Tax-Exempt Organizations: Operational Requirements (Portfolio 451)

Tax Management Portfolio No. 451, Tax-Exempt Organizations: Operational Requirements, describes the operation of organizations exempt from federal income taxation under the Internal Revenue Code of 1986, as amended. To view this Portfolio, visit Bloomberg Tax for a free trial.

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Tax Management Portfolio No. 451, Tax-Exempt Organizations: Operational Requirements, describes the operation of organizations exempt from federal income taxation under the Internal Revenue Code of 1986, as amended. Tax-exempt organizations are required to meet both the Organizational Test and the Operational Test in order to qualify for tax-exempt status. This Portfolio emphasizes the Operational Test. There is much overlap in the Organizational Test and the Operational Test so readers should be careful to consult both this Portfolio and its companion, Tax Management Portfolio No. 450, Tax-Exempt Organizations: Operational Requirements. Because § 501(c)(3) organizations dominate the tax-exempt community, the Portfolio concentrates on the operational aspects of those organizations.

In addition to discussing the general operational requirements of §501(c)(3) organizations, this Portfolio analyzes the operational requirements of hospitals, health care providers, legal assistance and litigation organizations, public works organizations, educational organizations, scientific organizations and other types of charitable organizations. This Portfolio also discusses the legislative and political activities tax-exempt organizations are allowed to engage in, as well as the prohibition against engaging in a trade or business by these tax-exempt organizations.

The reporting and record-keeping requirements of exempt organizations are discussed in 452 T.M., Tax-Exempt Organizations: Reporting, Disclosure and Other Procedural Aspects. Other issues relating to tax-exempt organizations discussed herein are covered in greater detail in other Portfolios, to which reference is made where appropriate.

This Portfolio may be cited as Webster, 451 T.M., Tax-Exempt Organizations: Operational  Requirements.


Hugh K. Webster, Esq.

Hugh K. Webster, A.B., Middlebury College (1983); J.D., Duke Law School (1986); Author, 452 T.M., Tax-Exempt Organizations: Reporting, Disclosure and Other Procedural Aspects; Author, 488 T.M., Fiduciary Duties of Nonprofit Directors and Officers; Author, 613 T.M., Lobbying and Political Expenditures; Author, 614 T.M., Trade Associations; Author, The Law of Associations (Matthew Bender & Company); Editor, Nonprofit Legal and Tax Letter.

Table of Contents

Detailed Analysis
I. General Considerations — Introduction
II. The Organizational and Operational Tests of §501(c)(3)
Introductory Material
A. The Organizational Test
B. The Operational Test
III. Religious Organizations
Introductory Material
A. Definitions of Religious Organization and Church
1. Characteristics of a Religious Organization
2. The IRS's Standards to Define the Term “Church”
3. Compliance with Other Requirements of §501(c)(3)
4. Inquiries into Religious Beliefs
5. Religious Social Retreats
B. Mail Order Churches and Other Organizations Furthering Private Interests
1. Mail Order Churches
2. Other Organizations Furthering Private Interests
IV. Charitable Organizations
Introductory Material
A. Background
B. Relief of the Poor or of the Underprivileged
C. Legal Assistance and Litigating Organizations
1. Legal Aid Organizations
2. Human and Civil Rights Organizations
3. Organizations Acting as Litigation Plaintiffs
4. Public Interest Law Firms
D. Public Works, Lessening the Burdens of Government, and Promotion of Social Welfare
1. Organizations that Erect or Maintain Public Works
2. Organizations that Lessen the Burdens of Government
3. Organizations that Promote the Social Welfare
E. Hospitals, Health Care Providers, and the Promotion of Health
1. Patient Protection and Affordable Care Act Requirements
2. Hospitals
a. General Requirements for Exemption
b. Congressional Hearings
c. Hospital Audit Guidelines
d. Physician Recruitment Incentives
e. Hospital/Physician Joint Ventures
f. Purchase of Physician Practices
g. Reorganizations
h. Integrated Delivery Systems
i. Whole Hospital Joint Ventures
j. Title-Holding Companies
k. State Law Concerns
l. Pennsylvania State Law Developments
3. Health Maintenance Organizations
4. Section 501(m) and the Provision of Commercial-Type Insurance
5. Peer Review Organizations
6. Faculty Group Practice Organizations
7. Home Health Agencies
V. Educational Organizations
Introductory Material
A. Instruction or Training of the Individual
B. Education of the Public
C. College and University Examination Guidelines
VI. Scientific Organizations
VII. Other Organizations
Introductory Material
A. Literary
B. Testing for Public Safety
C. Prevention of Cruelty to Children or Animals
D. Amateur Athletic Organizations
E. Cooperative Hospital Service Organizations
F. Cooperative Service Organizations of Operating Educational Organizations
G. Child Care Facilities
VIII. Private Inurement, Private Benefit, and Intermediate Sanctions
Introductory Material
A. Private Inurement
1. Background
2. Relationship to Private Benefit and “Exclusively”
B. Common Types of Inurement or Private Benefit
1. Unreasonable Payments
a. Compensation
b. Rent
c. Loans
d. Retained Interests
2. Other Forms of Private Inurement or Private Benefit
a. Organization Formed to Reduce Founder's Tax Liability
b. Conversion of For-Profit Organization to Nonprofit Status
c. Conversion of Nonprofit Organization to For-Profit Status
C. Public v. Private Benefit
D. Intermediate Sanctions
1. Introduction
2. Excess Benefit Transactions
3. Disqualified Persons
4. Applicable Organizations
5. Liability for the Tax
6. Effective Dates
IX. Legislative and Political Activities
Introductory Material
A. Background
B. Legislative Activities
1. Action Organizations
2. What Constitutes an Attempt to Influence Legislation
3. “Substantial Part” Test
4. Section 501(h) Election
5. Sanctions for Excessive Lobbying
6. Disallowance of Deduction for Dues Paid to Trade Associations Engaged in Lobbying
C. Political Activities
1. Prohibition on Political Activities
2. 1987 Act
D. Educational Activities
E. Constitutional Considerations
F. Lobbying and Political Campaign Activities of Other Types of Tax-Exempt Organizations
1. Social Welfare Organizations
2. Labor, Agricultural and Horticultural Organizations
3. Business Leagues or Trade Associations
4. Social Clubs
5. Veterans Organizations
6. Other Considerations
G. Attribution of Political Campaign Activities to an Organization
X. Engaging in a Trade or Business
Introductory Material
A. Generally
B. Revenue Act of 1950 and 1969 Act
1. Background
2. Revenue Act of 1950
3. 1969 Act
4. Rate of Tax
C. Elements of an Unrelated Trade or Business
1. The Requirement of a Trade or Business
2. Regularly Carried On
3. Substantially Related
D. Exclusions from the Definition of Unrelated Trade or Business
1. Trade or Business Carried on by Volunteers
2. Convenience Exception
3. Exception for Donated Property
4. Qualified Public Entertainment Activities
5. Trade Shows
6. Hospital Services
7. Bingo and Other Games of Chance
8. Low-Cost Articles
9. Exchanges and Rentals of Mailing Lists
10. Pole Rentals
E. Examples of Related and Unrelated Trades or Businesses
1. Related Activities
2. Unrelated Activities
F. Corporate Sponsorship Payments and UBIT Liability
1. Prior Law
a. In General
b. Audit Guidelines
c. 1993 Proposed Sponsorship Regulations
2. Current Law
a. 1997 Legislation
b. Regulations
G. How Much Unrelated Income?
1. Generally
2. Commensurate Test
H. Computation of UBTI
I. Modifications to an Organization's UBTI
1. In General
a. Dividends, Interest, and Payments with Regard to Securities Loans
b. Royalties
c. Rental Income
d. Other Modifications
2. Section 512(b)(13) Controlled Organizations
3. Other Rules
a. S Corporation Shareholder
b. Income From Controlled Foreign Corporation
J. Partnerships of Exempt and Non-Exempt Entities
K. Deductions
L. Periodical Income
M. Special UBIT Rules for Social Clubs
N. Other Rules
XI. Unrelated Debt-Financed Income
Introductory Material
A. Background
B. Computation of Unrelated Debt-Financed Income
1. Debt-Financed Property
2. Acquisition Indebtedness
3. Average Adjusted Basis
C. Exception for Qualified Organizations
XII. Excise Tax on Accommodation Parties in Tax Shelter Transactions

Working Papers

Table of Worksheets
Worksheet 1 Common Tax Law Restrictions on Activities of Exempt Organizations
Worksheet 2 Compensation Policy
Worksheet 3 Compensation Rebuttable Presumption Checklist
Worksheet 4 Sample Joint Venture Policy
Worksheet 5 Public Disclosure Policy
Worksheet 6 Board of Directors Conflict of Interest Policy