I am looking at an IRS letter ruling wherein somebody was applying for tax-exempt status.
The main section of the Code that addresses tax-exempts is Section 501. You may already know that the premier tax-exempt is a 501(c)(3), although there are other varieties. The advantage to the (c)(3) is that:
· The entity itself is (normally) nontaxable, and
· Contributions to it are (again, normally) tax-deductible.
Not everything associated with a (c)(3) is tax-exempt, of course. If you work at one, you will file and pay income taxes on your paycheck like anyone else. There are limits to the tax break.
A key limit involves non-exempt activities.
Let’s say that you want to open a school to teach car manufacturing. You have read and understood that schools are usually tax-exempt. You want to vertically scale your vision. You want to teach auto design, engineering, manufacturing and eventual sale of the said automobiles. Soup to nuts and all.
And you want the whole thing to be tax-exempt under (c)(3).
It won’t work, of course. There are private companies that manufacture and sell cars for a living. You are not making this thing tax-exempt by attaching a school to it.
In the jargon, the school would be an exempt activity.
Everything else would be non-exempt activity.
There is a famous quote from the Better Business Bureau of Washington D.C. tax case:
... a single non-exempt purpose, if substantial in nature, will destroy the exemption regardless of the number or importance of truly exempt purposes.”
You might be able to sell a car at the end of the school year, but any sales activity must be insubstantial in comparison to all other activities. Sell a fleet of cars and you are surely doomed.
Let’s look at our Ruling.
A member-based organization functions as a clearinghouse for basketball officials. The organization recruits, trains, certifies and assigns its coaches to officiate at elementary, middle and high schools. The school districts pay the referees directly, with pay levels varying upon experience and qualifications. The association has an assignment secretary who assigns the coaches “based on their availability and qualifications.”
The organization provides testing to assess and develop each official’s understanding of basketball rules and regulations. The organization also ensures that referees meet fitness requirements as well as maintain effective communication skills.
The organization is funded primarily by member dues, although it also receives fees from scrimmage games and basketball camps. The organization’s principal expense is the assignment secretary.
COMMENT: There is the job I want.
The IRS looked at the two overall tests for a tax-exempt:
· How it is organized
· How it actually operates
Let’s go to the second test.
· There is a clear educational component to this organization. It actively educates and trains its members so they can obtain and retain employment as basketball officials.
· There is also a clear business component. Frankly, the organization serves as placement agency for its members, almost like a union hall. That is fine, but it is not an exempt purpose. That activity serves the private economic interests of the members and is not grounds for tax exemption.
So we have the question:
Is the “non-exempt purpose” substantial enough in nature to capsize the exempt educational activities of the organization?
The IRS determined that it was substantial enough. It denied the (c)(3) application.
This time we have discussed IRS Letter Ruling 202521023.
