regulatory definition also gives examples of “scientific” activities or organization that will not qualify as “scientific” under section 501(c)(3) and further explains how the unrelated business income rules might come into play for the organization that engages in research that is not qualified as “scientific” under section 501(c)(3). For additional information on the subject of unrelated business income tax for the tax-exempt organization, see the three-part series, Tax Exemption and Unrelated Business Income Rules.

On December 13, 2022, the IRS published a 51-page Technical Guidance for Exempt Purpose, Scientific Organizations 501(c)(3) (the “IRS Scientific Guidance”).

The IRS Scientific Guidance first addresses, as a matter of course, that the organization must meet the standard organizational and operational requirements of section 501(c)(3). Basically, the organization must be organized and operated exclusively (ah-hem, primarily) to advance a qualified purpose defined in section 501(c)(3), one of which is “scientific” purposes. For additional information about the generally applicable requirements for qualification under section 501(c)(3), see page 4-5 of 12 of this Texas State Bar paper that I presented back in February 2022: Representing Texas Nonprofit Corporations.

Certainly, the organization’s articles of organization should include “scientific” as a core organizational purpose. Here is an example of a purposes statement for articles of organization of a scientific organization: “The organization is organized exclusively to perform educational, charitable, religious, and scientific activities within the meaning of Section 501(c)(3) of the Code and related Treasury Regulations, including, but not limited to 26 C.F.R. § 1.501(c)(3)-1(d)(1)-(5). Specifically, but not by limitation, the organization’s purposes within the meaning of Section 501(c)(3) of the Code are to serve public interests through the development and support educational programs and research in regard to [insert targeted public issue to be supported by the scientific activity].”

The IRS Scientific Guidance notes that familiar examples of “scientific” include medical research and research programs of major colleges and universities. But, the scope of “scientific” is broader than might be believed, and the IRS Scientific Guidance and the Treasury Regulations support such a broader interpretation.

Importantly, a “scientific” organization must serve a public rather than a private interest. For example, “scientific” research, for these purposes, does not include activities of a type ordinarily carried on as an incident to commercial or industrial operations. The scientific activity must be carried on in the public interest. For example, if research is the basis for tax exemption under section 501(c)(3), the research must be made available to the public on a nondiscriminatory basis, performed for a governmental agency, or directed toward benefiting the public.

The key to qualification under section 501(c)(3) is whether the “scientific” activity, research, or other is conducted for the greater good or for the ordinary testing or inspection of material or products or for the designing of equipment and so furth for the benefit of some of private interest.

Questions for the organization to evaluate: Is the activity scientific? Is the activity research? Is the research in the public interest? Activities in these qualified areas include medical, agricultural, and even some research incidental to commercial enterprises or operations.

The tax-exempt organization must evaluate whether the scientific activity creates any prohibited inurement, private benefit, or other benefit that might trigger an excise tax or other detrimental tax consequence to the organization or to those in management. In addition, if the scientific activity produces income, and if that income is for a commercial purpose or unrelated to the organization’s basis for tax exemption, the organization must evaluate unrelated business income tax issues that may be triggered.

The IRS Scientific Guidance is a useful tool, but, as the Guide expressly states on page 1: “This document is not an official pronouncement of the law or the position of the IRS and cannot be used, cited, or relied upon as such.” Thus, the Code, the Treasury Regulations, and judicial authorities on the subject should be carefully consulted with respect to any “scientific” organization seeking or that exempt under section 501(c)(3) of the Code. See 26 C.F.R. § 1.501(c)(3)-1(d)(5) (providing a definition of “scientific” in this context).

Yeah, science! (And, yay for section 501(c)(3) exemption from federal income tax!)