According to the IRS, tens of thousands of nonprofit organizations have their tax-exempt status revoked every year. Many of these revocations are simply the result of failure to file the proper IRS forms, an oversight more common among smaller, less sophisticated nonprofits. Increasingly, though, these revocations are the result of challenges brought by state and local authorities, Congress or other federal agencies, and the general public.
Consider the following headlines: Mayor Challenges the University of Pittsburgh Medical Center's (UPMC) Tax-Exempt Status (Allegheny Co. News); Princeton's Tax-Exempt Status Challenged by Neighbors' Lawsuit (Huffington Post); or Examining NFL's Tax-Exempt Status (ESPN.com). These examples cite well-known cases involving larger nonprofits, but nonprofits of all sizes are facing challenges from their municipal governments and the public. So what's behind all this?
Local governments and tax assessors, struggling under the financial pressures of lower tax revenues, are certainly one group leading the charge to challenge the special benefits afforded to tax-exempt organizations. The federal government is another. The expectation is that nonprofit organizations will reduce the burden on government, so when organizations provide minimal public services -- questions arise. Recent years have seen more and more cases where legislators and regulators are challenging the tax-exempt status of health care and human service organizations which provide minimal care to the uninsured. Then there's the public's perception of the activities of a nonprofit organization. When nonprofits start to behave like businesses, selling products and charging fees similar to their for-profit counterparts, confusion arises over the difference between the two and the fairness of tax exemptions. So, should an organization be worried about a challenge to its exempt status? Let's look at the arguments being made in the cases mentioned above.
In the case of UPMC, the mayor cited a lack of charity care provided by the hospital and a move of facilities from struggling communities to more economically thriving communities. While UPMC provided its own statistics and vigorously contested these issues, the fact that Pittsburgh's tax revenues would go up by an estimated $20 million annually if UPMC lost its tax exemption caused widespread public support for the challenge.
In the Princeton University case, residents complained that the university carried on significant commercial activities through its theaters, food outlets, and health service facilities. In addition, the university engaged in multiple commercial ventures, receiving millions in patent royalties, a portion of which was returned to faculty members, and millions in federal research dollars. The university believes its exemption is justified and it devotes its resources to serving the public good through teaching and research programs, and welcomes the opportunity to address the issue in court. Here again, the underlying complaint is that the taxpayers of Princeton pay an estimated one-third more in taxes due to the university's exemption.
The NFL's case is a bit different, in that it is exempt under the Internal Revenue Code (the "Code") as an organization whose primary purpose is to further the industry or profession it represents. It is not a charity. Furthermore, the Code specifically mentions professional football leagues as exempt. Nevertheless, Senator Coburn (R), Oklahoma, is pushing to end the NFL's exemption from taxation, primarily arguing that the NFL does not represent the entire football industry and is only furthering a segment of the industry, or its 32 member clubs. He argues that the league's exemption deprives the federal government of significant tax revenue and avoids state and local taxes. The NFL obviously disagrees, and notes that its nonprofit organization is separate and distinct from its for-profit endeavors. Revenue earned from the NFL Network, national sponsorships, and merchandise is already being taxed through the organization's for-profit company, as is national broadcast TV revenue, which is passed through to the 32 clubs and taxed at their level.
While these larger and more notable cases are still pending, smaller organizations all across the country are also being successfully challenged. According to the National Center for Charitable Statistics, in 2011, the most recent year for which statistics are available, 78% of nonprofit revenues came from fees for program services, sales, and other than charitable contribution sources. This makes some nonprofits barely distinguishable from their for-profit counterparts. There is a perception that charities should give things away for free, and when that is not the case, charities are finding that they are being challenged by government authorities, competitors, and the public to justify why they deserve their property tax and/or income tax exemptions. In Minnesota, a child care center was denied its property tax exemption basically because it gave nothing away. It charged the same fee for each child, regardless of whether the parents paid the full amount themselves or received government subsidies to pay the fee. In Oregon, a residential substance abuse treatment center was denied property tax exemption for the same reason, not giving away any of its services.
Given the state of the economy, it is not unreasonable to assume that these types of challenges will continue. These cases cost money and time to defend, and often result in the type of publicity that no nonprofit organization wants. Therefore, a proactive approach to these possible challenges is probably best. Now, more than ever, it's important for the management and governing bodies of nonprofit organizations to: 1. Compare their activities to their mission, for which they were granted exemption, and make sure they are in agreement, 2. Become familiar with IRS compliance requirements and prohibited activities (see Publication 1828), and avoid even the appearance of engaging in prohibited activities, and 3. Pay attention to filing requirements and deadlines.
If you have questions or need assistance with implementing best practices, please contact Audrey Sherrick at ASherrick@Friedmanllp.com or contact your engagement partner.