Nonprofits: don't jeopardize exempt status

NONPROFIT NEWS

In February, we saw a continuation of the charged political and social environment that the election and this new administration have ushered in, with many exempt organizations moving forward with opposing policies they view as contrary to their exempt purposes or harmful to the populations they serve. While there are many advocacy-related activities that exempt organizations may engage in in furtherance of their purposes, it may be a good time for a reminder that organizations that engage in or encourage activities that are illegal or contrary to established public policies may potentially jeopardize their exempt status. Relatedly, the conservative Christian Bob Jones University, which had its 501(c)(3) exempt status revoked many years ago due to its racially discriminatory policies, which the IRS deemed were contrary to public policy, announced in February that it would regain exemption as of March 1.

Bob Jones University Regains Exemption

In mid-February, Bob Jones University, a conservative Christian college, announced that it would regain its status as a tax-exempt 501(c)(3) organization on March 1 after a more than two-year long process. The university had previously been recognized as exempt under IRC Section 501(c)(3), but lost its exemption more than 30 years ago, following a 13-year battle with the Internal Revenue Service. The IRS maintained that the university's policy prohibiting interracial dating or marriage amongst its students, staff, and faculty precluded it from exemption as a religious educational institution.

Although the IRS had historically recognized private schools as exempt under Section 501(c)(3) regardless of whether they maintained racially discriminatory admissions policies, in 1970, it revised its policy regarding the eligibility for exempt-status of such schools. In 1971, the IRS issued Revenue Ruling 71-447 setting forth this revised policy and stating that "discrimination in education is contrary to Federal public policy. Therefore, a school not having a racially nondiscriminatory policy as to students is not 'charitable' within the common law concepts reflected in sections 170 and 501(c)(3) of the Code and in other relevant Federal statutes and accordingly does not qualify as an organization exempt from Federal income tax."

In 1970, the IRS formally notified Bob Jones University of its change in policy and announced its intention to challenge the tax-exemption of discriminatory private schools. In response, in 1971, the university filed a lawsuit seeking to enjoin the IRS from revoking its exempt-status, which failed. In April 1975, the IRS notified the university of the proposed revocation of its tax-exemption, which was officially revoked in January 1976, retroactive to December 1970. The university paid a minimal tax of $21 for one employee for the year of 1975 and then requested a refund. When the refund was denied by the IRS, the university filed suit challenging the denial and revocation and the government counterclaimed for unpaid taxes plus interest.

The university's challenge went all the way up to the Supreme Court, which ruled in 1983 to uphold the IRS's revocation of exemption. The court found that the government's fundamental, overriding interest in eliminating racial discrimination in education substantially outweighed any impact denial of tax-exemption placed on the university's First Amendment rights to exercise its religious beliefs.

The university abandoned its prohibition on interracial dating and marriage in 2000, but did not begin the process of reinstating its tax-exempt status until 2014. Regaining status as a 501(c)(3) organization will mean that donors can give tax-deductible charitable contributions directly to the university to support its general operations, capital campaigns, or other initiatives. Previously, donors wishing to give tax-deductible contributions typically instead supported nonprofit arms of the university, such as its art museum, athletic foundation, or scholarship fund.

Activities that Violate Public Policy

The IRS's position regarding racially discriminatory schools and eligibility for exemption turns on the intersection of tax-exemption and public policy - an issue that has come up recently as some exempt organizations struggle with how to best oppose policies flowing from the current presidential administration that they view as problematic and harmful. For example, a CNN article in February asked whether churches could provide legal sanctuary to undocumented immigrants present in the U.S. and facing potential deportation.

According to the article, while churches are not able to provide actual sanctuary protection to undocumented immigrants, immigration enforcement officials rarely enter places of worship to make arrests, thereby leading some churches to offer their buildings as places of refuge. U.S. Immigration and Customs Enforcement has said that the policy is not absolute, but is intended to ensure that people can seek services and participate in activities in sensitive places without fear.

Moreover, the Immigration and Nationality Act prohibits anyone from knowingly harboring an undocumented immigrant in any place. Although individuals who are convicted of violating this prohibition may face prison time, prosecutors have also generally been reluctant to go after pastors or other religious leaders for such activities, and the optics of doing so may not play out favorably for the government. Nonetheless, the possibility of prosecution exists and pastors have on occasion been arrested for such activities in the past.

An interesting question, however, is whether offering such sanctuary housing could jeopardize a church's exemption under Section 501(c)(3). The IRS has made clear in prior publications that organizations face denial or revocation of exemption if they engage in illegal activity or in activity that violates public policy, referred to as the "illegality doctrine." The notion behind the illegality doctrine is that the government should not provide support in the form of tax-exemption for behavior that it is charged with preventing and that increases the burdens of government rather than serving a public purpose.

An organization with purposes that are illegal is not formed exclusively for exempt purposes as set forth in Section 501(c)(3) as required by the operational test and is therefore not qualified for exemption. On the other hand, when an organization is formed for legal and exempt purposes, but engages in some illegal activities, the substantiality (both quantitatively and qualitatively) of those illegal activities will determine whether the organization satisfies the operational test and qualifies for exemption under Section 501(c)(3).

However, the IRS has generally been reluctant to revoke or deny exemption in circumstances where the illegality of the actions is not clearly established and has noted that the IRS is generally not in a position to make determinations as to the legality of an action under laws other than the Internal Revenue Code. With respect to actions that may not be inherently illegal, but possibly violate public policy, the IRS has indicated that such public policies should be clearly defined and established, important, and fundamental and has similarly been reluctant to revoke exemption on this basis.

Nonetheless, it is an important limitation for exempt organizations to be mindful of in the current political environment. 501(c)(3) organizations generally have wide latitude to engage in non-lobbying advocacy activities in furtherance of their exempt purposes, and public charities are generally able to engage in a limited amount of lobbying activities, as well. However, 501(c)(3) organizations that engage in or encourage others to engage in activities that are illegal or contrary to established public policies could potentially be jeopardizing their exempt-status, particularly if the organization's purpose is to engage in such activities or such activities represent a substantial part of the organization's overall activities.