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Nonprofit Organizations Update |Winter 2007
Internal Revenue Service Denies Federal Income Tax Exemption forOrganization That Changed Purposes and Projected Programs RepeatedlyDuring Application Process
 The Internal Revenue Service has denied a federal income tax exemption to anonprofit organization under Section 501(c)(3) ofthe Internal Revenue Code afterthat entity changed its purposes and projected programs numerous times during thecourse ofthe exemption application process and failed to provide the IRS sufficientdetailed information to allow the Service to conclude that it would be operated forexempt purposes.The nonprofit was properly organized for charitable andeducational purposes,namely,"to create and foster high quality educational programsthat enriched the lives ofchildren and adults." But it then changed its purposes solely to building a Christian theme park that would "support outreach ministries that teachthe gospel ofJesus Christ worldwide as well as help children and adults in need."In rejecting the nonprofit's application for recognition ofexempt status,the IRSnoted that the nonprofit's articles ofincorporation had never been amended tochange its original purposes.The IRS also pointed out that,during the three years in which the IRS was considering the nonprofit's application,the organization's originally intended class ofbeneficiaries,"children and adults," had not been benefited at allfrom the minimal progress the organization had made in the activities and programs ithad originally proposed to undertake so as to achieve the purpose stated in its articlesofincorporation,namely,developing drafts ofan educational game and book forretail marketing.On the other hand,the organization had engaged in certain outreach activities whilethe exemption application was being processed,involving the collection ofshoes andclothing for orphans in Haiti and assistance to victims ofa hurricane in Haiti,as wellas tsunami survivors.While these activities were charitable and worthy,the Servicesaid that they had no connection to the organization's original purposes,and theService could not conclude that the nonprofit was continuing to perform charitable,educational or religious purposes,or that it would continue any activities that it hadperformed in the past. As for the religious purposes the organization purposed to achieve through thedevelopment and operation ofa Christian theme park,the IRS pointed out that thenonprofit had provided the Service only some broad ideas concerning the park,including no plans for the location ofthe park,no projected date for construction of the park,and no tangible plans for its construction.All the organization had done was to state to the IRS that it was "securing a committed,working board ofdirectorsto help plan,organize,fund raise,oversee operations and maintain" the theme park,and this showed the nonprofit had done very little toward the realization ofthe themepark,in the opinion ofthe IRS.
About our NonprofitPractice Group
Arnstein & Lehr LLPprovides legal servicesto trade associations, professional societies,public charities, private foundations, fraternalorganizations, group insurance trusts,political action committees, schools,hospitals, medical staffs, "captive" insurancecompanies, and other organizations exemptfrom federal income tax under Section501(c) of the Internal Revenue Code. TheFirm's attorneys help such clients deal with awide array of issues, including:•Corporate and trust formation andmaintenance• Development of bylaws• Obtaining and maintaining federal andstate tax exemptions• Avoiding and minimizing unrelatedbusiness income taxes• Registrations and annual filings withattorneys general and othergovernment officials• Proper conduct of organizationelections• Avoiding antitrust problems• Fund raising campaigns, including useof professional fundraisers• Self-dealing, inurement andintermediate sanctions• Relations with subsidiary groups,including group tax exemptions• Protection of intellectual property• Charitable gaming• Limitations on political and legislativeactivity• Professional ethics matters• Public and member disclosurerequirements• Deductions for donors• Nonprofit mailing permits• Partnerships and joint ventures with for-profits• Employment issues• Insurance issues
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 The IRS further advised that details offundraising projectsand funds to be raised from the public were not provided by the nonprofit,and the information submitted to the Serviceshowed that funds for completed projects had been,in largepart,provided by the organizers ofthe nonprofit.Especially for the theme park,which the IRS thought would be acomplex and expensive undertaking,the Service felt thatbudgets and financial information submitted by the nonprofitprovided insufficient detail.Finally,while the organization's bylaws required a boardconsisting ofseven Christian ministers and business people,the Service noted that the nonprofit had identified only twoboard members for the Service.One ofthose identifiedindividuals,furthermore,appeared to be ineligible for serviceas a board member under the bylaws.For all ofthe above reasons,the IRS concluded that thenonprofit had not presented the standards,criteria,procedures,or other means by which it intended to effectuate its purposes,the anticipated sources ofreceipts,or the nature of contemplated expenditures,as required by law for recognitionofexempt status.Because the IRS concluded that theorganization had failed to demonstration that it would beoperated for exempt purposes,within the meaning ofSection501(c)(3) ofthe Code,the IRS refused to recognize thenonprofit as a Section 501(c)(3) organization.
Nonprofit Assisting Charitable Donors by SellingDonated Personal Property and Distributing Funds toCharity Denied Tax Exemption
In a private letter ruling,the Internal Revenue Service hasdenied a federal income tax exemption under Section 501(c)(3)ofthe Internal Revenue Code for a nonprofit organizationcreated "to benefit the public" by accepting donations,selling donated property,and disbursing funds to the charity ofthedonor's choice.The IRS noted that the organization solicitedphotographs ofpersonal property,other than automobiles,from individuals who wished to have the items sold and theproceeds disbursed to charity.The nonprofit sold the donateditems over the Internet through a commercial website. Analyzing the activities ofthe nonprofit,the IRS said that it was performing services for the donors as their agent in a way that was characteristic ofa trade or business ordinarily carriedon by for-profit commercial businesses.In fact,all theindividuals associated with the nonprofit were working for afor-profit Internet business that carried on essentially the sameactivities as the nonprofit performed for donors.Because the nonprofit's primary purpose was to providepersonal services for individuals,the IRS concluded that it didnot operate for a public purpose,as required for exemptionunder Section 501(c)(3).The IRS further stated that thepresence ofthis substantial,single,nonexempt purposepreventing the nonprofit from qualifying for exemption.
Merger ofHospital Organizations Controlled by SameParent Does Not Result in Adverse Tax Consequences
In a pair ofidentical private letter rulings,the Internal RevenueService has held that two health care provider organizationsexempt from federal income tax under Section 501(c)(3) oftheInternal Revenue Code,both ofwhich were controlled by another Section 501(c)(3) parent organization that providedservices to both health care providers,as well as othercontrolled exempt health care provider organizations,couldmerge without adverse tax consequences to any oftheparticipating entities.The entities represented to the Servicethat the merger ofone ofthe subsidiary entities into the other would enable the surviving entity to expand its acute careservices to a broader community,eliminate duplication of services within the parent's system ofhealth care providerorganizations,and create a more synergistic integration oftheorganizations' strengths for the benefit ofresidents oftheareas served by the organizations.In this case,both ofthe subsidiary organizations operatedhospitals.Under the terms ofthe merger,all ofthe assets andliabilities ofone subsidiary were to be merged with and intothe surviving entity ofthe merger,the surviving entity was touse all ofthe assets ofthe other merging entity incontinuation ofits tax-exempt purposes,and the surviving entity was to continue to perform its activities and those ofthemerging entity that the two corporations had performed priorto the merger. After the merger,the surviving entity would continue to begoverned by a board ofdirectors,a majority ofits members would be appointed by the parent organization,and the board would be representative ofthe community.The surviving entity would continue to maintain a compensation committeethat would approve executive compensation and review itsreasonableness.Also,the surviving entity would continue tomaintain a conflict ofinterest policy,a charity care policy,andan uninsured discount policy,and would continue to makeavailable and promote its charity care policy and uninsureddiscount policy to all patients regardless oftheir ability to pay.Finally,the survivor would continue to maintain an openmedical stafffor a majority ofits departments,imposereasonable eligibility criteria for medical staffmembers of 
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other departments,and maintain emergency rooms at the twohospitals operated previously by the merging entities,which would be available to all patients regardless oftheir ability topay.Considering the facts as presented by the parent organizationand the surviving entity,the Internal Revenue Service gavethem the rulings they requested regarding the merger.TheIRS held that the merger would not adversely affect the tax-exempt status ofthe two merging entities under Section501(c)(3) ofthe Code and would not adversely affect theirnonprofit foundation status under Code Section 509(a).Further,the IRS held that the transfer ofassets and liabilitiesfrom one ofthe merging entities to the other pursuant to themerger would not produce unrelated business income to eithermerging entity,because the merger was a one-time event,andthus not a "regularly carried on" business activity.
Reorganization ofHospital,SupportingOrganization and Fund-raiser for Hospital Will Not Affect Their Exempt Status
 The Internal Revenue Service,in a pair ofprivate letter rulings,has held that a reorganization ofa hospital,its fund-raising organization and a supporting entity providing management,administrative and marketing services for the hospital will notadversely affect the exempt status ofthe participating entities. These nonprofits represented to the IRS that thereorganization,which basically allowed the supporting organization to control both the hospital and its fund-raising entity,would ease management ofthe existing organizations,promote cost savings,slow the increase in community healthcare costs,and facilitate the expansion ofprograms andservices through additional entities that might be added to thisgroup ofrelated organizations in the future. The hospital,in this case,provided specialized health care inthe areas ofrehabilitation,arthritis treatment,and specializedpsychiatric care for geriatric patients and for children andadolescents.The hospital also provided hospice and homehealth care services for patients in the community.Prior to the reorganization,the hospital was managed by itsBoard ofTrustees,which also composed the membership of the hospital corporation.The hospital corporation controlledthe fund-raising entity through its board ofdirectors,and thesupporting entity,which was a nonmember nonprofit,wasmanaged by its own board ofdirectors.All ofthe entities were recognized as exempt from federal income tax underSection 501(c)(3) ofthe Internal Revenue Code.In order to effectuate the reorganization,the governing documents ofthe hospital and its fund-raising organization were to be restated to provide for control ofthe hospital by the supporting entity,which would be the sole member ofthehospital corporation and would elect all ofits board members. The hospital would provide operating capital to the supporting organization,the costs incurred by the supporting organizationfrom providing services to the other two entities would beallocated to those entities based on their relative budgets,and,after the reorganization,the hospital and its fund-raiser wouldcontinue to have the same purposes and conduct the sameactivities as before it.Considering the facts regarding the reorganization,aspresented by the participating entities,the Internal RevenueService gave them the rulings they requested.The IRS ruledthat,following the reorganization,the participating entities would remain tax-exempt under Section 501(c)(3),andcontributions to them by the public would continue to bedeductible under Code Section 170.
Private Foundation's Grant to EducationalOrganization Employing the Spouse of Foundation's Manager Not Self-Dealing
In a private letter ruling,the Internal Revenue Service has heldthat a private foundation did not engage in self-dealing by making a grant to a publicly supported educationalorganization that was the employer ofthe foundationmanager's spouse.The foundation was created to makecharitable grants and awards,among other things,and thegrant was in support ofthe educational organization'soperation ofcertain facilities providing a learning environmentfor academic innovation,where students would undertake andcomplete assignments with assistance from one or morelearning facilitators.Key to the IRS decision was the fact that the terms ofthegrant indicated that grant funds were to be used exclusively forthe educational facilities,and no portion was to be used toprovide any form ofcompensation or benefits to thefoundation manager's spouse,or for the educationalorganization's general operating expenses other than thefacilities that could include payments to the spouse.Alsoimportant was the fact that the spouse was not in a position toexercise substantial influence over the educationalorganization's affairs or expenditures,and the educationalorganization had no director,officer,employee or other personin a position to exercise substantial influence over its affairs orexpenditures who was a disqualified person with respect to thefoundation within the meaning ofInternal Revenue CodeSection 4946.
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