What is a Charity? Changing Views on Tax Exemption

In exchange for their public service, charitable organizations may be rewarded at the state and federal level through property tax exemptions and income tax exemptions respectively. However, with lower tax revenues and the increasing disproportion between donations and commercial sources that make up a charity’s earned income, charities are being asked to defend their special treatment.

At the local level, the New York Times reported that various rough estimates show property tax exemptions cost local governments approximately $8 to $13 billion annually and with decreasing tax revenues, state and local governments are feeling pressure to more precisely define “charity” in order to determine which organizations are justified in receiving a property tax exemption. This is a difficult question for both local governments as well as those involved in the nonprofit sector as many nonprofit organizations are becoming increasingly less distinguishable from businesses in light of such fundraising activities as the selling of products as well as the scrutiny that accompanies charging fees for services and other financial concerns about whether an organization is really providing anything for “free” that warrants an exemption.

Last December, the Minnesota Supreme Court attempted to answer this question when it ruled that the Under the Rainbow Child Care Center, a small nonprofit day care agency with 95% of its revenue coming from fees paid by families or by country and tribal governments, was not eligible for the property tax exemption because it charged the same fee for services regardless of the parents’ ability to pay and did not offer rates lower than its competitors. The Court therefore determined that it did not provide services that would qualify it as a “purely public charity.” Jon Pratt, executive director of the Minnesota Council of Nonprofits, disagrees with the Court’s straightforward reliance on an organization’s “free services” without also giving weight to government payments as evidence of the organization’s charitable status. If an organization is charitable only when it “gives anything away,” Pratt argues that an estimated 300 and 500 nonprofit groups could lose their property tax exemptions in the state of Minnesota alone.

Federal government officials, which are primarily concerned with an organization’s income tax exemption, are also feeling compelled to address this growing concern given that service fees, sales, and sources other than charitable contributions comprised roughly 88% of overall nonprofit revenues in 2005, according to the National Center for Charitable Statistics. With these kinds of statistics, Congress is questioning whether organizations are truly fulfilling their charitable purposes and relieving the government’s burden enough to justify special treatment. However, although they are taking steps to address concerns over services provided by nonprofit hospitals, the expenses made by religious organizations, and the balance between endowment payments and its large accumulation of wealth such as Harvard’s $35 billion endowment, the federal officials seem no more knowledgeable than local officials about how to base their decisions.

In the end, these debates over proper legislation leave the private citizens and nonprofit organizations unclear as to what constitutes a “charity” on a state and federal level and how organizations are to raise the necessary capital beyond what the government can give in order to provide their services without overstepping their boundaries into the for-profit sector. Property and sales taxes can range from thousands to millions of dollars – certainly a large sum of money to revoke from an organization based on seemingly vague definitions. While it is important to justify the special treatment afforded to nonprofit organizations not only to maintain healthy tax revenues as well as the integrity of the nonprofit system, we should be wary of broad adjudication so as not to deter charitable organizations from undertaking their charitable aims or deprive worthy organizations from funds that are much better used in supporting their social services.

For more information, see Stephanie Strom’s article "The Case of Under the Rainbow Child Care Center v. Goodhue County" in The Nonprofit Quarterly and the Nonprofit Congress Blog.

– Emily Chan