Written by attorney Gorham Sharpless Clark


A. Absolute Prohibition of Private Inurement

To qualify for and maintain tax-exempt status under section 501(c)(3) of the Internal Revenue Code (“I.R.C."), “no part" of the organization’s net earnings may “inure" in whole or in part to the benefit of any persons who have a personal or private interest in the activities of the organization. [1] While there is an absolute prohibition against inurement, the term is not precisely defined. There is no de minimus exception and net earnings may inure in ways other than by actual distribution of dividends or excessive payments. [2] Generally speaking, the inurement doctrine prohibits conferring a personal benefit on so-called “insiders." What constitutes inurement in any case is the subject of a factual determination in which the organization claiming tax-exempt status bears the burden of proof. [3] If there is any private inurement, the I.R.S. revokes the organizations tax-exempt status and can do so retroactively. [4] This doctrine was analyzed extensively in our earlier memorandum to the Board of Trustees addressing the activities at the equestrian center.

B. Separate Private Benefit Prohibition as Distinguished from Private Inurement

Despite overlapping characteristics, the private benefit and private inurement doctrines are distinct. [5] Where the inurement prohibition captures “insiders," the private benefit prohibition casts a wider net to include both insiders and unrelated or “disinterested" persons. [6] Private benefit analysis thus involves fact-specific investigation of whether an organization’s activities confer nonincidential private benefits on unrelated persons. [7] For purposes of this memorandum, it is significant to note that the inquiry into whether certain activities violate one prohibition does not preclude inquiry into whether the same activity violates another prohibition. Therefore, an activity may not violate the self-dealing rules, but still may violate the private benefit doctrine. Of course, the penalty for violation of the private benefit doctrine is revocation (possibly on a retroactive basis) of 501(c)(3) status.

[1] I.R.C. §501(c)(3) (“Corporations…organized and operated exclusively for…charitable…or educational purposes…no part of the net earnings of which inures to the benefit of any private shareholder or individual…"); see also, 26 C.F.R. §1-501(c)(3)-1(c)(2) (“An organization is not operated exclusively for one or more exempt purposes if its net earnings inure in whole or in part to the benefit of private shareholders or individuals."); see also, 26 C.F.R. §1-501(a)-1(e) (broadly defining private shareholder or individual.)

[2] See, e.g., Redlands Surgical Services v. Comm., 113 T.C. 47, 74 (1999) (benefit may be an advantage).

[3]Ltr.Rul. 200511016 (“The Court concluded that plaintiff failed to meet its burden of proof that a part of the corporate net earnings was not a source of benefit to private individuals." (citing, Founding Church of Scientology v. U.S., 412 F.2d 1197 (Ct.Cl. 1969))); see also, Salvation Navy, Inc. v. Comm., T.C. Memo. 2002-275 (company failed to meet burden to show no inurement to private individual.)

[4] See, e.g., Tauber v. Commonwealth of Virginia, 263 Va. 520, 526 (2002) (referencing I.R.S.’s 1972 revocation of Jefferson Memorial Hospital, Inc.’s tax-exempt status retroactive to 1965.)

[5] American Campaign Academy v. Comm., 92 T.C. 1053, 1068 (1989) (“We have consistently recognized that while the prohibitions against private inurement and private benefits share common and often overlapping elements [citations omitted], the two are distinct requirements which must be independently satisfied."); see also, Redlands Surgical Services v. Comm., 113 T.C. 47, 74 (1999) (same).

[6] See, Redlands, supra, 113 T.C. 47, 74 (“The proscription against private benefit encompasses not only benefits conferred on insiders having a personal and private interest in the organization, but also benefits conferred on unrelated or disinterested persons.")

[7] Id. (“Prohibited private benefits may include an advantage; profit; fruit; privilege; gain; or interest.")

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