Is it a Private Foundation in the Eyes of the IRS?


The Internal Revenue Service ("IRS") recently held in Private Letter Ruling 201323035 that a corporation that was established as a nonprofit corporation under state law should not be granted tax exempt status because its funds were used in part for the private benefit of its organizers including a member of its board of directors and his spouse.  The IRS observed a lack of adequate recordkeeping that would typically support valid expenditures that were made for charitable, educational, and religious purposes.   

The organization in question was formed for appropriate charitable reasons, including to provide referral services and information to families and children concerning medical and substance abuse treatment, to provide job placement services for the unemployed,  and to provide assistance to families coping with domestic violence, to name but a few of the purposes included in its articles of organization.  The IRS noted that a single non-exempt purpose, if substantial enough, will result in “for profit,” rather than “tax exempt” status.1   For this reason, nonprofit organizations should take the time needed to detail their mission and purposes for existing.  

Likewise they should maintain adequate records for all expenditures.  The IRS reminded the organization that ordinary transactions, for example, a loan to an officer, should be supported with evidence of a promissory note and an obligation to repay the loan.  Without proper documentation, the IRS will likely find that the monies were used for personal use, resulting in what is referred to as “private inurement,” which can be fatal to tax exempt status.  The use of credit cards for both personal and organizational expenses can cause issues in this regard and can complicate record keeping.  

Nonprofit organizations must be vigilant in maintaining good records, establishing checks and balances for all organization expenditures, and in scrutinizing the purpose for every expenditure, else an application for exemption will surely be denied.   If nothing else, the analysis in Private Letter Ruling 201323035 will serve as a good roadmap for organizers of nonprofit entities and provide some clues as to the kinds of activity that the Internal Revenue Service will review before granting 501(c)(3) status.

[1] Better Business Bureau of Washington, D.C., Inc. v. United States, 325 U.S. 844.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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