Some organizations are founded for the purpose of serving the public good, rather than making money for owners. These organizations may operate as Tax-Exempt and avoid paying income taxes on the money they earn or obtain as long as that money is used to fulfill the organization’s purpose. An organization must apply to the Internal Revenue Service to be classified as a Nonprofit and obtain Tax-Exempt Status. Different sections of the Internal Revenue Code (IRC) allow different types of organizations to be classified as Exempt Nonprofits. Most charitable and religious organizations, as well as organizations intended to promote science or literacy or protect kids and animals – obtain their Tax-Exempt Status under section 501(c)(3) of the Internal Revenue Code.
Section 501(c)(3) of the Internal Revenue Code allows for an organization to be a Tax-Exempt Nonprofit only if it is organized exclusively for an exempt purpose. This section of the IRS Code doesn’t specifically use the term “Private Benefit.” However, an organization is not organized exclusively for an exempt purpose if it concerns Private Benefits that are more than just incidental to furthering its charitable goals.
In other words, if an individual benefits from an organization rather than society or the public, then this can jeopardize the organizations’s Tax-Exempt Status. The distinction between a public good and a Private Benefit can be difficult to make, and an experienced Scottsdale Arizona nonprofit lawyer should be consulted for help understanding the meaning of Private Benefit and how it applies to your organization.
Defining a Private Benefit
Drawing a distinction between an organization intended to provide a Private Benefit and one intended to serve an exempt purpose can be difficult. After all, individuals are members of the public. A soup kitchen, for example, feeds individuals. However, while a soup kitchen is created to benefit the individuals who are being fed, this does not necessarily mean that the soup kitchen is conferring a Private Benefit and should lose its Tax-Exempt Status. If the soup kitchen was set up to provide food only to a small select group of people, however, this could mean that it was conferring Private Benefits that are not permissible if the organization wants to maintain Tax-Exempt Status. This is true even if the small select group of people are among the hungry who are part of a larger charitable class.
To draw a distinction between a Private Benefit that is impermissible and a charitable purpose, it is essential to assess whether the benefit is qualitatively and quantitatively incidental. The Private Benefit, for example, will need to be a by product of the benefit to the public (qualitatively incidental) and will need to be insubstantial (quantitatively incidental) in order for the organization to be considered Tax-Exempt under 501(c)(3) provisions. To determine if the organization is benefitting the public or a private individual, the IRS will consider:
- The size of the group of people who will benefit.
- Whether the organization is entering into transactions on unreasonable or unfavorable terms.
- Whether the organization engages in a substantial amount of activities that are not directly related to fulfilling a charitable purpose.
- Whether private parties are receiving more benefits than would be necessary for the charity of fulfill its exempt purposes.
- Whether the 501(c)(3) organization establishes exclusive business dealings with a for-profit enterprise or fails to compare prices or consider alternative sources of services or goods.
It is very important to avoid conferring Private Benefits if your organization is Tax-Exempt under 501(c)(3). Call a Scottsdale Arizona nonprofit lawyer at Lotzar Law Firm, P.C. for help to ensure you are able to avoid mistakes that could jeopardize your nonprofit status.
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