The private benefit doctrine is the broadest of the private benefit rules that apply to 501(c)(3) organizations. It generally provides that a 501(c)(3) organization may not confer any benefit, monetary or otherwise, on any individual or entity that is not incidental, quantitatively and qualitatively, to furthering the organization’s exempt purposes. The concern behind the doctrine is that, by providing more than an incidental private benefit to an individual or entity, the organization may not be organized exclusively and operated primarily for an exempt purpose, as Section 501(c)(3) requires. Although the rule is relatively simple to state, it can be tricky to apply. Here are a few examples that may help to clarify the applicability of the private benefit doctrine:
Can a charity hire a fundraising consultant who charges very high fees?
A charity is free to hire a fundraising consultant in the course of its operations. However, as with any goods or services that the organization purchases, it needs to ensure that it is not providing a benefit to any individual or entity that exceeds the fair value of the goods or services being provided to the organization in return. Violating the prohibition against providing a private benefit may result in revocation of 501(c)(3) tax-exempt status. In addition, there may be associated state law implications, including charges against the organization’s directors for breaching their fiduciary duty to the organization and failing to enforce the charitable trust impressed upon the organization’s assets. In order to avoid these consequences, and as a best practice, the organization’s board of directors will want to take appropriate steps to ensure that the compensation to the fundraising consultant is reasonable by gathering comparability data from other consultants in the same or similar field providing services to an organization of a similar size, and by documenting the basis for the board’s approval of the transaction concurrently with giving the approval (see, generally, the IRS webpage discussing rebuttable presumption procedures).
Does running an art gallery which displays and sells members’ art constitute a private benefit?
Although promotion of the arts is generally an acceptable exempt purpose, an art gallery that is not operated exclusively for this purpose may not qualify as a 501(c)(3) tax-exempt organization. The IRS issued a private letter ruling in late 2011 stating that, although the organization at issue conducted some educational classes and workshops, its primary activity was the operation of an art gallery in which the organization’s members could display and sell their art, and “perpetuating sales of art works for [its] members” is a non-exempt activity. The IRS further stated that a provision in the organization’s member agreement indicating that the artist was responsible for the cost of show materials, determining the exhibit details, and selecting invitees demonstrated a private benefit to the artist rather than community art education, which was merely incidental to the commercial nature of the organization’s activities. The IRS concluded “[b]ecause you operate for the private interests of your members in providing a space and a means for artwork to be viewed and sold rather than promoting the arts in general you are not serving public purposes and do not qualify [under Section 501(c)(3)].” The IRS further stated that, generally, “a cooperative art gallery formed and operated by a group of artists for the purpose of exhibiting and selling their works does not qualify for exemption under section 501(c)(3).”
What if an organization has social and professional development events to benefit its members?
Where an organization has as more than an insubstantial part of its activities social events to build relationships among its members or professional development events to help members advance their careers, this may constitute providing a private benefit to members that is not merely incidental to providing a public benefit. If this is the case, the organization is not operated exclusively for exempt purposes as required by Section 501(c)(3). Charging non-members more than members to attend organizational events also may constitute a private benefit to the members. In a private letter ruling issued in 2011, the IRS stated “[b]ecause more than an insubstantial part of your activities further the career and social interests of your members, which is a private benefit to your members that is not incidental to furthering any exempt purpose, and provide a private benefit to non-exempt organizations which is not incidental to furthering your exempt purposes, you are not operatedexclusively for exempt purposes. Accordingly, you are not an organization described in section 501(c)(3) of the Code.”
Although there are many other situations in which a nonprofit organization may potentially provide a prohibited private benefit, hopefully these examples help to illustrate a few scenarios in which the
private benefit doctrine may arise.