'Must Operate Exclusively for Exempt Purposes' Really Means Exclusively (as Defined in the Regulations)

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By Kathleen Ford Bay

Richards Rodriguez & Skeith LLP, Austin, TX

Cleverness in the tax world may, at times, lead to draconian
results that would have been avoided if the taxpayer had taken a
more conservative approach to applicable rules. The recent Tax
Court Memorandum decision in Capital Gymnastics Booster Club,
Inc. v. Commissioner
, T.C. Memo 2013-193, illustrates
cleverness gone awry.

Any parent whose child participates in extracurricular athletics
finds out early on that the cost of doing so is not just the price
of the weekly lessons. Coaches urge, nay even require, that the
young athletes participate in meets, in competitions. Generally,
those meets are not in the city where you live and there are entry
fees and other costs.

About 240 families of young gymnasts (ages 6 - 18), all of whom
belonged to one training center gym in Virginia, were required by
the training center to be members of Capital Gymnastics Booster
Club. The Booster Club, located in Burke, Virginia, had
incorporated in 1987 and received recognition of its tax-exempt
status in 1988.  Apparently, in 1987, gymnastic training had
far more athletes than in 2003. The Memorandum decision does not
discuss the first 15 years of the Booster Club's operations;
however, the inference is that times had changed by 2003 in ways
that, when the Booster Club devised strategies to make money and
alleviate the costs borne by parents, the Booster Club lost its
tax-exempt status.

The problem was this: Booster Club parents not only were
required to be members of the Booster Cub, but where required to
"donate"/pay to the Booster Club amounts equal to the entry fees
for meets plus estimated cost of the coaches' travel
expenses.  The donations/assessments were tied to the
athlete's competitive level and ranged from $600 to $1,400 per
athlete in 2003. These were in addition to the training fees paid
directly to the training center.  What if a parent just did
not have enough, or did not want, to cover both the regular
training fees ($200/month to $330/month depending on the age group)
plus the assessments for meets? Also, parents paid additional
expenses directly, including national dues, a registration fee of
$100, the cost of specialized equipment such as grips and official
gym uniforms, travel to gymnastics meets (airline tickets, hotels,
and restaurants for the athletes, and for their parents attending
those competitions.) Parents whose children have been involved in
athletic clubs know that you cannot choose just not to attend
certain meets due to the cost, for those meets are almost always
mandatory.  In fact, the training center did not allow
athletes to compete unless the assessment, and late fees if any,
had been paid in full. Parents could fulfill their assessment
obligation by raising funds for the Booster Club. About half the
families did so. The Booster Club then transferred raised funds to
the training center and those transferred funds were credited to
the parents who had raised them, using a "point" system. Nothing in
the record at the Tax Court level indicated that there were
scholarships or any leeway on the rule that assessments had to be
paid in order for each athlete to compete. Nothing indicated that
the parents who did fundraising instead of paying the assessments
directly were themselves treated as a charitable class - indigent,
for example.

The Tax Court considered only the issue of whether or not the
Booster Club's operations were exclusively for exempt
purposes.  It did not consider and was not presented with the
following: (1) whether or not the parents were taking charitable
deductions on their income tax returns for payment of the
assessments, either directly to the Booster Club or via "donations"
to the Booster Club, be they in the form of cash donations or the
earning of "points" by fundraising or (2) if the training center, a
private for profit organization, was receiving benefits such that
there was private inurement to the training center. The Tax Court,
in reviewing the IRS's determination, may consider only "a case of
actual controversy;" that is, the reasons the IRS offers in its
final determination or at trial for revocation. §7428(a).
(Interestingly, the Tax Court noted that there were these other
issues, but it was not basing its ruling on them, with the
inference that these other issues might also form the basis for
revocation.)

The Booster Club maintained that its primary purpose was
fundraising to support and foster amateur gymnastics.  The Tax
Court focused not only on the way in which Booster Club funds were
used - in ways intended for and that did benefit private
individuals: private inurement, but also on the fundraising
operations.  One-fourth of the funds raised for the Booster
Club ($180,000 in 2003) came from the sale of "scrip" from local
merchants.  For example, a grocery store would sell coupons
with a face value of $100 to the Booster Club for $95 each. When
the Booster Club re-sold them, it made a $5 profit on each coupon.
Who bought the coupons from the Booster Club? "Virtually" only the
parents bought these coupons. The Tax Court noted that by engaging
in this type of fundraising, the parents did so at virtually no
cost to the Booster Club. (This is sometimes referred to as one of
the "painless" ways of raising funds for an organization. Merchants
only provided "scrips" to organizations recognized as being
charitable.)

In 2005, the IRS examined the Booster Club's operations for
2003. In October 2006, the IRS notified the Booster Club that it
intended to revoke its tax-exempt status. The Booster Club appealed
this decision. In December 2009 (notice that this is more than two
years after the first notification, but, of course, the Booster
Club knew it was being examined), the IRS issued a final adverse
determination letter stating that the Booster Club "had failed to
establish that its income `did not inure to the benefit of private
individuals and shareholders, which is prohibited by I.R.C.
§501(c)(3). You are operated for a substantial private purpose,
which is prohibited by Internal Revenue Code section 501(c)(3).' "
The revocation was effective for 2003 forward.

The Tax Court's ruling was in response to a declaratory judgment
sought by the Booster Club under §7428.  The Booster Club also
chose to be aggressive, taking the position that, basically, all
booster clubs raise funds like it did and that since the children
are a "charitable class" and all the funds raised redound to their
benefit, the Booster Club was operating properly. The Booster Club
argued that "it seems inconceivable that Congress could have
intended such an absurd result" as to prohibit booster clubs from
spending any part of their earnings for the benefit of the children
who are on an athletic team. The Tax Court wrote that "In the end,
Capital Gymnastics seeks the Court's endorsement that its `method
for allocating fundraising profits is not only permissible and
lawful, but it should be recognized as a `best practice' for
similar organizations to follow.' "

The Tax Court noted that it was the Booster Club's burden to
overcome the IRS's determination that, because of the manner in
which Capital Gymnastics credited fundraising points, (1) part of
its net earnings inured to the benefit of private individuals
(i.e., parent-members) and (2) it operated in that substantial
respect not for the benefit of the public but for the benefit of
designated private individuals (i.e., the children of fundraising
families).  Tax Court Rule 142(a); Rameses School of San
Antonio, Tex. v. Commissioner
, T.C. Memo 2007-85.

The Booster Club apparently made great efforts to show that it
did more than just the scrip fundraising activities to which the
point system applied. Regs. §1.501(c)(3)-1(c)(1), provides: "An
organization will be regarded as operated exclusively or one or
more exempt purposes only if it engages primarily in
activities which accomplish one or more of such exempt purposes
specified in section 501(c)(3). An organization will not be so
regarded if more than an insubstantial part of its
activities is not in furtherance of an exempt purpose." Even if
operations are not entirely tax exempt, if only an "insubstantial"
part of those operations are non-tax-exempt, its operations will
still be treated as being "exclusively" for exempt purposes.
However, the Tax Court found that the non-exempt operational
activities were not "insubstantial." The Booster Club did not meet
its burden of proof and the Tax Court affirmed the revocation of
its exemption beginning in its 2003 fiscal year.

What now? Will the IRS review the income tax returns of the
merchants which provided scrip and disallow any charitable
deductions? Will the IRS review the income tax returns of Booster
Club members with, perhaps, the goal of: (1) disallowing any
charitable deductions for direct payment of the training center
assessment and (2) additional income to those parents who paid part
or all of their assessment through points? Will the IRS assess
income tax on the Booster Club for all fundraising receipts in 2003
forward? Has the statute of limitations run on any of the tax years
in question? When will the Booster Club be removed from the IRS
list of tax-exempt entities? As of early October 2013, the Booster
Club was still listed as a public charity on the IRS website. Why
is it still there? Until the Tax Court's ruling, and as an
exception to the general principle that action by the IRS may not
be enjoined (§7421(a)), §7428 to provides that an organization may
challenge "a determination by the Secretary * * * with respect to
the * * * continuing qualification of an organization as an
organization described in section 501(c)(3)." Thus, until the Tax
Court's ruling is final, the Booster Club will probably remain on
the IRS's website. Perhaps there should be a note setting forth the
status of the revocation proceedings.  As of now, even though
the proceedings are a public record, apparently the potential donor
taxpayer must search them out. Query: If an organization whose
charitable status has been revoked, but which has appealed that
decision, does not inform its potential donors of this fact (for
doing so could result in a decrease in donations; perhaps in no
donations) and later the donors lose the charitable deduction for
donations and must pay additional income taxes (and interest;
hopefully, avoiding penalties), do the Board members of the
organization potentially bear any liability for failing in their
fiduciary duties by a failure to inform? Looking to the state of
incorporation, as of early October 2013, the Virginia Department of
Agriculture and Consumer Services, Charitable Organizations
Database, reflected the revocation of the Booster Club's ITS tax
exemption. The Booster Club is not listed on the Better Business
Bureau website. Laura Sanders with The Wall Street
Journal
 wrote a story on this case dated September 13,
2013, available online, "Booster Clubs Attract Scrutiny," in which
she quotes Sandra Englund, attorney founder of Parent Booster USA
(a §501(c)(3) charity which, among its exempt activities, advises
about 1,500 booster clubs on tax compliance) as suggesting three
options for booster clubs going forward: (1) switch from mandatory
membership and requirement of donation and/or labor and just
encourage participation in the booster club; (2) switch from a
§501(c) to a different income tax-exempt entity, perhaps a
§501(c)(6); or (3) just be a for profit business entity.

For more information, in the Tax Management Portfolios, see
Webster, 450 T.M.
, Tax-Exempt Organizations: Organizational
Requirements, Webster 451 T.M., Tax-Exempt Organizations:
Operations Requirements, and Webster, 452 T.M., Tax-Exempt
Organizations: Reporting, Disclosure and Other Procedural Aspects,
and in Tax Practice Series, see ¶6510, Charitable
Organizations, and ¶6520, Other Tax-Exempt Organizations.

Copyright©2013 by The Bureau of
National Affairs, Inc.