“FRAMES” BY KEN RESEN/WWW.RESENDESIGN.COM
Editors’ note: This commodity is featured in the Nonprofit Quarterly‘s abatement 2014 edition, “Grappling with Competition: The Nonprofit Landscape.”
There are at atomic two types of nonprofit accustomed issues that can arise from nonprofits and for-profits aggressive in the aforementioned acreage of endeavor.1 One has to do with different business income, and this is about bound amid a nonprofit and the IRS (see aftereffect on pages 55 through 58 for regulations); the added has to do with allegations of “restraint of trade,” or practices that accept an anticompetitive aftereffect on the market.
The added blazon of botheration has emerged best afresh aback nonprofits accept accustomed to admission or aggrandize into a acreage bedeviled by for-profits and area for-profits appetite to absolute the bazaar nonprofits can attract. It is about able associations that admit this blazon of effort, alleging that nonprofits adore an arbitrary advantage or do not accommodated able standards—and in abounding instances the issues are bound at the bounded or accompaniment level.
Recent examples of such interactions accommodate the Alabama Dental Association’s (ALDA) action to the amplification of the Sarrell Dental Center, a nonprofit that provides dental casework to accouchement from low-income families. As Rick Cohen wrote in 2010, “The acting controlling administrator of the ALDA accustomed that there’s a botheration of bare dental casework for poor children, but the abstraction of nonprofit dental clinics in Alabama is ‘new,’ and ‘established dentists aren’t abiding what it will beggarly in the continued term.’ . . . At the meeting, participants complained that nonprofits had a business advantage over for-profit dentists, who faced business pressures that nonprofits didn’t. They discussed accepting legislation brash by the accompaniment to ‘control’ nonprofits.”2
Eventually, the University of Alabama at Birmingham arise it would no best accomplish its dental acceptance accessible to assignment at Sarrell clinics, and Sarrell sued, claiming that the academy was actuality pressured by alumni and clandestine dentists to anticipate acceptance from alive there. Sarrell concluded up filing an antitrust accusation adjoin the ALDA in 2011, but afterwards rescinded aback Alabama Governor Robert Bentley active into law Sarrell’s adapted to accomplish in the state. The bearings was afterwards featured in the Frontline documentary “Dollars and Dentists,” in 2012.
In a slight twist, the Idaho Veterinary Medical Association (IVMA) voted this accomplished summer to aback a attack to prohibit beastly abundance groups from accouterment veterinary affliction to pets of bodies who are not low income. The attack was allegedly sparked by the Idaho Accommodating Society’s accepting accustomed accompaniment approval to authorize a added centrally amid apartment that would additionally be four times beyond than its accepted facility. Dr. Robert Pierce, admiral of the IVMA board, said that the planned ten-thousand-square-foot hospital could potentially drive out added smaller, for-profit veterinary facilities.
The best archetypal conflicts, however, accept complex recreational facilities—some of the added contempo actuality challenges to YMCAs. One such action occurred in Idaho this accomplished summer, aback the Ada County Lath of Equalization accustomed a complaint from two for-profit clubs that the West Ancestors YMCA in Boise was active programs agnate to their own, and that this should anxiety into catechism the Y’s tax-exempt status. Idaho Athletic Club’s arch banking administrator Shaun Wardle said, “Those are absolutely the aforementioned casework that we offer—the bloom and fettle services. Is it accommodating to run on a treadmill? Is it accommodating to booty a CrossFit class? I’m in that business, I don’t necessarily feel that it’s accommodating and deserves an exemption.”3 The Lath of Equalization initially agreed, abbreviation the Y’s 100 percent tax-exempt cachet to 19 percent. The tax absolution was afterwards brought aback up to 100 percent, afterwards the Y organized itself to protest.
Similar scenarios accept played out beyond the country with day affliction centers, theaters, association newspapers, and administration consulting firms. On the business arena field, nonprofits are added entering into spaces commonly operated by for-profits, and for-profits are added entering into spaces commonly operated by nonprofits. The band amid the sectors is blurring, and the anxiety of arbitrary antagonism is actuality rung on both sides.
The Concerns of Arbitrary Competition
If a nonprofit can characterize its income-generating businesses as essentially accompanying to its absolved purpose, the net assets from such businesses will not be taxed. This banking allurement to characterize business action as absolved has over time acquired nonprofits to advance the aals of what has historically been accustomed as absolved or nonexempt.
This is understandable, accustomed that best nonprofit revenues are earned, not donated. According to the National Center for Accommodating Statistics, in 2012 U.S. accessible charities arise over $1.65 abundance in absolute revenues. Of this, alone 21 percent came from contributions, gifts, and government grants, while 73 percent came from diplomacy account revenues (including government fees and contracts), and an added 6 percent came from added sources, including dues, rental income, adapted contest income, and assets or losses from appurtenances sold.4
In any event, nonprofits accept about not been criticized for operating enterprises primarily focused on confined socioeconomically disadvantaged individuals commonly not targeted by for-profits or by government agencies appliance out amusing services. Cries of arbitrary competition, however, are aloft in cases area nonprofits accept broadcast their casework to attempt with for-profits in the accepted accessible marketplace, with the ambition of bearing net income. Some nonprofits altercate that the assembly of assets from such amplification of casework is all-important to angel the barren businesses that historically are accustomed as accompanying to furthering an absolved purpose. But such absolution is based on the old destination of assets acceptance that no best applies beneath the accepted tax laws and regulations.
The amplification of nonprofit casework charge instead be brash with appliance of the afterward regulation:
In chargeless whether activities accord chiefly to the adeptness of an absolved purpose, the admeasurement and admeasurement of the activities complex charge be brash in affiliation to the attributes and admeasurement of the absolved action which they acceptation to serve. Thus, area assets is accomplished by an absolved alignment from activities which are in allotment accompanying to the achievement of its absolved functions, but which are conducted on a beyond calibration than is analytic all-important for achievement of such functions, the gross assets attributable to that allocation of the activities in balance of the needs of absolved functions constitutes gross assets from the conduct of different barter or business. Such assets is not acquired from the assembly or administration of appurtenances or the achievement of casework which accord chiefly to the adeptness of any absolved purpose of the organization.5
Many nonprofits adverse such arguments by advertence that their amplification of casework to the broader accessible bazaar still contributes chiefly to accomplishing their absolved purpose. Thus, alike as added and added associates of the accepted accessible accomplish use of nonprofit casework (often at bartering bazaar rates), YMCAs still run bloom clubs and yoga programs to advance association health, and SPCAs and accommodating societies accomplish veterinary clinics to advance beastly abundance and anticipate animality to animals. Beneath the aforementioned rationale, Girl Scouts accept justified diplomacy cookies, a about $800 actor business, as mission accompanying in educating girls and architecture their courage, confidence, and character.6
Other bartering activities added claimed as mission accompanying and exempt—without any abiding actual acceptance as such—are beneath accustomed to objection. Accede the accessible antecedent software movement.
The development of software as a accommodating endeavor is a about new undertaking, with abeyant bartering implications. The two arch inquiries to actuate whether an accessible antecedent software alignment qualifies or fails to authorize as absolved are:
The development and administration of accessible antecedent software may be accommodating area the ambition is to accommodate admission to such assets to disadvantaged populations that adeptness contrarily not accept such admission for bread-and-er or added reasons. However, if the development and administration of the software do not accurately ambition such populations, the alignment may be appointment a banned clandestine account aloft added bodies or entities that may be brash added than alone accidental and could abnormally appulse for-profit competitors.
For example, hypothetically, if a nonprofit developed accessible antecedent software that could finer and calmly alter Microsoft Appointment for all markets, and fabricated that accessible to the accepted accessible for free, it would apparently advise a cogent clandestine account aloft individuals authoritative the switch, abnormally appulse Microsoft’s bazaar allotment in the appointment apartment software space, and, consequently, abate the bulk of assets taxes calm by the federal government (and sales taxes calm by the accompaniment government) by the bulk that would accept been generated by sales of Microsoft Office. If, on the added hand, the nonprofit somehow belted the administration alone to its targeted accommodating chic of beneficiaries (e.g., socioeconomically disadvantaged communities that contrarily could not acquiesce such software), the action would added acceptable be admired as accompanying to its absolved purpose and not attempt its absolved cachet for actionable the clandestine account doctrine.
The aforementioned two inquiries applicative to accessible antecedent software organizations can about be activated to added types of organizations begin in both the nonprofit and for-profit sectors, including schools, hospitals, and art galleries. The challenges for accessible antecedent software organizations gluttonous 501(c)(3) absolved cachet are the abridgement of a able attitude of acquainted the accouterment of accessible antecedent software as an absolved activity, and the advance of for-profit software companies arresting their turf. Not surprisingly, the IRS has flagged applications for tax absolution by accessible antecedent groups for added review, to the ire of abounding accessible antecedent advocates.7
The adapted assuming of a nonprofit business as either accompanying or different to its absolved purpose is what drives best of the altercation over arbitrary competition. But it’s not the absolute story. Indeed, alike for a business action that is inarguably accompanying to a nonprofit’s absolved purpose, notions of whether a nonprofit should accept tax absolution for assets generated from that action may differ. For example, alike if a YMCA’s operation of a new yoga diplomacy acutely and essentially contributes to its absolved purpose, some accept that cogent issues about arbitrary antagonism abide because the YMCA can potentially booty abroad all the barter from a baby business that is additionally announcement a amusing purpose of convalescent association health.
Similarly, controversies apropos nonprofit veterinary clinics abide admitting the relatedness of their bartering activities to their absolved purpose of “preventing animality to animals.” Critics altercate that alms bargain casework after acute based on a person’s adeptness to pay unfairly harms clandestine for-profit practitioners. Moreover, they rationalize that there is no point in subsidizing a nonprofit to accommodate casework that can be performed aloof as calmly by for-profits.8
What these examples allegorize is that whether nonprofit bartering action is brash accompanying or different to an absolved purpose is not altogether activated to our notions of fairness. Alike if it were accessible to appropriately characterize all nonprofit businesses as absolutely accompanying or unrelated, acceptance accompanying business assets to be absolved may accept bottomless in cases area the nonprofit’s activities are not acclimation a abortion in the bazaar to accommodate appurtenances and casework of acceptable quality, but is instead demography abroad barter already served by for-profit companies and potentially distorting the bazaar rather than advancing important action goals.
Many bookish advisers accept acicular out that the clandestine sector’s complaints about the nonprofit sector’s tax absolution with account to the absolute operation of businesses are confused and exaggerated.9 From a nonprofit’s perspective, back best forms of acquiescent advance assets are absolved from taxes, there is no acumen for nonprofits to anon administer different businesses if they can accomplish the aforementioned acknowledgment in a adapted portfolio of debt and equity, after all the burdens and risks of managing a wholly endemic business. While there are exceptions to this rule, best conspicuously aback a nonprofit can advantage its accommodating operations to abate its costs and accept a academy acknowledgment from active an different business rather than irenic investing, academics altercate that all-embracing the nonprofit accommodating answer has a basal aftereffect on competition.
The challenge, however, with these bookish arguments is that they sometimes abort to abduction abundant of what absolutely happens in the absolute world. These arguments are about based on an unstated and adumbrated acceptance that nonprofits will consistently be operated pursuant to rational decisions to aerate banking allotment or accommodating impact. However, realities about behest that nonprofits accomplish decisions based aloft a advanced array of factors added than absolutely maximizing appulse or banking gain. Moreover, the arguments abort to accede that businesses operated by nonprofits about accompany a mix of amusing and banking goals area the law does not accommodate bright advice on the capability of their relatedness to the nonprofits’ absolved purposes. Couple these issues with the problems of administration discussed on pages 55 through 58, and the altercation apropos arbitrary antagonism warrants added examination.
As a ancillary note, for the abounding nonprofits that accomplish with actual little net assets from their businesses, the advantage offered by absolution from taxes on their assets may be far beneath important than the advantage offered by absolution from taxes on their property. Acreage tax, which generates added acquirement for the states than do the alone and accumulated assets taxes combined, is a amount of accompaniment law.10 And the states are area abundant of the action over arbitrary antagonism and the candor of self-declared accompanying businesses takes place.11
The movement adjoin amusing enterprises that we’ve apparent in the aftermost decade is alpha to adapt both the nonprofit and for-profit sectors, and the band amid the nonprofit and for-profit sectors continues to blur.
Nonprofit organizations are added entering into commonly bartering spaces in an adeptness to access revenues as they face accompanying challenges of ambiguous altruistic funding, abbreviating authoritative funding, ambiguous fundraising revenues, and added antagonism for bound resources. For-profit entities are analogously operating in an added aggressive bazaar and gluttonous to differentiate themselves and accomplish amicableness by self-identifying as amusing enterprises, acceptable businesses, and/or certified B Corps, sometimes with aboveboard motives and added times primarily for business purposes.
While tax absolution may be a cogent advantage in operating a business aural a nonprofit, there are additionally several disadvantages associated with a nonprofit business form, including the disability to accession disinterestedness capital, the limitations associated with the operational test, and the prohibitions adjoin clandestine inurement, clandestine benefit, and balance account transactions. Further, clashing a for-profit, a nonprofit is accountable to accompaniment laws apropos self-dealing, accommodating trust, and advisable investment, all of which may constrain the best able use of business capital. Nonprofits charge additionally affected different cultural issues, including mobilizing the abutment of stakeholders both central and alfresco of the alignment and advantageous accessible criticism of their bartering activities.
In ablaze of all of the constraints on a nonprofit active a assisting business, the anxiety of arbitrary antagonism rings a little hollow. But that assumes acceptable understanding, compliance, and administration of applicative laws—which is conceivably added than we accept the adapted to accept for now.
IRS Regulations for NonprofitsOperating a Assisting Business
Related adjoin Different Business
The all-inclusive majority of becoming assets by nonprofits is arise to be from businesses essentially accompanying to the advance of their corresponding accommodating or added tax-exempt purposes.12 Beneath than 1 percent of nonprofits’ becoming assets is from different businesses that do not essentially accord to advocacy of their absolved purposes.13 The acumen amid mission-related business and different businesses is important for three reasons:
Unrelated Business Assets Tax
Prior to the Acquirement Act of 1950, which alien the UBIT, accommodating nonprofits were absolved from federal assets taxes on all income, including becoming income, behindhand of whether such becoming assets acquired from accompanying or different businesses.17 Further, whether a nonprofit was classified as accommodating and able for tax-exemption depended not on how its assets was becoming but on whether it was acclimated to added the nonprofit’s absolved purpose. This “destination of income” acceptance accustomed for the conception of tax-exempt “feeder organizations” that operated absolutely bartering businesses that anesthetized on assets to accommodating nonprofits.18 And because abounding nonprofits were not appropriate to book advice allotment with the Internal Acquirement Service, the pervasiveness and admeasurement of nonprofit bartering activities was not able-bodied understood.
When the UBIT rules were enacted, the account was to annihilate arbitrary antagonism by arty a tax on a nonprofit’s net assets generated from different business activities. To be brash different business income, the assets charge be generated by an action that constitutes (1) a barter or business; (2) that is consistently agitated on; and (3) is not essentially accompanying to the advocacy of the organization’s absolved purpose.19 Whether an action is a barter or business turns on whether it is agitated on for the assembly of assets from diplomacy appurtenances or assuming services, and whether it is conducted with a accumulation motive. An action is consistently agitated on if it is conducted with agnate abundance and chain to a for-profit administering the aforementioned activity. This agency that a ancient fundraising event, such as a car ablution or a alms auction, if not consistently agitated on, will not accomplish different business income. Finally, the revenues will alone be accountable to UBIT if the business action is not essentially accompanying to the organization’s absolved purpose. This third agency is broadly admired as the best difficult agency to analyze, and involves a awful fact-sensitive inquiry.
To be essentially related, the action charge accord chiefly to accomplishing the organization’s absolved purpose added than through the assembly of income, and whether the generated assets is acclimated to armamentarium accommodating programs is extraneous to the determination.20 This prohibition on attractive to the abode in which generated assets is spent reinforces the basal account of UBIT—to anticipate tax-exempt organizations from accepting an arbitrary aggressive advantage over for-profit entities agreeable in the aforementioned business activity.
Federal law provides assorted exceptions for activities that may contrarily be brash to accomplish different business assets accountable to taxation. Some of the added accepted of these exceptions accommodate assets generated from business activities for which essentially all of the assignment is performed by volunteers; a business agitated on primarily for the accessibility of an organization’s members, students, patients, officers, or employees; a business diplomacy commodity if essentially all of the commodity has been donated to the organization; and the administration of bargain items as allotment of accommodating fundraising efforts.21 Another barring applies to able advocacy payments fabricated to an absolved alignment if there is no adjustment or apprehension that the payor will accept any acknowledgment account in affiliation with the payment. There are additionally exceptions from UBIT that about administer to assertive forms of acquiescent income, including absolute acreage rental income; interests, dividends, and annuities; adeptness payments; and assertive basic assets from the auction of property.22 A nonprofit’s net different business assets that does not authorize for one of the applicative exceptions or exclusions is burdened at the ante applicative to corporations or trusts, depending on the organization’s accustomed structure.23
Operational Analysis and Commerciality Doctrine
Nonprofits are additionally accountable to the operational analysis and the commerciality doctrine, which serve to bind the income-generating activities they may appoint in. The operational analysis provides that a 501(c)(3) alignment charge be operated primarily for one or added of the absolved purposes set alternating in Internal Acquirement Code Section 501(c)(3).24 Alone an “insubstantial part” of the organization’s activities may be adherent to non-exempt purposes, such as operating an different business.25 While operating a accompanying business would not abnormally appulse an organization’s 501(c)(3) status, its primary purpose charge not be to backpack on an different barter or business. The regulations accommodate that in chargeless the actuality or antithesis of such primary purpose, all the diplomacy charge be considered, including the admeasurement and admeasurement of the different barter or business and the admeasurement and admeasurement of the organization’s activities that are in advocacy of one or added of its absolved purposes.26
Under the commerciality doctrine, a court-created acquired of the operational test, if a nonprofit is operating in a abode that is too commercial, it may accident accident its absolved status. In applying the commerciality doctrine, the IRS or the courts will about attending to whether a nonprofit is agreeable in activities that are in absolute antagonism with those of for-profits.27 In assessing commerciality, courts accept brash such factors as:
The limitations created by the operational analysis and commerciality commodity accomplish it difficult for a nonprofit to anon accomplish one or added different businesses that collectively adeptness arise to be abundant in admeasurement in affiliation to its absolute activities. Because declining the operational analysis would aftereffect in accident of absolved status, nonprofits with businesses that adeptness be brash both abundant and different are about counseled to accede bottomward such businesses into a wholly endemic for-profit taxable subsidiary, which will be accountable to the aforementioned taxation rules as added for-profits. For example, the nonprofit National Geographic Society operates its publishing services, agenda media properties, and television channels through for-profit subsidiaries such as National Geographic Academy Publishing, Inc., National Geographic Ventures, and National Geographic Channel. Similarly, the nonprofit Mozilla Foundation wholly owns the Mozilla Corporation, which handles the development and commercial-revenue-generating activities of the accepted Firefox browser.
The operational analysis and commerciality commodity advice to abode the affair over nonprofits aggressive with for-profits in businesses that would be brash different to the nonprofits’ absolved purposes. Additionally, nonprofits face several added restrictions that would arrest their adeptness to admission into the absolutely bartering arena acreage in antagonism with for-profits, including federal tax law prohibitions adjoin clandestine benefit, clandestine inurement, and balance account transactions.29
Private Account Restrictions
To authorize as absolved beneath Internal Acquirement Code Section 501(c)(3), an alignment charge serve a accessible rather than a clandestine interest.30 To amuse this requirement, referred to as the clandestine account doctrine, the alignment charge authorize that it is not operated for the account of clandestine interests. This does not beggarly that the alignment is absolutely banned from appointment allowances to individuals; rather, it provides that such allowances charge be incidental—quantitatively and qualitatively— to furthering of the organization’s absolved purposes.31
An alignment will analogously abort to authorize as a 501(c)(3) alignment if any allotment of its net balance accustom to the account of any clandestine actor or individual.32 This requirement, accepted as the clandestine inurement doctrine, about prohibits a 501(c)(3) alignment from appliance its assets for the account of a actuality accepting a claimed and clandestine absorption in the organization’s activities (i.e., an cabal such as a director, officer, or key employee).33 An alignment that engages in an inurement transaction (e.g., advantageous an absurd advantage to an insider) may face aishment of its absolved status.
While the clandestine account and clandestine inurement doctrines arise actual similar, there are two important differences. First, the clandestine account commodity is abundant broader than—and absolutely subsumes—the clandestine inurement doctrine, because it applies whenever an blamable account is actuality conferred on any clandestine party, not aloof insiders. Second, clashing the case with clandestine inurement, a banned clandestine account may not account a accident or abnegation of absolved status. But if the transaction involves one or added assembly accepted as “disqualified persons,”34 it may abatement aural the analogue of an balance account transaction35 and accountable the organization, the erfingers person, and alike lath associates who advisedly accustomed the transaction to cogent amends taxes.36 These limitations, which for-profits are not accountable to, serve to absolute the means in which individuals can alone account from the assets generated by a nonprofit, including through different business activities.
Lack of Enforcement
The vagueness of the law surrounding what is essentially accompanying to furthering an absolved purpose and what is not makes constant acquiescence and administration impracticable. In a final address of its Colleges and Universities Acquiescence Project, the IRS declared that 90 percent of the brash institutions underreported different business assets (“UBI”).37 Among the primary affidavit for the underreporting were the following: misreporting different business activities as accompanying activities; advertisement losses as affiliated to different business activities aback they were not (thereby blurred their UBIT liability); and misallocating costs that were acclimated to backpack out both absolved and different business activities and again applying an boundless allocation to account UBI.38 The report’s controlling arbitrary concluded: “The examinations of academy and universities articular some cogent issues with account to both UBI and advantage that may able-bodied be present abroad beyond the tax-exempt sector. As a result, the IRS diplomacy to attending at UBI advertisement added broadly. . . .”39
In 2014, the Advisory Committee on Tax Absolved and Government Entities (ACT), appointed by the Department of the Treasury, recommended that the IRS Absolved Organizations Division broadcast a absolute acquirement cardinal on a ambit of UBI issues, including identification of categories of activities that would be brash accompanying or unrelated.40 The ACT added recommended abnegation appliance of the commerciality analysis as continued as an organization’s assets and its banking assets were acclimated able in ambit with its accommodating program.41 This advocacy acceptable stems from the asperous appliance of the commerciality commodity and the ACT’s affirmation that “[n]either the tax law nor the implementing regulations accommodate abutment for a commerciality test.”42 It charcoal to be apparent whether these recommendations will be adopted and implemented.
Vague regulations both accord to and admixture the weakness of IRS enforcement, which has faced accurate analysis and criticism back the adumbration in 2013 of its inappropriate administration of absolution applications absolute assertive names or political themes. With bereft assets to abundantly baby-sit a area of over 1.4 actor absolved organizations43 and accountable to crippling account cuts that aggravate the administration challenges it is already facing, it’s absurd that the Absolved Organizations Division of the IRS will be able to decidedly strengthen its administration diplomacy in the a future.44 The severity of this botheration will acceptable be amplified by the July 2014 addition of Anatomy 1023-EZ, the abbreviate anatomy absolution appliance that will acquiesce a all-inclusive majority of abate organizations to administer for and accept 501(c)(3) cachet while accouterment about no description of their absolute and brash activities.
Gene Takagi, JD, MNA, is managing advocate of the NEO Law Group, a San Francisco–based law close focused on apery nonprofit and tax-exempt organizations. Takagi is additionally a accidental editor of the Nonprofit Law Blog. Tony Wang, JD, MBA, is a law agent at Gunderson Dettmer, a Silicon Valley–based law close focused on apery entrepreneurs, arising advance companies, and adventure capitalists. Prior to alive at Gunderson Dettmer, Wang brash altruistic foundations on their amusing action and appulse advance strategies.
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