L. FUND RAISING Internal Revenue Service records indicate that

L. FUND RAISING

Internal Revenue Service records indicate that over 12,000 exempt

organizations are listed as having fund raising as a major purpose. Since IRC

501(c)(3) organizations are designated as proper recipients of IRC 170(c)(2)

charitable contributions, it seems logical that there are tens of thousands of

additional organizations that engage in fund raising programs to various degrees.

Further, there can be no doubt that there are thousands of organizations exempt

under other subsections of IRC 501(c) that engage in fund raising projects.

This is a controversial area with generally no published guidelines. There

may perhaps be no part of the exempt organizations' universe where the adage,

"facts and circumstances of the individual case" is more applicable. This topic will

discuss fund raising in regard to exemption, UBIT, private foundation, and

charitable contribution issues.

1. An Overview

IRC 170(c)(2) allows persons to itemize donations to charitable

organizations exempt under IRC 501(c)(3) both on 1040 and now 1040A returns.

Many of these persons attempt to do more than just contribute money or goods.

They devote their time, reputations, and energies to group fund raising projects.

These groups may work directly within the organizational structure of an exempt

charity. If they do, the Service rarely has any problems with the exempt status of

the charity. In many situations, however, the beneficiary charity may not have the

administrative means or expertise to engage directly in the fund raising activity.

Instead, it provides only its name and good will to the fund raising effort. A

separate organization is often set up for the purpose of raising funds.

Operation of an athletic, social, entertainment, or gambling event is a very

attractive means of raising funds. Some of the more popular mediums include

charity balls, benefit concerts, theater and movie premieres, horse shows, football

games, antique shows, flea markets, auctions, bingo, fish, beef, and fowl frys,

cocktail parties, and celebrity athletic events. Recently, in this age of a slumping

real estate market, charitable organizations have even been holding lotteries with

houses as prizes.

An annual event with a gate attraction provides a vehicle that naturally

attracts community support and news media publicity. Such an event has a

1982 EO CPE Text

potential work force of volunteers who share some general interest or hobby in the

activity as well as being "charitably" minded. (e.g. amateur golfers helping to run a

professional golf tournament for charity.) However, fund raising events often

require large expenditures for the services of gate attractions and salaried fund

raisers or coordinators. A fund raising event of magnitude may not be merely a

collective, legally unorganized effort by community spirited individuals. Since

such an effort is subject to individual liability in contract, insurance, and tort law,

the collective effort may desire incorporation under appropriate state not-for-profit

corporation laws. At this point, the newly formed organization often files a Form

1023 with its key District Director.

The not-for-profit incorporated annual fund raising event organization has

valid reasons for applying for recognition of exemption under the federal income

tax laws. Recognition under IRC 501(c)(3) often stimulates the public to attend the

events and contribute to the fund raising efforts. In addition, IRC 501(c)(3)

exemption has the significant effect of freeing the organization from the charitable

deductibility limit provided in IRC 170(b)(2) for non-exempt corporations,

although the Economic Recovery Act of 1981 has raised the limit to 10 percent of

taxable income. This limit is not overcome by alleging an independent agency for

the benefit of charity theory. The Service has generally held that assignments of

income to charity by non-exempt corporations may not be excluded by the latter

from gross income or deducted as charitable contributions except to the extent

authorized by IRC 170(b)(2). See Reg. 1.61-2(c); G.C.M. 27026, 1951-2 C.B. 7;

Rev. Ruls. 68-503, 1968-2 C.B. 44 71-33, 1971-1 C.B. 30, and 76-20, 1976-1 C.B.

22.

In considering the recognition of IRC 501(c)(3) exemption in any given

case, the Service is bound by its organizational and operational tests. In respect to

these tests, the Service historically has had problems with organizations that base

their charitable status on the "destination of their incomes." As we will discuss, an

organization has often been on tenuous exemption grounds when its primary

activity consists of the operation of a business enterprise, regardless of the fact that

all net income derived is payable to charitable beneficiaries.

The Service has had difficulties with event fund raising organizations when

the events are packaged with the commercial trappings of a profit activity.

Invariably, the event aspects of a representative organization are tied to high priced

gate attractions. Such events are often saddled with costly administrative overheads

such as payments for publicity. Also, professional promoters are often present.

These promoters allegedly work for the charitable organization, but in some cases

may work for themselves at the expense of the organization.

The Service has often avoided the "destination of income" problem with the

fund raising organization by distinguishing annual fund raising for charity as an

activity conceptually separate from "trade or business." We have been strongly

influenced by the voluntary labor and donated goods exception rules under IRC

513(a) and (c) and IRC 502 (especially after the 1969 Tax Reform Act

amendments), and by the "intermittent activity for the benefit of charity" exception

in the IRC 513 regulations and Congressional background

In recent years, consideration of possible exemption under IRC 501(c)(3) for

annual event fund raiser exemption cases has primarily centered on the

"commensurate test." Taken into conjunction with the IRC 502 and 513

exceptions, the Service has often granted IRC 501(c)(3) exemption status to the

typical fund raiser if there has been a sufficient turnover of funds to charity.

Unfortunately, this approach has been marked by confusion and inconsistency.

Today, fund raisers of all varieties have been subject to much public

criticism. Charitable fund raisers have not been excepted. In fact, many revelations

about these organizations have been published alleging gross misrepresentations,

private kick backs, waste, and lack of significant charitable accomplishments. [For

an investigation of the multi-billion dollar American charity industry, see "Charity

USA," by Earl Bakal, Times Books (1979).]

The Service has relatively minor authority to deal with fund raising

organizations except on fundamental exemption issues, and issues of unrelated

trade or business income. For example, Internal Revenue Service instructions to

the field on the subject of erroneous and misleading advertisements by exempt

fund raisers merely advise key district officers (1) to inform the wrongdoers about

Rev. Rul. 67-246, 1967-2 C.B. 104 (concerned with donations and deductions to

charitable fund raising events), or (2) to put out appropriate local news releases

about wrongdoers after National Office approval in cases of flagrant disregard. See

IRM 7(10) 63.6 This part of the IRM along with an extract of Rev. Rul. 67-246 are

reproduced as Appendixes 1 and 2.

In the past, there have been a number of pieces of legislation introduced in

the Congress that would have had the effect of clarifying this area. Fund raising

cases are difficult vehicles for revenue rulings because of their highly factual

natures. Some legislative proposals would have required that public charity fund

raising organizations be required to have a minimum pay out similar to that

required of private foundations in IRC 4942. Both the Filer Commission (1976)

and the Department of the Treasury (1977) recommended that some federal

regulatory control be enacted to monitor fund raising activities. However, no

legislative proposals have ever cleared Congressional Committees for full House

or Senate vote. There is no federal legislation on fund raising pending in the 97th

Congress.

2. Basic Issues

In fund raising, several basic issue areas present themselves:

A. What criteria should be utilized in considering IRC 501(c)(3)

exemption for fund raising organizations? What positions have been taken by the

Service in published and unpublished form? What positions have been taken by the

courts?

B. Is IRC 502 an obstacle to exemption?

C. What is the unrelated trade or business treatment of annual events for

the benefit of charity carried on by otherwise exempt organizations?

D. What issues emanate from fund raising in the private foundation and

charitable contribution areas?

3. The Published Service Position

Although there are no revenue rulings directly touching on the exempt status

of an annual or intermittent event charitable fund raising organization and there are

no examples provided in the regulations on the issue, a few revenue rulings

indirectly touch upon the Service position with regard to these organizations.

For example, a community fund type of organization, which carries on no

operation other than to receive contributions and incidental investment income, and

to make distribution of all its income periodically to several IRC 501(c)(3)

organizations, has been recognized as exempt since 1924. (I.T. 1945, III-1 C.B.

273 (1924)). The principle was restated in Rev. Rul. 67-149, 1967-1 C.B. 133.

In a multi-example revenue ruling in 1967, the Service discussed the IRC

170 charitable deductibility allowances of payments made by taxpayers in

connection with certain fund raising activities frequently employed "by or on

behalf of charitable organizations." Rev. Rul. 67-246, 1967-2 C.B. 104 (also

published by the Service as Publication 483). Rev. Rul. 67-246 mentions that some

of these fund raising activities are charity balls, bazaars, shows, and athletic events.

Rev. Rul. 69-636 1969-2 C.B. 126, provides that the exempt status of an

IRC 501(c)(7) country club will not be adversely affected if it makes its facilities

available to an IRC 501(c)(3) organization for charitable fund raising activities at a

charge equal to or less than cost. One inference here is that a golf tournament for

the benefit of charity is permissible under IRC 501(c)(3).

One existing revenue ruling that seems on its face to address annual event

fund raisers is Rev. Rul. 57-52, 1957-1 C.B. 196. The latter provide that a

corporation organized for the purpose of promoting and conducting home shows,

the net earnings of which inure to the benefit of a county recreational board in the

form of rent for the use of its premises, is not exempt under IRC 501(c)(3). The

rationale for denial is essentially IRC 502 and it must be distinguished on the basis

of the implied contractual rental relationship and/or subsidiary status the

organization has with its beneficiary. In any situation, because Rev. Rul. 57-52 was

published long before the extensive application of the commensurate test and the

Tax Reform Act of 1969 amendments to IRC 502, its validity may be doubtful

today.

Rev. Rul. 75-201, 1975-1 C.B. 164, involves an organization exempt under

IRC 501(c)(3) that carries on an annual fund raising dance for charity. Although

the revenue ruling favorably addresses the UBIT issue, by implication, it could

stand for the proposition that an organization that raises funds for charity can be

exempt under section 501(c)(3).

There are also many revenue rulings concerning event organizations which

may have fund raising purposes but which also present traditional IRC 501(c)(3)

educational or charitable activities. Examples follow:

Rev. Rul. 67-148, 1967-1 C.B. 132, provides for the exemption, on

educational grounds, of an organization carrying on, as a principal activity the

reenactment of Civil War battles for which participation and spectator fees are

charged.

Rev. Rul. 66-146, 1966-1 C.B. 136, holds that an entity organized and

operated to make awards to prominant citizens is eligible for IRC 501(c)(3)

exemption following Box v. McCauglin, 42 F. 2d 616 (1930). It would seem that

an organization conducting a testimonial dinner with paying guests, with the net

proceeds distributed to charity, would find authority for exemption in Rev. Rul. 66-

146.

Rev. Ruls. 67-392, 1967-2 C.B. 191 and 65-271, 1965-2 C.B. 161, stand for

the principal that sponsoring cultural performances for the arts before a paying

public may further the educational ends of an organization for purposes of IRC

501(c)(3).

A garden club that furthers interest and instructs on horticultural subjects

through public flower shows and charges admission fees may be exempt under

IRC 501(c)(3). (Rev. Rul. 66-179, 1966-1 C.B. 139).

Rev. Rul. 67-216, 1967-2 C.B. 180, provides for the exemption of an

organization exclusively organized and engaged in instructing the public on

agricultural matters by conducting annual public fairs. The fairs generated income

from admissions and commercially provided midway shows, refreshment stands,

and a rodeo.

Rev. Rul. 66-178, 1966-1 C.B. 178, provides that the Service recognizes the

IRC 501(c)(3) exemption of an organization sponsoring an annual public art

exhibit. The organization charged admission fees and sold a catalogue.

Finally, Rev. Rul. 71-545, 1971-2 C.B. 235, provides that an organization

that conducts an international exposition commemorating historical events and

cultural achievements, and exhibits products of various nations is exempt under

IRC 501(c)(3).

See also other examples in the Promotion of Fine Arts and Performing Arts

topic, 1982 EO CPE Textbook.

4. A Survey of Annual Event Charitable Fund Raisers

A. Social Event Fund Raisers

It is fair to say that the general public identities the charity ball as being a

traditional device for annual event fund raising. Many other types of events may

produce far more in revenue. Still many charity balls remain in existence. Great

amounts of volunteer labor are generally involved in the preparation and operation

of a charity ball. In addition and most importantly for our purposes the balls

invariably produce for charity.

On the other hand, social event fund raisers, like the other varieties

discussed later, have commercial aspects and social recreation aspects. For

example, in a case considered in the 1960's, a fund raising event for charity was

considered in the context of an unrelated trade or business issue. [The National

Office rulings and technical advice cases described in this topic are for illustrative

purposes and are not to be taken as precedent.] The organization conducted an

annual antique show held in a local armory which was rented for the occasion. The

show was run by a paid manager, although most of the other labor necessary to

prepare for and operate the event was of a volunteer nature. Income was generated

from the sale of exhibit space to antique dealers ($11,000), admission charges from

the public ($6,000), a "preview party" ($15,000), and from the sale of an elaborate

program which emphasized the charitable aspect of the show ($9,000). In addition,

income was collected from a lecture show held prior to the show which had the

services of volunteer ticket sellers and a volunteer lecturer. Although there was no

information with respect to the outflow of funds, the organization indicated that the

net proceeds from the above income producers went to charity. No part of the sales

made by the antique dealers were to be distributed to charity. The paid manager

and the antique dealers (with their antiques) were analogous to the professional

fund raisers and drawing card professionals, respectively, encountered in spectator

event fund raising cases. In holding that the antique show was a fund raising event

for charitable purposes and that it was not the operation of an unrelated trade or

business, the ruling stated that:

Many organizations exempt under section 501(c)(3) of the

Code engage in various fund raising activities such as theater benefits,

card parties, dances, fashion shows, or other semi-social affairs. It is

our conclusion that the antique show is in the nature of a fund raising

event for charitable purposes.

In order to conduct a fund raising event it is necessary to

present an affair to attract the public interest. In the instant case, the

antique show was selected for its interest to the general public rather

than to serve a business interest of the members or officers. The hiring

of a manager for the antique show is analogous to the hiring of a fund

raiser in connection with general drives to raise charitable

contributions. Volunteer help is utilized in the performances of all

functions where it is practical to use such help. Rentals from booth

space to antique dealers represent less than one fourth of the gross

receipts from the show. Income from the sale of tickets to the preview

party and the sale of advertising space in the program is substantially

in the nature of charitable contributions.

Another illustrative ruling in the social event fund raiser area during the

1960's involved an organization whose stated purpose was "to raise funds for

equipping and furnishing a children's hospital." The only activity was holding an

annual charity ball and turning over the entire net proceeds to the hospital. The

facts in the case indicated that substantially all of the labor put into the activity was

of a volunteer nature, and the prizes to be awarded by drawings at the ball were

donated or bought at cost by local merchants. However, considerable outlay was

made for such expenses as professional musicians, ballroom rental and prizes.

The following is extracted from our technical advice and represents a good

vintage exposition of why a fund raising event organization qualifies for IRC

501(c)(3) exemption:

Charitable organizations have traditionally engaged in fund

raising activities as a means of raising funds to carry out their

charitable purposes. In processing cases of this sort we attempt to

distinguish "fund raising" from ordinary business activities by

considering the nature of the activity, the purpose for which it is being

conducted, how it is conducted, its frequency and the use made of the

proceeds. Certain types of activities which lack the usual

characteristics of regular conduct of a trade or business and which are

commonly regarded as being of a "fund raising" nature do not effect

the exempt status of charitable organizations.

Some factors to consider in determining whether a particular

activity is fund raising are the following:

1. Occasional activity of a nature not usually

considered to be commercial;

2. Members volunteer substantial services, so far as

practical under the circumstances;

3. Advertising in programs is of the type usually

regarded as charitable contributions;

4. Merchandise which is donated or furnished at cost;

5. This does not preclude the payment of reasonable

rents, fees for professional services, and reimbursement of

members for out-of-pocket expenses.

Where an income-producing activity is conducted primarily in

the manner set forth above, the Service takes the position that the

activity is "fund-raising." A determination as to whether an activity is

the primary activity of the organization claiming exemption under

section 501(c)(3) depends upon all the facts and circumstances of a

particular case. As a general rule, however, if an organization

otherwise qualified under that section is shown, in fact, to be carrying

on a charitable program reasonable commensurate with its fund

raising activities, there appears to be no basis for holding that the

primary activity of the organization is other than charitable. The mere

fact that an organization derives its income primarily from such fund-

raising activity is not considered to defeat either the primary purposes

or the substantial activity tests of section 1.501(c)(3)-1(c) of the

Income Tax Regulations.

Upon consideration of all of the facts of the instant case, we are

of the opinion that the activities of the charity ball committee are such

as to constitute fund-raising. Further, inasmuch as this organization

contributes substantially all of its income to another charitable

organization, we have concluded that the primary purpose of this

organization is charitable, and the organization is entitled to continued

exemption from Federal income tax as an organization described in

section 501(c)(3) of the Code.

This case, however, does not contain a specific reference to IRC 502. Such a

reference is not necessary. By distinguishing fund raising from a trade or business,

we take out of consideration the trade or business threshold requisite provided in

IRC 502.

In another technical advice case, a favorable ruling was issued to a fashion

show event fund raiser. In this case, the stated purpose of the organization was "the

making of distributions to organizations that qualify as exempt organizations under

section 501(c)(3) of the Internal Revenue Code of 1954." The only activity of the

organization was the sponsoring of annual fashion shows, the net proceeds of

which were distributed to charity. Items modeled in the fashion show, along with

the models, music, and entertainers, were donated by a local department store.

Along with the factors considered in the previously discussed charity ball

case, the technical advice cited Reg. 1.502-1(a) in regard to determining the

primary purposes of an organization by considering the size and extent of the trade

or business and the size and extent of the charitable activities. In addition, there

was reference to the then newly enacted 1969 amendments to IRC 502, which of

course added the donated goods and services exceptions to the Feeder statute.

Unfortunately, there was no information relating to financial information in the

file. The technical advice concluded with the following:

Since the fashion show is held once a year and because

merchandise and services are donated and net proceeds are distributed

commensurate to an exempt purpose, the fashion show constitutes an

exempt fund raising activity rather than an ordinary business activity.

In a more recent technical advice from the 1970's involving a social fund

raiser, the stated objective of the organization was "to raise money for charity

through members, family and friends sponsoring socials, lunches and dinners, and

donations for the affairs to be given for various charitable organizations." The

organization's activities consisted of sponsoring social events such as "birthday

parties," etc., in a clubhouse which the organization owned. A review of receipts

and disbursements for a four-year period showed that a third to one-half of all

moneys received were distributed to charity. After citing the pertinent regulations

under IRC 501(c)(3), the technical advice noted the following:

Many charitable organizations do not engage in active

charitable undertakings themselves, but rather assist the work of

religious, charitable, educational or similar organizations by

contributing money to them. Providing financial assistance to such

organizations is a charitable activity justifying exemption.

Although remarking that the medium utilized, i.e. birthday parties, etc., were

social in nature, the technical advice found that it was the means by which funds

were raised. Paraphrasing the TA, this raising of funds commensurate in scope

with the organization's financial resources was a charitable activity and qualified

the organization for exemption. Rev. Rul. 64-182, 1964-1 C.B. (Part 1) 186 was

cited. In a ruling from the 1970's, an organization ran a beer "kegger" for the

benefit of local charities. The party produced a considerable profit and was

operated by volunteer labor. It was held that the organization qualified for

exemption under IRC 501(c)(3).

In another interesting case, an organization proposed operating a rock music

concert for the purpose of raising money for charities. The organization claimed

that 50 percent of the income collected from admissions, records, and tapes

emanating from the concert would be donated to charity. The ruling, however,

found that the "predominant orientation" of the organization was directed to

running an unrelated trade or business, apparently not accepting the organization's

charitable proposal, and denied exemption using Reg. 1.501(c)(3)-1(e) as authority.

It is clear that the commensurate test had become the controlling rationale in

the area of social event fund raising cases.

B. Horse Shows

The National Office has had many horse show organization applications.

Horse shows often have both the more commercial aspects of professional golf

tournaments and the social recreation aspects of the charity balls. At least before

the enactment of the Tax Reform Act of 1969, horse shows confronted the feeder

problem under IRC 502.

In general, horse shows are entities that conceivably have standing under a

number of IRC 501(c) sections. One case even suggested IRC 521. IRC 501(c)(7)

consideration could be made because of the ostensible social and recreational

aspects that benefit a particular horse show organization's membership. However,

the once a year nature of a horse show, the lack of meetings for social reasons, the

general lack of comingling within the meaning of IRC 501(c)(7), and the amounts

of non-member income received would apparently foreclose an applicant

organization from qualifying under the section. We are aware of no cases to date

contesting this interpretation. IRC 501(c)(5) is certainly a possibility. One case

recognized exemption under that section for a horse show organization that had

been holding annual horse shows for over 110 years. In that case, the ruling held

that the rearing, raising, and management of livestock was within the meaning of

Reg. 1.501(c)(5), and since the horse show served as an incentive for improving

breeds of horses, the organization qualified for exemption under IRC 501(c)(5).

IRC 501(c)(4) has provided a haven for an occasional horse show.

Significantly, two IRC 501(c)(4) cases concerned fund raising efforts. In two

technical advices, the organizations were granted exemptions partly because they

were fund raising projects for the benefit of local civic organizations performing

social welfare activities. The primary rationale for exemption in both cases was a

questionable analogy to Rev. Rul. 68-224, 1968-1 C.B. 263, which provided IRC

501(c)(4) exemption to an organization conducting an annual festival, with a rodeo

featuring professional riders and livestock procured from commercial enterprises,

in a particular locale deeply entrenched in Western regional customs.

Most applications for horse show exemption have been directed to IRC

501(c)(3). A typical horse show is not in itself an organization advancing education

within the meaning of IRC 501(c)(3). However, a horse show might now be

exempt under IRC 501(c)(3) if it meets the requirements of the amateur athletic

provision. [For more information on the amateur athletic provision, see 1980

EOATRI Textbook p. 62.] Generally, an educational benefits argument is rejected

because the instruction of the public and individuals on useful subjects is at best

only an incidental activity of a horse show.

Usually IRC 501(c)(3) exemption for this type of organization has rested on

the issue of fund raising for charity. A 1960's technical advice, for example,

probably set the stage for subsequent cases. The facts indicated that the

organization was established for "the purpose of operating horse shows and to do

all those things necessary and proper in connection with such operation." The

organization stated that its only purpose was the sponsorship of a three day annual

horse show, the furthering of horsemanship in the local county, the fostering of

interest in horses among area children, and the raising of funds for charitable

purposes. Stressed was the substantial amount of disbursements for prize moneys,

social affairs, ribbons and trophies, and the corresponding small amounts

distributed to charity ($4,000 out of $75,000 in gross receipts over a five year

period). Our ruling denied exemption because the organization's purposes were too

broad and because a horse show is not an activity enumerated in IRC 501(c)(3), but

it is apparent that it was denied because the output for charity was not

commensurate in scope with its financial resources. This was not spelled out

precisely except for a "compare" reference to Rev. Rul. 67-5, 1967-1 .C.B.

In another 1968 case, reliance on the commensurate test was bolder. The

organization was granted IRC 501(c)(3) on the basis that the first two shows

generated 11% and 20% for charity, respectively, from gross receipts.

Contemporaneously with this case, the Service ruled unfavorably on a horse show

by applying IRC 502. In that technical advice case, the net proceeds of the

organization were to be distributed to a charity designated in advance. However,

the first year's show did not produce a profit. And thus nothing was distributed to

the charitable beneficiary.

The Service found that substantial educational purposes were absent, and the

horse show was indistinguishable from a business ordinarily carried on for profit

subject to IRC 502. It seems apparent here, and inconsistent in light of the

commensurate test utilized in other horse show cases of the time, that if the facts

had indicated a substantial turnover of funds to the beneficiary charity, the

organization would still have been rejected.

A different approach was followed in another 1960's case. The organization

was granted exemption under IRC 501(c)(3) through the use of the following

criteria:

1. an examination of all activities to include volunteer

work;

2. whether the show is large or small;

3. the extent of social activities; and,

4. a complete disregard of the ratio between value of prizes

and funds ultimately donated.

In another case from the 1970's, a new horse show organization was

incorporated under the not-for-profit corporation law of a state for the purpose of

holding an annual horse show with "the proceeds therefrom, if any, to be used to

perpetuate the holding of such show as well as making contributions to charitable

organizations assisting the corporation in the holding of said horse show." Because

there was no information disclosing what the charitable distribution was to be, it

was found that the primary purpose of the organization was the operation of a

commercial business for profit. (It may have been argued that no charity existed

even with distributions to the charitable organizations proposed to be benefited,

because the latter were providing a quid pro quo - i.e. "assisting the corporation in

the holding of said horse show.")

In a more recent case, a ruling emphasized through statistics that the subject

organization collected $1,250,000 in gross receipts over a time span of seven years,

but only distributed $3,000 to charity. From such statistics, little deliberation was

necessary to arrive at a denial. Pertinent reasoning was provided along the

following lines:

The certificate of incorporation does not provide

that the organization is organized exclusively for

charitable purposes. Operations since incorporation

clearly indicate that the primary activity has been the

annual promotion and conduct of an international horse

show. The promotion and conduct of such a show is not

of itself in furtherance of an educational or charitable

purpose. Further, it is shown that charitable activities

have been de minimis. Therefore, the manner of the

operation indicates that the primary thrust is to conduct a

successful sporting event with any profit for charity

being incidental.

It would seem from this, that the commensurate test has become the basic

exemption rationale for the horse show fund raiser, whether said in so many words

or not.

A last case of note involved the classic situation in which the IRC 502

"feeder" factor stood in the way of exemption. Originally applying for exemption

under section 101(8) of the Internal Revenue Code of 1939 (predecessor to

501(c)(4)), the applicant organization stated that its purposes were:

to put on horse shows, to encourage the breeding and riding

horses, and to support worthy charities with the proceeds from such

shows.

In the 1940's, the Service denied exemption under IRC 501(c)(4) on the

grounds that the funds of the organization were not expended for purposes

beneficial to the community or for social welfare. The file does not show what

information led to that decision. However, it was noted that the decision was

thought to be predicated on a lack of proof that the grantee organization involved

was an exempt organization.

Ten years after denial the organization filed for exemption as a IRC

501(c)(3) organization. The certificate of incorporation of the organization

provided that:

The corporation is formed for the purpose of raising funds for

the support of the children's hospital, through the sponsorship and

holding of horse shows and exhibitions, the receipt of donations,

ticket sales and other fund raising activities. All net proceeds collected

from the organization's activities were dedicated to the hospital and to

the hospital's predecessor foundation. The primary activity of the

organization related to carrying on the horse show.

It was found that:

1. The show was annual, and involved tremendous amounts of volunteer

time. Volunteers were local enthusiasts who solicited contributions for the prizes

and trophies to be awarded at the show and to help defray additional costs related

to the show.

2. Most of the work performed prior to and during the show was

performed by approximately 1,000 volunteers.

3. There was repeated advertising in the show's official program that the

show was being presented for the benefit of the children's hospital.

4. Income was produced from concessions, program sales, advertising

sales contributions, and entrance fees. This amount excluded ticket sales to the

general public totalling $97,000. The total expenses, including trophy and prize

costs, resulted in a $15,000 loss. However, the loss was cancelled by contributions

collected by volunteers. $99,000 was donated to the designated charity in the noted

year and similar financial activities produced almost $800,000 for the hospital

throughout a time span of 12 years.

The following was argued in support of exemption:

1. The organization satisfied the organizational test under IRC 501(c)(3)

since the exclusive purpose of the organization was to raise money for the

designated hospital.

2. The horse show could be characterized as a widely supported and

highly successful community fund raising project for the hospital. It was

reasonable for those people involved in organizing and operating the show to turn

to a "natural medium" to accomplish their purpose of aiding the hospital since they

were horse fanciers.

3. The organization was operated exclusively for charitable purposes

under IRC 501(c)(3).

4. The horse show did not constitute a trade or business for purposes of

IRC 511 through 513 because of the -

a. once a year nature of the event;

b. clear purpose of benefit to charity;

c. advertising clearly reflecting the event as one for the specific

purpose of benefiting charity similar to an annual fireman's ball;

d. amount of voluntary help and time spent in the selling of the

tickets, organizing and managing the show;

e. assumption by volunteers of the financial risk;

f. entire net proceeds of the ticket sales being distributed to

charity; and

g. lack of prevailing indicia indicating that the operation of the

show constituted a trade or business.

It would seem clear that these findings and arguments could be utilized as

guidelines and the horse show would have no difficulty in obtaining exemption

with a demonstration of distributions to charity commensurate with its financial

resources as noted. However, in the actual above-described case, the IRC 502

"feeder" issue was raised. Many in the Service were bothered by the relationship

between 502 and IRC 511-513. Essentially, concern revolved around a

fundamental question as to whether the conduct of an annual fund raising event is

sufficient to constitute the "carrying on of a trade or business for profit" within the

meaning of IRC 502, even though such activity would not be carried on with

sufficient regularity to constitute unrelated trade or business "regularly carried on"

for purposes of unrelated business income tax. Although this question remains

officially unanswered today, this horse show's problems were somewhat resolved

by legislation in the Tax Reform Act of 1969, excluding activities with

"substantially all" voluntary labor or donated goods from IRC 502 application.

C. Spectator Sporting Events

Charity sporting events are often initiated by weekend sports participants. If

the proposed event is, for example, a golf tournament, golfers might volunteer their

golfing knowledge and energies, and/or obtain the facilities of their country club

on a cost basis. However, a practical limit exists on the amount of donated goods

and/or voluntary labor that can be utilized. Invariably, athletes and organizers must

be contracted and compensated for.

On the face of it, evidence of high administrative expenses and costly gate

attractions stands in potential conflict with IRC 501(c)(3) and the regulations

thereunder. An organization sponsoring athletic events can be exempt under IRC

501(c)(3) if it meets the amateur athletic provision enacted in 1976. If the events

are solely for children, the organization may be exempt on the ground that it is

preventing juvenile delinquency. See Rev. Rul. 80-215, 1980-2 C.B. 174, and Rev.

Rul. 65-2, 1965-1 C.B. 227. Also, an organization can be exempt under IRC

501(c)(3) if its events are part of the educational program of an educational

institution. See Rev. Rul. 55-587, 1955-2 C.B. 261, for example. Organizations

which do not have any of the above aspects often request IRC 501(c)(3) exemption

as charitable fund raisers. Such an organization might also apply under IRC

501(c)(4) on the grounds that the event creates community publicity, civic pride,

and recreational opportunities. However, an organization operating a professional

golf tournament was held to be operated in a manner similar to golf tournaments

operated for profit and was denied exempt status under IRC 501(c)(4). See Rev.

Rul. 74-298, 1974-1 C.B. 133. IRC 501(c)(6) exemption is also possible. Athletic

event attractions, such as bowl games, may indeed promote the business interests

of the community and have been carried on by chamber of commerce type

organizations. In the matter of IRC 501(c)(3) exemption, the Cumulative List

contains a number of Shrine Bowl football game fund raisers. Records indicate that

the sole activity of the organizations was to promote annual football games

between high school players of neighboring states, the net proceeds of such games

being distributed to Hospitals for Crippled Children. The exemptions were granted

in the early 1950's and it appears that emphasis was placed on the fact that a

substantial amount of contributed services was involved in the operations of the

organizations and the fact that the participants in the games were high school

amateurs.

An early example of an adverse position is represented in a case where it

was held that because the specific purpose for which the organization was formed

was to sponsor a professional football game, and because the football game was

the only activity performed, the organization could not qualify for exemption under

IRC 501(c)(3), regardless of the fact that net proceeds were to be used for

charitable purposes. IRC 502 was invoked in its most undiluted form in the

following manner:

IRC 502 specifically provides that an organization operated for

the primary purpose of carrying on a trade or business for profit shall

not be exempt under IRC 501 on the ground that all of its profits are

payable to organizations which do qualify under the latter section. It is

concluded, therefore, that the organization is not organized

exclusively for the purposes specified in IRC 501(c)(3), and fails to

meet the first part of the dual test referred to.

No financial statistics were included to indicate whether there was any actual

output for charity, much less any mention of the commensurate test as later

expressed in Rev. Ruls. 64-182, 1964-1 C.B. 186 and 67-5

, 1967-1 C.B 123.

The above described case was noteworthy in its use and distinction of

Mobile Arts and Sports Association v. United States, 148 F. Supp. 311 (1957), in

which the District Court held that an organization organized and operated to

sponsor the annual Senior Bowl game in Mobile, Alabama, was entitled to

exemption under IRC 501(c)(3) and 501(c)(4). The court in Mobile Arts found

(and this case noted) that the organization, in addition to sponsoring the football

game (incidentally professional in that the players, all graduating All-Americans,

were being paid for their participation), and a collegiate basketball tournament,

was also sponsoring outdoor symphony concerts, ballet performances, choral

singing performances, a recreation program for several thousand youths of the city,

etc. These activities were either free to the public or offered at reduced admission

prices. It was found that, as to the game itself, the primary objective was not

necessarily to make money, but to provide some educational value and, at the very

least, it was an integral part of the organization's civic and educational program.

Mobile Arts was considered wrong by the Service and not acquiesced to.

Another case from the 1960's involved a youth fund. The principal issue in

the case was whether or not the organization's purposes and activities in connection

with the conduct of an open golf tournament precluded the organization from

exemption under IRC 501(c)(3). For our purposes, the organization was a fund

raiser exclusively. According to the articles of incorporation, as amended, the

purposes and activities of the organization were "directed principally" to the

support of various educational and charitable programs through grants of funds

received by conducting the golf tournament.

In contrast to many other vintage spectator athletic event organization cases,

which typically lack financial data in respect to output for charity, this case

provided impressive statistics. In a representative year, it produced gross receipts

of over $60,000, of which over 90% was derived from the tournament, with

distributions made for charity in the amount of $37,000. A period of a little more

than 2 years demonstrated that the grants, contributions, and pledges made by the

organization for charitable purposes totalled over $130,000. The financial output

made it obviously difficult for the Service to apply a negative rationale and deny

the organization's request for exemption.

An easy resolution of the problem was found because the organization did

not in actuality conduct the tournament, regardless of the organization's stated

purpose. It was found that the organization's members were conducting the

tournament on their own, and did not contract for the professional golfers' services.

Others assumed the risk of financial loss. In addition, we were influenced by an

amendment to the organization's articles separating its role from the tournament in

order "to be separate and apart from the tournament in all financial as well as

administrative aspects." What remained then for the issue of exemption was an

entity collecting funds from the golf tournament and distributing them for the

benefit of charity, and therefore exempt under the rationale of Rev. Rul. 67-149. It

was also held, however, that the organization could not be denied exemption nor be

held liable for unrelated business income, if in fact the organization had conducted

the tournament, because of the once a year nature of the tournament and the

substantial amount of contributed services involved. In respect to whether

exemption could be denied in the past, it was noted that:

The evidence, instead, shows rather clearly that the

organization was engaged in carrying on a definite and

substantial charitable program reasonably commensurate with

its resources and the size and extent of its activities in

connection with conduct of the tournament as an income

producing activity. Certainly, at least, it cannot be said that the

charitable activities were substantially or significantly

disproportionate to the income producing activity.

Another golf tournament case reached a different conclusion, however, on

the question of IRC 501(c)(3) exemption. There it was held that

The information also shows that your activities are

carried on for the purpose of bringing people to the area and

promoting it as a business and sporting area; that no profit has

been derived by you from the golf tournament, that without

contributed services no net income would be realized by the

fund raising activities; that funds are raised for charitable social

welfare purposes; and that the funds raised are destined for

charitable and social welfare use. Over $250,000 is available

for distribution to exempt charities.

Based on the above, this organization was granted exemption as a civic

organization under IRC 501(c)(4). However, the ruling letter added that

contributions received by the organization and distributed or held in trust for

organizations described in IRC 501(c)(3) would be deductible as charitable

contributions by donors as provided in IRC 170(c).

Another interesting case involved whether or not the annual sponsorship by

the subject organization of professional football and basketball games, a

professional tennis exhibition, and a Golden Gloves boxing match jeopardized the

exempt status of the organization, and whether the activities constituted unrelated

business activities, subject to IRC 511.

According to the facts in the case, the athletic events were fund raisers for

the benefit of a separately incorporated boy's camp that provided a summer

recreational camp for disturbed boys. It was found that even though the camp was

a separate entity (because of the necessity of having separate financial operations

and in order to receive Community Chest support), the running of the camp was

still the primary activity of the subject organization, and because of this the

organization was entitled to retain IRC 501(c)(3) exemption. This "integral part"

type rationale was supported by findings that indicated that in addition to providing

the camp with monetary support, members of the organization and board members

of the camp were the same; also that the camp's property was owned by the

organization; case histories of the boys were published in the organization's

bulletins; the camp was visited by members of the organization at least twice a

year (showing that "someone was interested in their welfare"); the boys were

transported to the spectator events conducted by the organization; and that the boys

were given an annual Christmas party by the organization. See Rev. Rul. 71-581,

1971-2 C.B. 236, for a similar approach involving a separately organized thrift

shop. See also, Rev. Rul. 78-41, 1978-1 C.B. 148.

In the mid-1960's, the National Office received a technical advice request

concerning the effect upon exemption of four organizations (two of which were

IRC 501(c)(3) organizations) conducting a professional tournament for the benefit

of charities.

Although the organizations concerned were also allegedly carrying on other

charitable activities so that the issue related primarily to IRC 511 taxation, the

discussion of fund raising activities in the TA is of interest and is extracted here:

A number of cases involving golf tournaments of

this nature have been and are being considered by this

office. Where a tournament uses only amateur golfers

and awards have only nominal cash value it is evident

that the tournament constitutes fund raising activity.

(These factors were present in the case of Golf Life

World Entertainment Golf Championship, Inc. v. United

States, 65-1 USTC 9174, 15 AFTR 2d 307 (1964).

Where the tournament uses professional golfers, the

activity becomes more questionable because of the

necessity for entering into an agreement with a

professional golfers association. This contractual

agreement permits the professional association to

determine the date of the tournament, the eligibility of

the players as well as the allocation of the 'Purse' further,

such an agreement prevents a conflict with another major

golf tournament and assures the finest pros -- both factors

being necessary for a successful tournament. While this

contract infuses an atmosphere of commercialism,

nevertheless, it may be equated with contracts entered

into with booking agents to secure orchestras for dances,

plays, ballets or other professional entertainment

frequently utilized by charitable organizations as an

annual or semi-annual means of raising funds with which

to carry out charitable programs. Such contracts provide

for supplying certain individuals or groups of individuals

to perform, the arranging of a date not in conflict with

other commitments of the performers and the payment of

reasonable compensation for services rendered. If the

entertainment being sponsored is not financially

successful, the organization is still liable for the fees

agreed to be paid under the contract entered into.

After quoting the legislative background in respect to determinations of

whether a golf tournament is "regularly carried on" for purposes of IRC 511, the

TA continued:

The subject organizations have established that the

golf tournament is the only golf tournament they sponsor

and this only once a year, that all work necessary to the

sponsoring is donated by volunteer services of its

members, and that the organizations are otherwise

primarily engaged in charitable or civic programs. This

once-a-year nature of the affair, and the substantial extent

to which the activity is carried on with contributed

services, make it highly doubtful whether this activity

could be sustained as being within the definition of

unrelated trade or business in section 513.

Since the 1960's, the Service has generally utilized the commensurate test in

spectator sporting event fund raiser cases. Although often marked by confusion

and insufficient information, more recent National Office cases have been

examined on the standpoint of financial output. A general observation would be

that if the financial output for charity is impressive, a favorable ruling or technical

advice would be issued in individual cases. Conversely, if the charitable

beneficiaries were not being concretely benefited, a denial would be issued on the

basis that the fund raising activity is incidental and the spectator sporting event in

itself is not an activity within the purview of IRC 501(c)(3).

For example, in a case decided in the mid-1970's, an organization operating

a golf tournament had almost $500,000 in income and only gave $12,000 to

charity. It provided $320,000 in prize money to the golf professionals who

participated. The organization was denied exempt status because it devoted large

amounts of time and money to an activity that produced very little for charity.

Therefore, the charitable activity was found to be secondary to the running of a

golf tournament.

On the other hand, a more recent case granted exemption under IRC

501(c)(3) to an organization operating a golf tournament that contributed

approximately $300,000 to charity out of an income of over $2,000,000 over a four

year period where substantial start-up expenses were shown and where the

percentage amounts contributed to charity had steadily increased over the years.

See also PLR 8142024.

D. Summary of Unpublished Service Rulings

It is clear that the attitude of the Service, at least in private letter rulings, has

been generally favorable towards annual event charitable fund raising

organizations in the matter of IRC 501(c)(3) exemption and IRC 511 tax liability.

The cases indicate that the typical organization granted exemption may be

characterized, give or take certain factors, as follows.

a. a purpose of turning over funds to other charitable

organizations through the medium of an otherwise non-charitable once-a-

year event which requires extensive planning;

b. the fund raising medium is carried on by community support

and considerable amounts of volunteer labor (but not generally

"substantially all") and donated goods or facilities that may produce the

difference between profit and loss;

c. the event activity is identified with its charitable purpose and

charitable beneficiaries through media news publicity, paid for promotion,

programs, and community leaders;

d. invariably present is a gate attraction (entertainers, athletes,

etc.) and often present are salaried or commissioned persons providing

necessary services;

e. income is produced from contributions (often including

program advertising income in excess of normal commercial rates),

admission charges, concession sales, program sales, television broadcasts,

etc., and contributions are given directly (or are claimed to be given) by the

general public to the charitable beneficiaries throughout the year somewhat

because of the recognition connection that the beneficiaries have with the

annual events; and,

f. the organizations invariably turn over their net proceeds, to

other charitable organizations except for a reserve for the following year's

event.

A determination of exemption in recent times has involved the use of a

commensurate test. However, the application of this test has often been marked

with inconsistency and a general lack of understanding about the nature of the test.

There is a general lack of uniformity as to what factual information is necessary in

order to apply the test.

In conjunction with, or independent of, the commensurate test, several cases

have taken the position that fund raising is not a trade or business (or unrelated

trade or business), thus removing potential confrontations with the primary purpose

tests under IRC 501(c)(3) and 502.

Quite readily apparent is the informal acceptance of the IRC 513 regulations

intermittent activity rule and the IRC 513 "substantially all" exceptions (even

before they were added to IRC 502 by TRA 1969) for use in exemption

considerations.

The topic will now be directed towards the treatment of annual fund raising

events under IRC 511-513, the proper basis for exemption of fund raising

organizations, and problems involving private foundation and charitable

contribution issues.

5. Exceptions Under the Unrelated Trade or Business Provisions

Annual event fund raising activities for charity, carried on by otherwise

exempt organizations, are generally not subject to IRC 511 taxation due to

exceptions under IRC 511-513 and the regulations thereunder.

In general, IRC 511 imposes a tax on the unrelated trade or business income

of organizations exempt from taxation under IRC 501(c).

IRC 512 defines "unrelated trade or business income" as income from any

unrelated trade or business regularly carried on by an exempt organization.

IRC 513(a) provides in essence that an "unrelated trade or business" is any

trade or business the conduct of which is not substantially related (aside from the

need of such organization for income or funds or the use it makes of the profits

derived) to the exercise or performance by such organization of its charitable

purpose constituting the basis of its exemption under IRC 501(c)(3), except that the

term does not include any trade or business:

(1) in which substantially all the work in carrying out such trade or

business is performed for the organization without compensation; or

(2) which is carried on ... (by an IRC 501(c)(3) organization) ...

primarily for the convenience of its members ...; or [The convenience

exception is not discussed in this topic. For discussion, see college retailing

topic in 1980 EOATRI Textbook, page 236, and that part of this year's

health care organization topic on lab testing.]

(3) which is the selling of merchandise, substantially all of which has

been received by the organization as gifts or contributions.

Thus, an activity (the event) may be excepted directly from the statutory

term "unrelated trade or business" because: (1) it is not arguably trade or business:

or (2) it is substantially related to the performance or exercise of the organization's

exempt purposes; or (3) it falls within the three above cited IRC 513(a) exceptions.

Also, and independently, exclusion of the income produced by an annual event

may be excluded under IRC 512's unrelated trade or business income on the basis

that the activity is not "regularly carried on."

A. Exception From the Term "Unrelated Trade or Business"

The IRC 513(a) Regs. and Congressional background provide general

interpretations of the exceptions to the term "unrelated trade or business."

1. Trade or Business

If an activity does not possess the characteristics of a trade or business

within the meaning of section 162 of the Code, the tax imposed by section 511

does not apply. For example, if an organization sends out low cost trinkets in

connection with the solicitation of charitable contributions, the unrelated business

income tax does not apply since the organization is not in competition with taxable

organizations. See section 1.513-1(b) of the regulations.

In The Hope School v. United States, 612 F 2d 298 (7th Cir. 1980), it was

held that the plaintiff's distribution of packaged greeting cards, which were mailed

to potential customer-donors together with a request for contributions, did not

constitute a trade or business within the meaning of section 513 of the Code. The

court held that the greeting cards would be considered "low cost articles" as a

matter of law. The Service does not plan to follow this decision since in our view

the distribution of packaged greeting cards, including reorder forms and follow-up

letters to persons who do not respond to the initial appeal is outside the intended

scope of the "low cost articles" exception.

In Disabled American Veterans v. United States, 46 AFTR 2d 80 5438 (Ct.

Cl. 1980), the organization operated a special solicitation program. Those who sent

money were given premiums in the form of books, maps, charts or calendars. It

was held that the income derived constituted income from an unrelated trade or

business. The activity was held to constitute a trade or business because the

premiums offered in return for the "contributions" were not priced so greatly in

excess of their retail values as to deprive the activity of the trade or business

character which as otherwise present. Affirmed by full U.S. Court of Claims at 81-

1 USTC 9443, May 20, 1981.

2. Substantially Related

As to whether an event activity is "substantially related", there are a number

of revenue rulings in the exemption context as noted in Part 3 of this topic. The

term "substantially related" would, for example, include a civil war battle

reenactment presented by a Civil War educational organization. See Rev. Rul. 67-

148. It would also likely include the sale of refreshments at the battle reenactment

to the general public since the service provides the patrons more time in which to

avail themselves at the event's educational features. See Rev. Rul. 74-399, 1974-2

C.B. 172, involving a cafeteria maintained by a museum for its patrons.

The Reg. 1.513-1(d) "contribute importantly" standard has been extended to

hospital gift shops, cafeterias, coffee shops, and parking lots because they

constitute a means by which visitors may provide, and patients be provided with,

"supportive therapy." (Rev. Ruls. 69-267, 69-268, 69-269. 1969-1 C.B. 160). For

more discussion in this area, see 1979 EOATRI Textbook (Vol. 2) topic on

Museum Retailing, page 502.

3. The Concept of "Substantially all" Uncompensated Labor or

Donated Goods

Reg. 1.513-1(e) illustrates the IRC 513(a) exceptions with examples of a

thrift shop, and a retail store operated by uncompensated labor. See Rev. Rul. 74-

361, 1974-2 C.B. 59, which holds in part that a volunteer fire department holding

weekly public dances with substantially all volunteer labor was not engaged in

unrelated trade or business. Rev. Rul. 80-106, 1980-1 C.B. 113, describes the

"substantially all" volunteer labor thrift shop.

There is no specific percentage provided by regulations as to the meaning of

the "substantially all" requirement attached to the donated goods and

uncompensated labor exceptions. No revenue rulings have specified the percentage

under IRC 513(a) or its counterpart IRC 502. But see Rev. Rul. 71-581, 1971-2

C.B. 236 which held pre-Tax Reform Act thrift shops to be exempt,

notwithstanding the pre-1970 IRC 502 feeder prohibition. In the subject case, the

thrift shops had an operation where substantially all of the goods had been donated

and more than half of the work was performed without compensation. It was noted

that an otherwise exempt organization carrying on such an activity would not be

charged with IRC 511 tax by virtue of IRC 513(a)(3). It is apparent here that the

IRC 513(a)(1) uncompensated labor exception is not applied where there is only a

50% showing.

The term "substantially all" is found elsewhere in the Internal Revenue Code

and has been interpreted as 85 percent or more. For example, IRC 512(b)(2)

requires that "substantially all" of the capital stock of a farmer's cooperative be

held by producers. This has been held to mean that at least 85 percent should be

held by producers. Rev. Rul. 73-248, 1973-1 C.B. 295.

For years prior to the 1969 Tax Reform Act, IRC 7701(a)(19) provided a

definition of a building and loan association that included a requirement that such

an organization have "substantially all" of its business in the acquiring of the

savings of the public and investing in loans. Reg. 301. 7701-13(a)(2) interpreted

this to mean 85 percent in dollar valuation.

IRC 4942(j)(3) defines an operating foundation as one which makes

qualifying distributions ... directly for the active conduct of the activities

constituting the purpose or function for which it is organized and operated equal to

"substantially all" of its adjusted net income ..." Regs. 53.4942(b)-1(c) provides

that for purposes of the above section "substantially all" means 85 percent or more.

Finally, IRC 514(b)(A)(1) provides an exception to the term "debt financed

property" for any property "substantially all" the use of which is substantially

related to its exempt purpose. Again, Reg. 1.514(b)-1(b)(1)( ii) interprets the

"substantially all" as 85 percent or more.

It is difficult to apply a percentage test in this exempt organizations area

because of the lack of ascertainable factual details upon which a percentage can be

applied. One may apply an 85 percent rule to a private foundation's adjusted net

income with certainty for example, but how is 85 percent of an organization's total

labor or goods measured? For example, in an annual golf tournament for charity,

how is an 85 percent rule applied to a year's worth of uncompensated services by

local citizens, a few months worth of compensated services by a tournament

director and/or fund raiser, and four days worth of the services of the professional

golfers competing for prizes?

Although 85 percent is the unofficial guideline, it is significant that few

cases under IRC 513(a)(1) have applied the percentage test strictly. "Substantially

all" has been applied in a general manner.

In Rev. Rul. 78-144, 1978-1 C.B. 168, an exempt organization rented

machinery on a long term basis. The lease agreements required the lessee to

provide insurance, pay any taxes, and pay for most repairs to the machinery. The

work in connection with finding a lessee, negotiating a lease, and processing the

rental payments was performed for the organization without compensation. The

revenue ruling reasoned that since most of the lessees kept the equipment on a

long-term basis, the volunteer work of finding lessees and negotiating leases was

rarely needed. Therefore, the performance of services was not a material income-

producing factor in the business and the volunteer labor exception of IRC

513(a)(1) did not apply.

In the courts, a case entertaining the concept of "substantially all" is Greene

County Medical Society v. U.S. (72-2 USTC 85, 430, W.D.Mo. No. 2596, July 3,

1972; affd. CA-8, No. 72-1871, April 20, 1973). In Greene the court ignored any

connection to a percentage test with "substantially all". The court held that the

contested activity, the sale of novelty record albums created by uncompensated

doctors, was within the "substantially all" exception because the doctors' role in the

activity was the "essence of the endeavor". See also 26 Tax Lawyer 700 (Summer

1973) which said that

the case held that the section should be construed to

measure the intrinsic importance of work performed by

the individuals participating in a business activity and

measured, across the board, whether or not substantially

all work is performed without compensation.

It should be noted that the Service does not follow the Greene case.

In Smith-Dodd Businessman's Association v. Commissioner, 65 T.C 620

(1975), the organization was operating a bingo game with individuals who were

paid $ 8 a night for four hours of work. The organization argued that this amount

represented reimbursement of expenses. However, the Tax Court held that the

payments constituted compensation and the exception for volunteer labor was not

applicable.

In a recent case, Waco Lodge No. 166, Benevolent & Protective Order of

Elks v. Commissioner, Docket No. 15696-79. T.C. Memo. 1981-546, filed

September 24, 1981, the Tax Court considered the "substantially all" volunteer

labor exception in the context of weekly bingo games carried on by an IRC

501(c)(8) organization. According to the facts, a minimum of five persons worked

the games: two collectors, two cashiers, and one caller. The caller was paid 20 of

the 49 weeks that the games were played. He received $ 10.00 each night for 3 1/2

hours of work, which amounted to $ 200 over the course of the year. (Court

testimony indicated that the hourly wage, $ 2.86, equalled the minimum hourly

wage.) Also the organization gave the two collectors and two cashiers free drinks

from the organization's bar operated by a paid bartender. In the particular year in

issue, the workers consumed drinks worth $ 435.50. The caller was not given free

drinks. Also, Lady Elks provided free sandwiches to the bingo players and were

given $ 15.00 each as reimbursement. Also the cleanup persons, such as children

of members, received a number of intermittent payments.

The organization had bingo receipts of $ 9,116.23 and gross sales from the

bar of $ 3,881.03 for the taxable year, which it reported on Form 990-T as

unrelated business income. It deducted as expenses, the bartender's salary, other

bar costs, bingo costs, and 67 percent of expenses such as depreciation which were

attributable to maintaining the organization's facilities. Included among the

deductions reported on Form 990-T as bingo expenses were:

Bingo workers - $ 435.50

Caller - $ 200.00

Lady Elks - $ 762.59

Cleanup - $ 50.00

The Tax Court found that the only uncompensated labor involved the

reimbursements to the Lady Elks. The court also found that the paid bartender's

services constituted part of the total work performed in carrying on the games. In

regard to the collectors and cashiers, the court found that the free drinks constituted

compensation. (Averaging the $ 435.50 worth of drinks consumed, each worker

imbibed 3 mixed drinks, 6.3 beers, or 8.9 soda waters per night.) The court's

reasoning included the following:

1. The organization gave free drinks to a limited group. The bingo

players and the caller paid for their drinks. Only the collectors and cashiers

received free drinks.

2. The collectors and cashiers were not entitled to free drinks every night

the lodge was open, but only on the nights that they worked the bingo games.

3. The organization's cost of running the bar and lodge was increased by

providing the workers with free drinks.

4. The organization could not have run the games without the services of

the collectors and cashiers.

The court held that the "substantially all" exception was inapplicable.

B. Exception For Intermittent Activities

As a general rule, IRC 512 and the regulations under IRC 512 and 513

require that unrelated trade or business income must be derived from an unrelated

trade or business regularly carried on. Special provision has always been made for

intermittent fund raising activities since the unrelated trade or business sections

were first incorporated into the Internal Revenue Code. As stated by the House

Committee Report in 1950:

Thus in determining whether the income of any exempt

organization from any trade or business is subject to the

Supplemental I Tax, it is first necessary to determine

whether it is income from a trade or business which is

regularly carried on, or the income from a sporadic

activity. If a charitable organization exempt under 101(6)

of the Code gives an occasional dance to which the

public is admitted for a charge, hiring an orchestra and

entertainers for that purpose, this would not be a trade or

business regularly carried on, within the meaning of

section 422. Likewise, an organization which operates a

sandwich stand during the week of an annual county fair,

it is not regularly carrying on a trade or business. (House

Report No. 2319, 81st Cong., 2d Sess., 1950-2 C.B. 458,

559.

Curiously, regulations expressing the intermittent rules were promulgated in

the IRC 513 regulations instead of in the more logical IRC 512 regulations.

Reg. 1.513-1(c)(2)(ii) and (iii) provide for general and special treatment of

fund raising activities as follows:

(ii) Intermittent activities; in general. *** in general,

exempt organization business activities which are

engaged in only discontinuously or periodically will not

be considered regularly carried on if they are conducted

without the competitive and promotional efforts typical

of commercial endeavors. For example, the publication

of advertising in programs for sports events or music or

drama performances will not ordinarily be deemed to be

regular carrying on of business.

(iii) Intermittent activities; special rule in certain cases of

infrequent conduct. *** /1/ income producing or fund

raising activities lasting only a short period of time will

not ordinarily be treated as regularly carried on if they

recur only occasionally or sporadically. Furthermore,

such activities will not be regarded as regularly carried

on merely because they are conducted on an annually

recurrent basis. Accordingly, income derived from the

conduct of an annual dance or similar fund raising event

for charity would not be income from trade or business

regularly carried on.

See also the report of the Staff of Joint Committee on Internal Revenue

Taxation, 91st Cong., 1st Sess., General Explanation of Tax Reform Act of 1969

(Comm. Print 1970), pp. 67, which provides -

The tax does not apply unless the business is "regularly"

carried on and therefore does not apply, for example, in cases

where income is derived from an annual athletic exhibition.

Thus the intermittent exception is applicable regardless of the year-to-year

continuity, for example, with annual charity golf classics.

Generally, most of the commonly recognized annual event fund raisers are

within the permissible time limits normally considered intermittent or sporadic for

purposes of the special rule. For example, some annual events extend for 4 days

(the golf tournaments) and many are for 1 day (charity balls, football games). See

PLR 8135010 for a favorable ruling involving an annual country/western show

carried on by an IRC 501(c)(4) local association of employees. If rulings in the

horse and dog racing field provide any precedents, the gray area is between 7 and

11 days. Rev. Rul. 68-505, 1968-2 C.B. 248, held that a two week horse racing

meet with pari-mutual betting carried on by an exempt county fair association

(Rev. Rul. 67-216, 1967-2 C.B. 180) was sufficiently regularly carried on for

purposes of IRC 511-513. (Rev. Rul. 68-505 has been legislatively overturned by

IRC 513(d), enacted in the Tax Reform Act of 1976.)

Following the 1950 House Committee Report, Reg. 1.513-1(c)(2) provides

as an example that the operating of a sandwich stand by a hospital auxiliary for

only two weeks at a state fair would not be the regular conduct of trade or business.

Reg. 1.513-1(c)(2) also provides as an example that the operation of a

commercial parking lot on Saturday of each week would be the regular conduct of

trade or business. See also Smith-Dodd Businessman's Association, Inc. v.

Commissioner, 65 T.C. 620, 624 (1975), in which the Tax Court held that weekly

bingo games satisfy the frequency and continuity requirement of Reg. 1.513-1(c).

In a recent Technical Advice case, private letter ruling 8139015 dated June

25, 1981 it was ruled that a nine day antique show for charity fell into the

intermittent rule under Reg. 1.513-1(c)(2)(iii).

Although, income derived from short-run fund raising events for charity is

not generally includable as IRC 512 income, we must be mindful that "an activity

does not lose identity as a trade or business merely because it is carried on within a

larger aggregate of similar activities or within a larger complex of other endeavors

which may, or may not, be related to the exempt purposes of the organization."

(IRC 513(c); Reg. 1.513-1(b)).

For example, fund raisers may distribute a program as an important part of

their event activities. These programs may be filled with commercial advertising,

the income from which may be IRC 512 income notwithstanding that the income

from the sales of the program itself may fall into the intermittent activity

exception. In Rev. Rul. 73-424, 1973-2 C.B. 190, the Service ruled that IRC 512

income results from the sale of advertising by an IRC 501(c)(5) organization for its

annual yearbook where an independent commercial firm, under a contract covering

a full calendar year, conducts an extensive advertising campaign in the

organization's name, and is paid a percentage of the gross advertising receipts for

selling the advertising, collecting from advertisers, and printing the yearbook. See

also Rev. Rul. 75-200, 1975-1 C.B. 163 and PLR 8142024.

However, in Rev. Rul. 75-201, 1975-1 C.B. 164, an organization conducting

an annual charity ball also published a program with advertising. Volunteers

designed the program and solicited advertising for it. The solicitation was an

intermittant activity that did not continue for an extended period. It was held that

the sale of the advertising in this case was not regularly carried on.

In sum, intermittent fund raising activities carried on by otherwise exempt

organizations are not generally taxable under IRC 511. As we have seen in the

survey section, the special exceptions in the IRC 513 regulations that support this

conclusion have also been persuasive in exemption considerations.

6. The Exemption Issue - Three Rationales

Regardless of the real and imaginary obstacles that potentially confront the

fund raiser in IRC 501(c)(3) and 502, and the regulations thereunder, annual event

charitable fund raising organizations may qualify for exemption.

The typical productive charitable annual event fund raiser organization has

one exclusive purpose - the turning over of funds to other organizations for

charitable use. Our subject organizations may in effect have two activities - the

actual turning over of funds and the event from which the funds to be turned over

are derived.

If the event activity is detached from fund raising, we are left with the

unquestionable charitable purpose and activity of turning over funds for charitable

use. Anglo-Saxon law has always equated "almsgiving" with charity. The Service

has always recognized that a person deserves charitable contribution deductions for

gratuitous transfers of cash and goods to charitable organizations.

In published form, we are familiar with the type of organization described in

Rev. Rul. 67-149 discussed earlier. In addition, section 34(12) of Chapter 300, IRC

7751, the Exempt Organizations Handbook, provides the following:

(1) Many charitable foundations do not engage in active

charitable undertakings themselves, but rather assist the work

of religious, charitable, educational, or similar organizations

by contributing money to them. The foundation's funds may

be dedicated to purposes, as broad as but no broader than, the

purposes set out in IRC 501(c)(3). These foundations are

charitable in the broad sense of the word.

(2) Some charitable foundations, whose names and work are

widely known, have very large endowments and dispose of

millions of dollars annually. There are in addition, many

foundations controlled by corporate and individual taxpayers

who use them as channels for their charitable contributions.

This form of indirect support of charity is itself a charitable

activity justifying exemption. ...

It is doubtful whether anyone would disagree with the above in respect to the

charitable fund raising event organization separate from its event activity.

However, when the event activity is included, many are bothered by the ostensible

trade or business aspects and find difficulty in reconciling the fund raising

organization as exclusively charitable within the purview of IRC 501(c)(3).

Practically speaking, no fund raising organization can be divorced from

commercial aspects. The existence of commercial activity does not preclude IRC

501(c)(3) exemption. The IRC 511 unrelated trade or business tax infers that

exempt organizations can carry on trade or business activities. However, questions

persist as to whether there is an upper limit to the extent of business activities

carried on by IRC 501(c)(3) organizations. There are a number of modern

precedents recognizing the IRC 501(c)(3) exemption of non-profit organizations

which use commercial means to carry out charitable ends. The principle is

embodied in the following language:

The performance of a particular activity that is not

inherently charitable may nonetheless further a charitable

purpose. The overall result in any given case is

dependent on why and how that activity is actually being

conducted. (Rev. Rul. 69-572 1969-2 C.B. 119).

Published examples include Rev. Rul. 70-585, 1970-2 C.B. 585, in which an

exempt organization provided housing to low and moderate income individuals;

Rev. Rul. 73-313, 1973-2 C.B. 174, which recognized an organization that built

facilities in order to attract doctors to an area; Rev. Rul. 74-587, 1974-2 C.B. 162,

which exempted an organization giving loans to businesses located in depressed

areas; [See also Rev. Rul. 81-276, 1981-47 I.R.B. 9, recognizing PSRO's under

IRC 501(c)(3) and Rev. Rul. 81-284, found in the 1981-49 I.R.B., recognizing

MESBIC's under IRC 501(c)(3).] Rev. Rul. 76-4, 1967-1 C.B. 121, which provides

exemption for an organization that publishes and sells a journal that educates the

public and encourages scientific research; Rev. Rul. 72-560, 1972-2 C.B. 248,

holding exempt an organization formed to educate the public about pollution and

operated to a substantial extent with proceeds from the sale of collected solid

wastes to profit recycling companies; Rev. Rul. 72-559, 1972-2 C.B. 257, holding

that exemption will not be precluded for an otherwise qualified organization that

carries out its purposes of educating and vocationally training unemployed and

underemployed individuals through the manufacturing and selling of toy products;

and Rev. Rul. 66-257, 1966-2 C.B. 212, holding that an organization providing

placement services to elderly unemployed persons of limited means was not barred

from being recognized as exempt under IRC 501(c)(3). See also the judicial

precedents noted at page 37, et. seq, of The Concept of Charity topic, 1980

EOATRI Textbook.

The above precedents are not on point with our subject organizations. Our

problem area, annual event charitable fund raisers, carry on ostensibly commercial

activities not as a means of doing charitable work directly, but as an end of

charitable work ultimately through the disbursement of funds to other exempt

organizations. Their "almsgiving" provides the connection to exemption.

Taking nothing else into consideration, the annual event charitable fund

raisers may find refuge in the following -

...charitable organizations may, with certain exceptions

and limitations not applicable here, engage in

commercial endeavors for the production of income to be

used for carrying on charitable programs and activities.

(Rev. Rul. 73-128, 1973-1 C.B. 222).

It seems well settled that an organization need not engage

in a functional charitable activity to be organized and

operated for charitable purposes within the meaning of

section 501(c)(3) ...Such charitable purposes may be

accomplished solely by providing funds to other exempt

organizations ...Moreover, the fact that plaintiff obtains

all of its income from a profit making activity does not

destroy the fact that it is organized and operated for

charitable purposes within the meaning of section

501(c)(3). Golf Life World Entertainment Championship

v. U.S. 65-1 USTC 9174. (Noted in Survey, supra.)

The philosophy of these excerpts are embodied in the commensurate test

rationale of Rev. Rul. 64-182, 1964-1 C.B. 175. If no other exemption rationale is

acceptable, Rev. Rul. 64-182, will suffice in the case of many charitable annual

event fund raising organizations.

There are three possible rationales supporting IRC 501(c)(3) exemption for

productive annual event fund raising organizations whose events are not in

themselves charitable. They are:

A. With a finding that fund raising events do not constitute a

"trade or business," no confrontation exists with the primary purpose

test of Reg. 1.501(c)(3)-1(e), and IRC 502.

B. With a finding that fund raising events do not fall within

the definition of an unrelated trade or business as provided by IRC

513, no confrontation exists with the primary purpose test of Reg.

1.501(c)(3)-1(e), and, pursuant to logical consistency, IRC 502.

C. Accepting a presumption that fund raising events do

constitute a trade or business, exemption is not precluded by a

showing that the organization, through its event, is productive

commensurate in scope with its financial resources and as a matter of

law not organized and operated for the primary purpose of operating a

trade or business within the meaning of Regs. 1.501(c)(3)-1(e) and

IRC 502.

The topic will discuss each rationale in turn.

A. Charitable Fund Raising Events Do Not Constitute A Trade Or

Business

It has often been argued that fund raising organizations do not participate in

a "trade or business," but rather in "fund raising activities." Whether this is a viable

distinction, is questionable.

"Trade or business" is not defined with precision. The problem is

compounded by occasional and inconsistent interchangeable uses of the terms

"trade or business" and "unrelated trade or business" which are ostensibly different

in the format of the primary purpose test of Reg. 1.501(c)(3)-1(e).

Reg. 1.513-1(b) states that the IRC 511 tax has the objective of eliminating

unfair competition by exempt organizations, vis-a-vis trade or business activities

with non-exempt business endeavors, and this situation generally exists with

...any activity of a section 511 organization which is

carried on for the production of income and which

otherwise possesses the characteristics required to

constitute a "trade or business" within the meaning of

section 162 - and which in addition, is not substantially

related to the performance of exempt functions - presents

sufficient likelihood of unfair competition to be within

the Policy of the Tax. Accordingly, for the purposes of

section 513 the term "trade or business" has the same

meaning it has in section 162, and generally includes any

activity carried on for the production of goods or

performance of services.

Neither the language of IRC 162 (or its predecessor Section 23(a)), nor the

regulations thereunder defines what is meant by "trade or business." Nor does it

provide what particular characteristics are required to classify an activity as a

"trade or business." The courts provide little material assistance. See: Deputy v.

Dupont, 308 U.S. 488, 499 (1940) for example. Other sections of the Code

containing reference to "trade or business" (e.g. IRC 482) also provide little

insight. Rev. Rul. 81-69, 1981-1 C.B. 351, holds that a long running unprofitable

"business" activity of an IRC 501(c)(7) organization did not constitute a trade or

business. See social club topic in this EO CPE Textbook.

There has been consideration along the following lines:

IRC 162 and the court decisions thereunder assume that trade or business

refers not to economic entities but to an income-producing process. It is the

process rather than the economic structures productive of the income that is

deemed relevant by the courts in determining whether or not the particular expense

is deductible. This is illustrated by the fact that the courts in interpreting the

meaning of the term trade or business as used in IRC 162 have shown concern not

with the existence or lack of existence of economic structures ordinarily thought of

as comprising business in the popular commercial sense, but instead with the

aggregate of income producing economic activity associated with the expense

claimed to be ordinary or necessary.

In the latter regard, an analysis of the cases under IRC 162 reveals that the

principal characteristics of a trade or business for purposes of deductibility of

expenses are: (1) activity regularly carried on (2) for production of income for

profit (3) from sale of goods or services and (4) excepting these passive investment

activities engaged in for the production of dividends, interest, royalties, and other

similar types of income. Although no decided cases under IRC 162 express the

character of a trade or business in precisely these terms, it is a fact that in not one

case involving deductibility of expenses under IRC 162 has a deduction been

denied where the expense in question was ordinary and necessary to the conduct of

an activity (1) regularly engaged in (2) for the production of profit (3) from the sale

of goods or services.

If we endorsed this view of tying "trade or business" with a characteristic

requirement that "it must be regularly carried on," annual fund raising events

would not be a trade or business as that term is used in the exempt organization

provisions of the Code and regulations.

In any situation, it would follow that if a questioned activity is not a trade or

business, no troublesome confrontations exist with the primary purpose test and

standards of Reg. 1.501(c)(3)-1(e), and IRC 502. In addition, the event activity

would not fall under the IRC 513 definition of unrelated trade or business.

Appealing as this approach may be, we will probably always be confronted

with problems unless all the appropriate regulations are specifically amended (or at

least consistently interpreted). Without such changes, an annual charitable fund

raising event is a "trade or business" because it is an example of "any activity

carried on for the production of income from the sale of goods or the performance

of services."

B. Charitable Fund Raising Events Are Not An "Unrelated Trade Or

Business"

Notwithstanding a finding that a fund raising event is a trade or business, a

plausible exemption rationale is that such a trade or business is not an "unrelated

trade or business."

Reg. 1.501(c)(3)-1(e) provides that an organization cannot be recognized

under IRC 501(c)(3) if it is organized or operated for the primary purpose of

carrying on an unrelated trade or business as defined in IRC 513.

As discussed in part 5A of this topic, IRC 513(a)(1) and (3) and Regs. 1.513-

1(e) and 2(b) provide exceptions from the term unrelated trade or business if

substantially all of the work in carrying on the trade or business is performed

without compensation or if substantially all of the goods that are part of the trade

or business have been received as gifts or contributions.

It would follow that the primary purpose test of Reg. 1.501(c)(3)-1(e) is

never confronted if the activity in question is not an unrelated trade or business

because it falls within one of the special exceptions in the IRC 513 definitions.

A similar finding can be made for purposes of IRC 502. Although the latter

is worded in terms of "trade or business," instead of "unrelated trade or business,"

the IRC 513(a)(1) and (3) exceptions are found in IRC 502(b)(2) and (3). We have

to assume that IRC 513 and IRC 502 are compatible with one another. This was

the 1969 intent of Congress:

Under prior law, an organization (known as a 'feeder'

organization) operated primarily to carry on a trade or

business for profit has not been exempt even though all

of its profits were payable to one or more exempt

organizations (sec. 502). On the other hand, the unrelated

trade or business tax does not apply to business in which

substantially all the work in carrying on the business is

performed for the organization without compensation or

a business (such as a thrift shop) which sells

merchandise, substantially all of which is received by the

organization as gifts or contributions (sec. 513(a)(1) and

(3)). These exceptions may not have applied to feeder

organizations under prior law. The Act specifically

extends these exceptions to such businesses, regardless of

whether the business is run for the benefit of one or more

exempt organizations, even though in a separate

organization or otherwise. (Staff of Joint Committee on

Internal Revenue Taxation, 91st Cong., 1st Sess., General

Explanation of Tax Reform Act of 1969 (Comm. Print

1970) p. 69.)

This approach although technically valid, suffers in practical application. As

pointed out, the concept of "substantially all" does not lend itself easily to typical

cases. In addition, judging by the Service's opposition to the Green "essence of

endeavor" approach, it may be extremely difficult to find "substantially all" in any

exempt organization situation where facts reveal anything more than a de minimis

amount of commercial activity with paid performances/or goods.

C. Commensurate Test

If we accept a presumption that annual charitable fund raising events do

constitute a trade or business (or an unrelated trade or business), but find that the

fund raising organizations through these events produce commensurately in scope

with their financial resources, exemption cannot be legally denied under IRC

501(c)(3). This is true because a commensurately producing typical fund raising

organization cannot be held to be organized or operated for the primary purpose of

operating a trade or business for purposes of Reg. 1.501(c)(3)-1(e) or IRC 502.

1. Commensurate Test Rationale

If we assume that annual charitable fund raising events constitute a trade or

business (or unrelated trade or business), we confront two characteristics that the

Service has traditionally believed to be contrary to IRC 501(c)(3) exemption. First,

the Service has opposed allowing exemption to charitable organizations which

carry on business activities to a substantial extent. With respect to a fund raising

organization whose most visible activity is the carrying on of an impressive annual

event (the trade or business), we are confronted with this problem.

Second, because fund raising organizations are by their nature donative

charities, it becomes impossible to avoid colliding with the so called "destination

of income" test.

The destination test originated with Trinidad v. Sagrada Orden de

Predicadores, etc., 263 U.S. 578 (1924), III-1 C.B. 270 (Jan.-Jun. 1924), and it has

disturbed Service personnel since it was first imprecisely interpreted.

Ignoring the full meaning of the Supreme Court in the Trinidad case, the

Service and various lower courts construed the destination test to simply mean that

the test of a business oriented charitable organization's exemption is based on the

destination of its income instead of the source of its income.

In a series of court cases involving taxable years prior to 1951 the decisions

were generally in favor of charitable exemption to organizations even though their

sole activity was engaging in commercial business, and their only basis for

exemption rested in the fact that their profits were payable to other exempt

organizations. (Noted examples include Roche's Beach, Inc., v. Commissioner, 96

F. 2d 776 (1938); C.F. Mueller Company v. Commissioner 190 F. 120 (1951).)

Even today the leading treatises in charity law still entertain the destination

notion -

The question is not whether the institution may receive a

profit, but what disposition is to be made of the profit, if

any, which may be received. If the profits are to inure to

benefit individuals, the institution is not charitable. But if

the profits, if any, are to be applied wholly to charitable

purposes, the institution is charitable. Scott on Trusts II

(Section 366, 1967).

In determining whether an activity is organized for

educational purposes and so exempt from social security

taxes, the purposes for which it spends its income and not

the means whereby it obtains income are conclusive, and

hence a fair association is exempt. Southeastern Fair

Association v. U.S., 1943, 52 F. Supp. 219, 100 Ct. Cl.

216.

If it will, in the opinion of the court, result in a

sufficiently widespread distribution of public benefits,

the trust should be supported as charitable. Bogert's

Trusts and Trustees (Second Ed. 1967, Chapter 19, Sec.

367).

In 1950, Congress enacted IRC 502 which, in effect, amounted to only a

very narrow statutory restriction on the exemption aspirations of donative business

activity charities. However, in post-1950 cases, the Government confronted

charitable organizations carrying on extensive business activities and continued its

opposition to the destination test. Using a broad interpretation of IRC 502, the

Government was supported in Veterans Foundation v. U.S. 178 F. Supp. 234

(1959), aff'd. 281 F.2d 912 (1960), in which a subsidiary organization was

cloaking its commercial activity with the exempt character of its parent. However,

reexamination of our position was in order when the Court of Claims rejected our

position in Sico Foundation v. U.S., 295 F. 2d 924 (1961).

As a result the Service published the commensurate test Rev. Ruls. 64-182,

1964-1 C.B. 186, (Pt. 1) and 67-5, 1967-1 C.B. 123.

The commensurate test does not amount to a return to the "destination of

income" test of yesterday's court encounters, but instead provides an interpretation

of what the Supreme Court originally meant in Trinidad. If a thorough analysis of

the Trinidad case is made to include a reading of that part of the decision which

follows the "destination" language, and especially those cases that are cited therein,

we see an exposition of the IRC 501(c)(3) organizational and operational tests

adopted to business charity situations.

The relevant section of Trinidad (p. 581 (1924)) follows:

Whether the contention is well taken turns primarily on

the meaning of the exceptions clause, before quoted from

taxing act. Two matters apparent on the face of the clause

go far toward settling its meaning. First it recognizes that

a corporation may be organized and operated exclusively

for educational purposes, and yet have a net income.

Next it says nothing about the source of the income, but

makes the destination the ultimate test of exemption.

Evidently the exemption is made in recognition of the

benefit which the public derives from corporate activities

of the class named and is intended to aid them when not

conducted for private gain. Such activities cannot be

carried on without money, and it is common knowledge

that they are largely carried on with money received from

properties dedicated to their pursuit. This is particularly

true of many charitable, scientific, and educational

corporations and is measurably true of many religious

corporations. Making such properties productive to that

end that the income may be thus used does not alter or

enlarge the purposes for which the corporation is created

and conducted. This is recognized in University v. People

(99 U.S. 309, 324), where this court said: 'The purpose of

a college or university is to give youth an education. The

money which comes from the sale or rent of land

dedicated to that object aids this purpose. Land so held

and leased is held for school purposes, in the fullest and

clearest sense.' To the same effect is Methodist Episcopal

Church, South v. Hinton (92 Tenn., 188, 200). And in our

opinion the excepting clause, taken according to its letter

and spirit, proceeds on this view of the subject.

In retrospect, the "destination of income" language in Trinidad should not

have been taken merely to provide a catchall phrase for use in justifying charitable

exemption. The Trinidad opinion as a whole, read in conjunction with the cases

cited therein prompts us to find that we were never required to rest exemption

determinations merely on a finding that profits from business activity income were

destined for charity or that net proceeds were to go to charity. Instead, Trinidad

obligated us to settle charitable exemption issues on whether the business charity

was legally devoted to a charitable purpose and whether the organization is

operationally faithful to that purpose exclusively, only one aspect of which is its

distribution of net proceeds.

In summation, aside from IRC 502, if we were to assume that the event

activity of an annual event fund raising organization is a trade or business, IRC

501(c)(3) exemption cannot be precluded if the organization is carrying on a

charitable program commensurate in scope with its financial resources.

2. The Commensurate Test With Feeder Factor

Feeder considerations have often played a part in IRC 501(c)(3) exemption

cases involved with annual event charitable fund raiser organizations.

A first reading of IRC 502 produces confusion. One is prompted to ask how

an organization operated for the primary purpose of carrying on a trade or business

for profit, which is specifically prohibited by Reg. 1.501(c)(3)-1(e), may qualify

for IRC 501(c)(3) exemption regardless of whether or not all of its profits are

payable to exempt organizations.

The answer to such a question is not ascertainable in logic, nor may it be

found in historical record. It is enough that both IRC 502 and Reg. 1.501(c)(3)-1(e)

contain "primary purpose" language which can be utilized consistently and in

conjunction with the commensurate test.

IRC 502 was originally enacted in 1950 as a complement to the

contemporaneously enacted unrelated trade or business tax provisions. The

statute's intention was to make it impossible for an exempt organization to evade

IRC 511 tax by setting up a business subsidiary that would "donate" back

everything it earned.

One school of thought within the Service believes that IRC 502 should be

directed only against business subsidiary organizations of exempt organizations.

Support for this position can be found in Reg. 1.502-1(b) and in feeder revenue

rulings (e.g. Rev. Ruls. 57-52, 1957-1 (C.B. 196; 68-26

, 1968-1 C.B. 272; 69-528,

1969-2 C.B. 127, 73-165, 1973-1 C.B. 224), all of which present situations

involving business subsidiary organizations only.

Whatever the validity of narrowing feeder application to business

subsidiaries of exempt organizations, the IRC 502 statutory language extant is not

restrictive on its face and must be looked at as potentially applying to all business

charities, including nonsubsidiary organizations.

A strict interpretation of the feeder statute has been made in respect to

"payable."

Significance behind "payable" in the context of IRC 502 may lie with

analogy to IRC 170. As stated by DeJong v. Commissioner, 62-2 USTC 9794, 309

F2d 373, (9th Cir. 1962) -

The value of a gift may be excluded from gross income

only if the gift proceeds from a 'detached and

disinterested generosity or out of affection, admiration,

charity or like impulses', and must be included if the

claimed gift proceeds primarily from the 'constraining

force of any moral or legal duty' or from the 'incentive of

anticipated benefit of an economic nature.' We must

conclude that such criteria are clearly applicable to a

charitable deduction under 170.

In respect to true feeder organizations, no

'detached or disinterested generosity' exists when they are

legally required by their articles of incorporation, or

otherwise, to turn over all their profits to "donee"

organizations. See also Crosby Value and Gage

Company v. Commissioner, 67-2 USTC 9569, 380 F. 2d

146 (1st Cir. 1967); Cert. denied, 389 U.S. 976 (1967).

Therefore, from this we can draw the conclusion for our purposes, that if the

fund raiser organizations are allowed any sort of discretion in paying over funds to

charitable beneficiaries, they would avoid IRC 502. However, the typical fund

raising event organization is organized and operated for the purpose of distributing

proceeds to other exempt organizations. In fact, if the tenets of the commensurate

test are to be applied consistently, the fund raising organization should be obligated

to turn over all of its funds.

This returns us to the initial problem presented in the beginning of this

subsection in respect to reconciling Reg. 1.501(c)(3)-1(e) with IRC 502. This can

be done in conjunction with the commensurate test, supported by the unique facts

that made typical fund raisers productive.

Essentially, IRC 502 roadblocks are removed in respect to business charities,

including annual event fund raiser organizations, by finding that such organizations

have a primary purpose that is not the carrying on of a business for profit.

Authority is derived from precedents involving cooperative investment

organizations. In Rev. Rul. 69-528, 1969-2 C.B. 127, the subject organization was

operating an investment service business for the benefit of exempt organizations

who were charged a fee. Finding that the business was an end unto itself and that

all profits were payable to exempt beneficiaries, Rev. Rul. 69-528 denied

exemption through application of IRC 502.

In Rev. Rul. 71-529, 1971-2 C.B. 234, the same facts existed except that the

beneficiary organizations were charged substantially below cost for the service,

because operations were subsidized by private foundation funds. Instead of the

investment business being held as an end unto itself, it was found to be an activity

providing an essential function for charitable organizations. It was held to be

exempt under IRC 501(c)(3). When the subject organization in Rev. Rul. 71-529

no longer needed subsidization, exemption was no longer tenable. IRC 501(f) was

enacted to provide exemption.

Rev. Rul. 71-581, 1971-2 C.B. 236, provides the following rationale to

support the exemption of pre-Tax Reform Act of 1969 thrift shops:

X, a nonprofit organization, operated a thrift shop. X was

organized by a group of nonprofit organizations

described in section 501(c)(3) of the Code and all of X's

profits were payable to these organizations. Substantially

all of the merchandise sold by X had been contributed

and more than half of the work in operating the thrift

shop was performed without compensation. Paid

employees were reasonably compensated for their

services.

Section 502 of the Code provides that an

organization operated for the primary purpose of carrying

on a trade or business for profit shall not be exempt under

section 501 on the ground that all of its profits are

payable to one or more organizations exempt under

section 501.

Had the activity described above been carried on

directly by any one of the exempt organizations, any

profit therefrom would have been excluded from taxation

under section 511 of the Code by the provisions of

section 513(a)(3) of the Code. X was organized as a

separate corporation to operated the thrift shop in order to

insulate the assets of the exempt organizations from any

potential liability arising out of the operations of the thrift

shop and to enable X to have a separate governing body

and organizational structure composed of persons

interested in aiding the exempt organizations principally

through volunteer work in connection with the operation

of the thrift shop.

The primary purpose for which X was operated

was to serve the group of exempt organizations by

performing an essential function for them; that is, to

solicit contributions of goods on behalf of the exempt

organizations and to convert the contributed goods to

cash for charitable uses with a minimum of expense by

the use of volunteer labor. X was organized as a separate

corporation only to secure the organizational advantages

described above.

Accordingly, it is held that X is not precluded from

qualifying for exemption under section 502 of the Code

prior to its amendment by the Tax Reform Act of 1969.

X may qualify as an organization described in section

501(c)(3) of the Code, if it otherwise meets the

requirements of that section.

The rationale expressed above is readily applicable to typical annual event

charitable fund raisers. They otherwise meet the requirements of IRC 501(c)(3)

exemption when they are carrying on a program of charitable giving commensurate

in scope with their financial resources. They are not subject to IRC 502 because the

feeder statute does not apply to an organization that has a primary purpose that is

not the carrying on of a business for profit. The primary purpose of annual event

charitable fund raisers is to serve other charitable organizations, whether in a

subsidiary role or not, by raising funds in their behalf for charitable use through

annual events, carried on by considerable amounts of gratuitous support (labor,

goods, and money).

For additional reading in this area, see "Charity and Commerce: Section

501(c)(3) - How Much Unrelated Business Activity," by Kenneth C. Eliasberg, 21

Tax Law Review 53 (1965).

3. The Commensurate Test - The Viable Rationale

The three exemption rationales presented all presuppose that a representative

fund raiser is productive. Producing for charitable use is a requirement that should

be ultimately satisfied. As an example, an annual charitable fund raising event

organization that produces nothing for charitable giving should not be granted

exemption without extenuating circumstances, regardless of whether all labor

involved in the running of the event was uncompensated. To say otherwise would

have the effect of recognizing exemption for fruitless endeavors. It will suffice to

point out here that an organization alleging a charitable purpose must in fact show

a charitable activity. If the charitable purpose is fund raising, then a program of

charitable giving must be demonstrated. Without such a demonstration, the

organization is carrying on an activity that has no connection to IRC 501(c)(3).

The commensurate test has been used as the dominant rationale for fund

raising event exemption cases in recent years, but its application has been more

often than not marked with confusion and inconsistency. In the following section

we will attempt to make the test more understandable by considering some

possible guidelines.

Our final note here is that the commensurate test is generally applicable only

to IRC 501(c)(3). For example, there is no analogous authority under IRC

501(c)(4) comparable to Reg. 1.501(c)(3)-1(e).

Reg. 1.501(c)(4)-1(a)(2) provide in effect only an activities test. If an

organization's primary activity is that of a business, notwithstanding generation of

a commensurate amount of income for social welfare use, it would be difficult to

justify recognition under IRC 501(c)(4).

7. Application of the Commensurate Test in Fund Raiser Exemption Cases

A. General

The commensurate test should be applied pursuant to our traditional

organizational and operational requirements.

The organizational test for fund raising organizations is the same as that

used for any other organization applying under IRC 501(c)(3).

Whether an organization is carrying on a real and substantial program

reasonably commensurate in scope with its financial resources and capabilities is

an essentially factual matter. A threshold consideration rests on an organization's

production of funds distributed for charitable use or, in the case of a new

organization, what is proposed to be distributed. A new organization applying for

exemption should be expected to submit a proposed budget, and describe in detail

financial expectations. In addition, it should demonstrate that it has a concrete plan

for achieving its purpose. See discussion of Reg. 1.509(a)-3(d)(3)(iv) in the next

subsection.

The amount of money distributed, however, even if required pursuant to a

certificate of incorporation dictate of "net proceeds to charity," is not the end of all

in exemption considerations, regardless of its quantitative significance. If it were,

we would fall into the catchall "destination of income" test.

Under the commensurate test, even ostensibly high returns for the benefit of

charity, in respect to gross income received may not be enough to justify IRC

501(c)(3) exemption. On the other hand, an unproductive showing may not

necessarily preclude exemption.

In any situation the program of charitable giving is important and it would

be very useful to devise a standardized percentage formula that could be applied to

a fund raiser's financial input and output. Unfortunately, this is impossible. The

facts and circumstances of individual cases are varied. The method of operation of

different types of fund raisers necessarily involves different ratios of costs and

receipts. For example, a charity ball organization may have a small but wealthy

base of guaranteed supporters from which to draw large sums for contributions and

admissions with a minimum of expense. On the other hand, an organization

carrying on a football game for charity, may be required to spend large amounts for

promotion, etc. Also, sporting event fund raisers, an amateur event in which the

player/gate attractions compete for trophies and which is conducted with

substantially all uncompensated labor, may turn over 60 percent of its gross

receipts to charity. This, however, may be a de minimis product in respect to a

productive professional event with only a 25 percent turn over. Another

consideration may be the nature of the organization's cause itself. An organization,

for example, raising money for health research to combat an "unpopular" illness

may have fund raising costs that are far in excess of the considered average due to

the fact that many people who would otherwise be expected to do volunteer work

fear that they will be identified as having the illness.

There are other considerations. Should funds submitted directly to the

beneficiary charities, undoubtedly provided because of the stimulation/recognition

factor created by a particular fund raising event, be included in output? If so, how

is it determined what funds are directly attributable to the fund raising event effort?

In addition how would you plug into the formula losses of expected income due to

unexpected low attendance, inclement weather, inadvertant or honest good faith

overspending on promotion, or an unanticipated drop in contributions. The start-up

expenses of a new organization should also be considered.

In essence, no percentage formula can be formulated. Instead, a threshold

factor of charitable giving should be fully analyzed in context with all the operative

facts involved. Exemption determinations should be based on the presence or

absence of factors indicating whether or not non-charitable purposes or private

benefits are being furthered by the annual event charitable fund raising

organizations. The determinations that must be made in the fund raising area are

factual in nature and must be made on a case by case basis.

B. The Productive Fund Raiser - Other Primary Purposes

In conjunction with the commensurate test, IRC 501(c)(3) and its regulations

provide that an organization whose purpose includes benefiting private interests is

not organized or operated exclusively for charitable purposes. In respect to the past

treatment of annual event charitable fund raisers the inurement and private benefit

issues have raised more problems than others because of the typical presence of

salaried or commissioned fund raisers or tournament directors and gate attractions

(salaried entertainers or athletes who compete for prizes).

The fund raiser organizations typically have many charity and community

spirited individuals and groups who gratuitously donate their time and energies to

perform sundry activities. Uncompensated labor may assist in selling tickets,

soliciting contributions, monitoring crowds, working concessions, obtaining

advertising, etc. In addition, the organization may be the recipient of facilities

donated for a nominal fee, free mass media reporting, perhaps even the assistance

of celebrities working without fees These, of course, are the elements that make the

difference between profit and loss. However, there are limits to success with the

use of voluntary labor.

Fund raising event organizations need gate attractions to draw the public.

They may need professional fund raiser/tournament directors in order to put the

event activity together. Professional publicity and publication services are

necessary. In sum, certain essential services that cannot be practically obtained

gratuitously must be paid for.

The presence of salaried or commissioned fund raiser personnel and

contracted drawing cards do not in themselves prejudice the exemption aspirations

of fund raising event organizations. While it is clear that an organization of a

commercial character that exists only for the benefit of its members or organizers

cannot be exempt from taxation even though it pays no dividends and devotes its

entire profits to charity University Oil Products v. Campbell, 181 F.2d 451, 7th

Cir. (1950), it is also clear that an organization that pays substantial fees and

commissions to its agents is not deprived of nonprofit tax exempt status so long as

such fees and commissions can be characterized as "reasonable compensation."

Forest Lawn Memorial Park Association v. Commissioner, 45 B.T.A. 1091 (1941).

An analogous situation is discussed in Rev. Rul. 73-126, 1973-1 C.B. 220,

which held that an exempt organization's payment of reasonable pensions to retired

employees at the discretion of its board of directors does not adversely affect its

exempt status. The ruling provides the following language:

The payment of pensions to retired employees is

an accepted method of employee compensation used by

many public and private organizations. Since the

payments for the pensions in this case are reasonable

compensation in light of the surrounding circumstances,

they are a proper expense in the operation of the

organization's charitable program and do not constitute

the improper use of the organization's charitable

resources, nor do they constitute inurement of the

organization's net earnings to private individuals within

the meaning of section 501(c)(3) of the Code.

As evidenced by Rev. Rul. 73-126, something more than "reasonable

compensation," a concept which we shall return to, is involved in the relationship

between exempt organizations and their employees It must be clear that the

employees of the employer organizations are in fact employees instead of persons

with a proprietary interest in the organization.

In Rev. Rul. 69-383, 1969-2 C.B. 113, the exempt status of a hospital was

considered in the context of its contractual arrangement with a radiologist for his

professional services. Facts indicated that the doctor had no control over, or

management authority with respect to, the hospital itself. The parties entered into a

contract after arm's-length negotiations, agreeing that the doctor would be

reasonably compensated on the basis of a fixed percentage of income received for

his services.

On the basis of these facts, the ruling held that the arrangement did not

jeopardize the exempt status of the hospital.

For our special interest here, Rev. Rul. 69-383, provides the following -

Under certain circumstances the use of a method of

compensation based upon a percentage of the income of

an exempt organization can constitute inurement of net

earnings to private individuals. For example, the presence

of a percentage compensation agreement will destroy the

organization's exemption under IRC 501(c)(3) of the

Code where such agreement transforms the principal

activity of the organization into a joint venture between it

and a group of physicians Lorain Avenue Clinic v.

Commissioner, 31 T.C. 141 (1958), or is merely a device

for distributing profits to persons in control (Birmingham

Business College v. Commissioner 276 F.2d 476 (1960).)

In respect to fund raising organizations, therefore, a finding should be made

that it is truly the organization that has the exclusive proprietary interest. The role

of the professional fund raiser (or gate attraction) must be that of an employee,

contracted for pursuant to arm's-length bargaining, to perform specific services.

When the employee(s) is(are) found to be a controlling element in the arrangement

and is(are) merely using the organization as a vehicle to carry on an activity for

personal profit, prima facie evidence of inurement exists requiring denial of IRC

501(c)(3) exemption to the organization. (See, for examples, Rev. Ruls. 69-266,

1969-1 C.B. 151, 80-106, 1980-1 C.B. 113, and 81-94, 1981 C.B. 330.) See also

Promotion of Fine Arts and Performing Arts topic in this EO CPE Textbook and

the Health Care Organization topic in the 1981 EO CPE Textbook, page 8 et seq.

For an interesting judicial opinion, see John Marshall Law School v. U.S., 1981-2

USTC 9514, June 24, 1981.

Support for this principle may be found by analogy in the income tax area in

respect to the prohibition against assignments of income to charity by non-exempt

persons as a means to exclude the latter from gross income.

In the income tax area, the proceeds of a "charity" event are either (1)

taxable to the promoters (or performers) as proceeds of an assignment of income or

(2) are not taxable to the promoter if the income is genuinely the income of a

charitable organization.

In general, situation (1) applies when the promoter has entered into an

agreement with a charitable organization under the terms of which the facilities of

the promoter are operated by him as agent for the charitable organization, and all

proceeds are received by him on account of the charitable organizations. Situation

(2) applies when the charitable organization is the actual promoter of the event.

See for example Rev. Rul. 68-503, 1968-2 C.B. 44, Rev. Rul. 72-542

, 1972-1 C.B.

37, and Rev. Rul. 77-121, 1977-1 C.B. 17.

Guidelines can be found by analogy in the regulations under IRC 509(a)(2)

which are concerned with factors to be taken into account in issuing advance

rulings to newly created organizations that are publicly supported and carry on

fund raising activities.

Reg. 1.509(a)-3(d)(3)(iv) provide the following –

In the case of an organization which carries on

fund-raising activities, whether the organization has

developed a concrete plan for solicitation of funds from

the general public on a community or area-wide basis;

whether any steps have been taken to implement such

plan; whether any firm commitments of financial or other

support have been made to the organization by civic,

religious, charitable or similar groups within the

community; and whether the organization has made any

commitments to, or established any working relationships

with those organizations or classes of persons intended as

the future recipients of its funds.

The elements of "concrete plan," "implementation," "commitments of

support," and "working relationships" in the cited regulation all point to

requirements of long term active participation and control on the part of the exempt

organization as opposed to a passive or secondary voice in respect to the work

loads of its salaried or commissioned employees (or contracted gate attractions).

Returning to the concept of "reasonable compensation," separate from the

factor of control (or proprietary interest), it is noted that in the income tax area, the

Service does not generally challenge deductions for compensation paid to

employees who have no proprietary interest, or a negligible one, in their

employers. This is true because when an employee's compensation is established

pursuant to arm's-length negotiation, it is presumed to be reasonable. (See IRC 162

and Reg. 1.162-7.)

On the other hand, Exempt Organizations exemption cases require evidence

of exclusive charitable purpose and activity. Employee salaries should be

examined as an independent factor, notwithstanding an evidentiary lack of

employee proprietary interest. For example, an organization established for

charitable ends may distribute so much of its gross income as salaries that the

organization may truthfully be said to exist as much for the benefit of its

employees as for any other purpose. Oregon Physicians Service v. S.W. Horn, 349

P.2d 831, 838, (1960). In any situation, reasonable compensation questions are

ordinarily resolved by comparisons. We are, however, aided by recent state

legislation in this area. At present, many of the states have enacted or are enacting

a new breed of charitable solicitation statute in response to contemporary

revelations about certain fund-raising "charities" siphoning off as much as 90

percent of monies collected for fund raising expenses. These new statutes may

resolve many of the public criticisms previously mentioned.

Some of the statutes require that an organization engaging in charitable fund

raising register with a particular state office along with the professional fund

raisers who work for the organization in fund raising activities. The statutes may

include requirements that prohibit misrepresentations such as erroneous tax

deduction claims. Most importantly, for our purposes here, some of these statutes

place limits on the percentage of gross receipts that may be received by the

professional fund raiser as compensation. The percentage most often noted is 15

percent. Stiff sanctions are imposed on organizations and persons for violations.

According to Giving USA, Bulletin Number 1, January 1981, a publication

of the American Association of Fund-Raising Counsel, Inc., there are 33 states plus

the District of Columbia with statutes aimed directly at charitable solicitations.

Thirteen of these states have fixed percentage limitations on amounts that can be

devoted to administrative costs. Of these 13 states, 10 permit exceptions, if it can

be shown that a greater percentage than that allowed by statute should be permitted

for expenses and administration.

It would seem that these laws, where applicable, could be helpful to Service

personnel in developing reasonableness of compensation issues. A computation of

these laws has been included in this topic as Appendix 3, reprinted through

permission of the American Association of Fund-Raising Counsel, Inc., New York,

New York.

There may be constitutional problems however with some of these state

statutes as evidenced by the U.S. Supreme Court in Village of Schaumberg v.

Citizens for a Better Environment, 444 U.S. 620 (1980). The issue presented in that

case was the validity, under the First and Fourteenth Amendments, of a municipal

ordinance prohibiting the solicitation of contributions by charitable organizations

that do not use at least 75 percent of their receipts for charitable purposes. Those

purposes were defined to exclude solicitation expenses, salaries, overhead, and

other administrative expenses. The Court determined that charitable appeals for

funds may involve a variety of speech interests -- communication of information,

dissemination and propagation of views and ideas, and advocacy of causes--that

are within the First Amendment's protection. The court held the 75 percent

requirement of the ordinance plainly insufficient to governmental interests to

justify its interference with protected speech. The ordinance was therefore held to

be unconstitutionally overbroad.

On the other hand, some state statutes and our commensurate test avoid a

strict percentage limitation on solicitations and could therefore be more akin to the

ordinance upheld in National Foundation v. Fort Worth, 415 F. 2d 41 (5th Cir.

1969), cert denied, 396 U.S. 1040 (1970). That ordinance permitted organizations

with excessive solicitation costs to demonstrate the reasonableness of such costs in

order to obtain solicitation permits.

C. The Unproductive Fund Raiser

We must be ever mindful of Mr. Jonson's adage about the "last refuge of

scoundrels." Instead of "patriotism," the last refuge of an alleged charitable

organization is often fund raising for some worthy cause when other arguments for

charitable exemption fail. An unproductive charitable fund raiser deserves special

consideration under the commensurate test.

For example, an annual event fund raising organization, otherwise qualified

for exemption, may attempt to characterize its annual dinner dances or social balls

as charitable fund raising events, even though these activities, over a period of

years, have been shown to always lose money or merely break even. The basis for

denial in such situations might include both a failure of charitable accomplishment

rationale and a showing that the organization engages in activities that further a

non charitable purpose - recreational purposes, for example.

Consider also Help The Children Inc. v. Commissioner, 28 TC 1128 (1957),

which is not an annual event charitable fund raiser case, but which does provide an

excellent presentation of the principles involved in the unproductive fund raiser.

Help the Children, Inc., a nonprofit organization organized under state law

for the purpose of raising funds for charity, applied for exemption under IRC

501(c)(3). Its activities consisted of running bingo games [It is noted that now

many bingo activities do not constitute unrelated trade or business. See IRC

513(f).] to carry out its charitable purpose. However, the net effect of its fund

raising was extremely small as evidenced by its paltry distribution of funds to

charity.

Instead of dismissing the organization on the basis of lack of

accomplishment, the court attacked the issue with thorough analysis.

The opinion spelled out the organization's financial activities for the taxable

years in question, 1953 and 1954. Gross receipts from bingo card sales, soda bar,

and miscellaneous activities amounted to $316,645.45 in 1953 and $309,973.47 in

1954. Major expenditures in 1953 were $236,696.74 for bingo prizes, $25,603.25

for salaries and $42,000 for rental of the bingo hall. The expenditures in 1954 were

approximately the same. The organization's "charitable" program consisted of

contributions to the extent of $2,880 in 1953 and $3,873.20 in 1954, 75% of which

were paid directly to individual doctors. Only $615 in 1953 and $1,418.25 in 1954

was actually distributed to 9 assorted bona fide charitable organizations.

The organization was otherwise qualified for exemption with a governing

board of uncompensated stockholders.

The court implied that the employees were reasonably compensated. The

court held that the organization was not entitled to IRC 501(c)(3) recognition and

used the following language -

Petitioner did not operate any charitable

institutions. Its principal activity was the profitable

operation of bingo games on a business or commercial

basis. The principal source of gross receipts was from the

fixed charge or donation assessed against each player for

the use of bingo cards. Petitioner also realized some

additional income from the operation of a soda bar and

miscellaneous activities.

The record shows that one of the purposes for

which petitioner was operated was to engage in

commercial activities for profit. Furthermore, the major

portion of its contributions was to individual doctors who

performed services at city-operated free baby clinics.

Clearly such payments were for noncharitable purposes.

Help The Children does not use the language of the commensurate test, but

in effect applies it. The organization alleged fund raising for charity but was

unproductive. The court found that the organization's principal activity was a trade

or business significantly furthering non-charitable purposes. In effect, Help The

Children, Inc. was not operating a real and substantial charitable program

commensurate in scope with its financial resources.

D. Practical Approach in Applying Commensurate Test to Annual

Charitable Fund Raising Event Exemption Cases

[The 10-step approach is not shown here]

8. Private Foundation Issues

A. IRC 509(a)(2) Support

An organization that is granted exempt status under IRC 501(c)(3) must also

be classified under IRC 509(a). Under IRC 509(a)(2), support consisting of gross

receipts from admissions, sales of merchandise, performance of services, or

furnishing of facilities, in an activity that is not unrelated trade or business (within

the meaning of IRC 513) is generally considered to be good support for purposes

of determining that the organization is not a private foundation.

As we have seen the income derived by many fund raising organizations is

not considered to be income from an unrelated trade or business because the events

are not regularly carried on. The term "regularly carried on" is mentioned in IRC

512 and not in IRC 513. However, the definition of "regularly carried on" is found

in the IRC 513 regulations. Therefore an unanswered issue is whether an

organization whose income is not taxed as unrelated business income because the

activity from which the income is derived is not regularly carried on could also

have this income classified as permissible IRC 509(a)(2) support. Of course, if the

fund raising event was carried on with substantially all donated labor or goods, the

activity would not constitute an unrelated trade or business under IRC 513 and the

income derived would be classified as permissible IRC 509(a)(2) support.

B. Fund Raising and IRC 4943

Even if an organization were classified as a private foundation, it would not

need to be concerned that a fund raising event activity would be classified as a

"business enterprise" under IRC 4943. Reg. 53.4943-10(a)(1) provides that the

term "business enterprise" includes the active conduct of a trade or business that is

regularly carried on for the production of income from the sale of goods or the

performance of services and that constitutes an unrelated trade or business under

IRC 513.

Further, if the private foundation did engage in a regularly carried on active

business (as opposed to an intermittent fund raising activity) and it was run with

substantially all volunteer labor it would not be classified as a "business

enterprise." Reg. 53.4943-10(b) provides that the term "business enterprise" does

not include a "functionally related business" as defined in IRC 4942(j)(5). Reg.

53.4942(a)-2(c)(3)(iii)(a)(1) provides that the term "functionally related business"

is a trade or business that is not "unrelated trade or business" as defined in IRC

513. Since a regularly carried on business run with substantially all uncompensated

labor is excepted from the term unrelated trade or business under IRC 513, it

would be classified as a functionally related business. Rev. Rul. 76-85, 1976-1

C.B. 357, also provides that assets from such a business would be excluded from

the minimum investment return under IRC 4942(e).

9. Deductibility and Fund Raising

We will raise one final thought that may help prevent abuse, inadvertence,

and a loss of federal tax dollars. Rev. Rul. 67-246 (or Publication 483) attached as

Appendix 1, provides rules for charitable deductibility of "contributions" to IRC

501(c)(3) organizations. Among the rules are prohibitions against "deductions" for

contributions to organizations in which there is a "quid pro quo," a prohibition

which may be largely unenforceable against donors, particularly small

contributors. It is suggested that exemption letters or examination correspondence

involving fund raising organizations, which receive income from the sale of

admissions, or which receive "contributions" for the exchange of premiums,

magazines, etc., include a special deductibility paragraph, containing a caveat

informing them to operate within the spirit of the rules of Rev. Rul. 67-246. We

have attached as Appendix 4 suggested pattern paragraphs for use when

appropriate. One of the suggested paragraphs is an extract from Rev. Rul. 80-286,

1980-2 C.B. 179, which holds that an organization formed to foster the cultural and

educational development of children by arranging for and participating in the

temporary exchange of children between families of a foreign country and the U.S.

qualifies for exemption under IRC 501(c)(3). The extract is the charitable

deductibility holding of the revenue ruling and we believe the language may be

tailored for use in many appropriate situations involving fund raising

organizations.

10. Concluding Remarks

Both the lack of judicial guidance and the highly factual nature of the cases

make it difficult to publish in the fund raising area. It is believed that this topic has

presented some guidelines that would be of assistance in the development of cases

both from the determination (or ruling) and examination standpoints. As a final

note, there is a possibility that some guidelines may ultimately emanate from the

publication of final regulations under IRC 4911. The latter, relating to the tax on

excess expenditures to influence legislation precludes charitable organizations

from including fund raising unit expenditures from the amount base ("exempt

purpose expenditures") from which permissible lobbying expenditures are

determined. It would seem that some useful definitions on fund raising may come

out of the regulations project.

[APPENDIX 1, 2, and 3 not shown here]

APPENDIX 4

Suggested Pattern Paragraphs

For Fund Raising Determinations, Rulings, and Correspondence

1. Contribution deductions are allowable to donors only to the extent that

their contributions are gifts, with no consideration received. Dues, subscriptions,

ticket purchases, and similar payments may not necessarily qualify as deductible

contributions, depending on the circumstances.

2. In the event you carry on fund raising activities, such as sales of

merchandise or admission tickets to benefit performances, you may not represent

that the full purchase price of such item entitles the patron to a deduction for

federal income tax purposes. In those cases in which your fund raising activity is

designed to solicit payments which are in part a gift and in part the consideration

for goods, services, or other benefits, you must determine in advance of solicitation

the amount to be attributed as the consideration and the amount to be attributed as

a gift. You should clearly indicate these respective amounts in the publicity for

such activity and upon any ticket, receipt, or other evidence issued in connection

with payment. Moreover, the amount attributable to the consideration must reflect

that fair market value of such goods, services, or other benefits and be reasonable

in comparison with those for which there are established charges.

3. Extract from Rev. Rul. 80-286, 1980-2 C.B. 179

Section 170(a) of the Code provides that there shall be allowed as a

deduction, subject to certain limitations any charitable contribution as defined in

section 170(c), payment of which is made within the taxable year. Section

170(c)(2)(B) defines a charitable contribution to include a contribution or gift to or

for the use of a corporation organized and operated exclusively for educational

purposes.

Although the term "contribution" is not defined either in the Code or in the

Income Tax Regulations, it is well established judicially that in order to be

deductible under section 170 of the Code, a contribution must qualify as a gift in

the common law sense of being a voluntary transfer of property without

consideration. To the extent a transferor receives or can expect to receive, for the

money or property he or she transfers, a financial or economic benefit, as

distinguished from the incidental benefit that inures to a donor as a member of the

general public, then no deduction under section 170 is allowable. Singer v. United

States, 449 F. 2d 413 (Ct., Cl. 1971); Rev. Rul. 67-246, 1967-2 C.B. 104 Rev. Rul.

76-185, 1976-1 C.B. 60.

Accordingly, the fees paid by families participating in the exchange program

are not deductible as charitable contributions under section 170 of the Code.

Further, the expenses incurred by a participating United States family contributing

to the support, maintenance, and cultural enrichment of the foreign child while the

child is a member of the United States family's household for the exchange

duration are not deductible as charitable contributions under section 170.

However, contributions from members of the general public, as well as

contributions from a family that exceed the fair market value of services received

from the family's participation in the exchange program, will be deductible under

section 170 of the Code in the manner and to the extend provided therein.