Commercial operations, abuse of charitable funds and Boy Scouts

NONPROFIT NEWS

In the height of the summer, we received an indication from the IRS in the form of a letter denying an applicant’s exemption under Section 501(c)(3) that the commerciality doctrine is still alive and well. We also saw the IRS, a bit late to the party, move to revoke the tax-exemption of a purported cancer charity that had settled a large lawsuit with the Federal Trade Commission two years ago. Finally, we witnessed the public relations nightmare that followed Trump’s speech to 40,000 Boy Scouts and their supporters, which he essentially used as an opportunity to hold a campaign rally for an election that already occurred.

Commerciality Doctrine and IRS Exemption Denial

In an exemption denial letter released in July (Denial 201729022), the IRS denied exemption under Section 501(c)(3) for an applicant on the basis that its activities demonstrated that it was not operated primarily in furtherance of an exempt purpose. The organization had indicated that it planned to provide colleges and universities with the ability to engage in science and engineering studies and research in marine science and engineering, including through acquiring, leasing or loaning submarines, and to provide related consulting services to such colleges and universities. It intended to provide such services, at least initially, through hiring independent third-party contractors rather than directly itself. It also planned to bill clients on a time and material basis, with an additional variable or flat fee to cover overhead expenses and reported that it was not planning to receive donations, but rather to be funded entirely by future earned revenue.

In denying exemption, the IRS found that the organization failed to meet the operational test required of 501(c)(3) organizations because its activities were not primarily in furtherance of 501(c)(3)-consistent exempt purposes. In so finding, the IRS relied heavily on what is referred to as the commerciality doctrine, a court-developed doctrine that assesses whether a nonprofit is operating in a manner that is too commercial in nature. The IRS cited Airlie Foundation v. Commissioner, 283 F. Supp. 2d 58 (D.D.C. 2003), in which the court found that the Airlie Foundation had operated a conference center in too commercial of a nature to qualify as exempt under Section 501(c)(3). In that decision, the court identified the following factors to be considered in assessing commerciality: (1) competition with for-profit commercial entities, (2) extent and degree to which below-cost services are provided; (3) pricing policies; (4) reasonableness of accumulated financial reserves; (5) use of commercial promotional methods; and (6) the extent to which the organization receives charitable contributions.

The marine research applicant tried to distinguish itself from other for-profit entities offering similar services by noting that it focused “on providing cost-effective, efficient, and comprehensive ways to execute operations while maximizing outcomes for grant-funded and low-resource academic/research groups.” However, the IRS nonetheless found that the applicant met a number of the Airlie factors for commerciality, including that it did not provide services below cost and did not plan to receive charitable contributions. The IRS concluded that the organization was “operated in a manner not significantly distinguishable from a commercial enterprise,” and was therefore furthering a substantial nonexempt purpose and thus failed the operational test required for 501(c)(3) exemption.

This denial is notable because of the continuing increase in the prevalence of earned revenue models in 501(c)(3)s and the IRS’s reliance on the court-derived commerciality doctrine. Although the IRS has somewhat selectively relied on the commerciality doctrine in the past in assessing whether organizations have satisfied the operational test, this denial letter signals that the doctrine appears to still be alive and well.

Caution: Shameless Greed Has No Place in the Nonprofit Sector

Nonprofits play an essential role in our society and I’m more than convinced that the vast majority of nonprofits strive to further their missions in a way that maximizes positive impact, is ethically sound, and legally compliant. Nonetheless, as with any area of society, there are occasionally stories of abuse within the nonprofit sector. While these stories tend to attract public attention due to their shock value, my hope is that they would instead serve as a cautionary tale to those who would wish to misuse charitable vehicles and charitable funds for their own benefit, leaving space for the inspirational and world-changing work being done by the many truly charitable entities.

A lawsuit was brought in May 2015 by the Federal Trade Commission, all 50 states, and D.C. against several “charitable” entities purporting to assist individuals with cancer and individuals associated with such entities. The four entities that were the subject of the suit were operated by James Reynolds, Sr. and his family members, and had allegedly raised more than $187 million in contributions. Two of the entities, Children’s Cancer Fund of America Inc. and The Breast Cancer Society Inc., along with several individual defendants, settled the same month that the complaint was filed. Two others, Cancer Fund of America Inc. and Cancer Support Services Inc., and Reynolds Sr., settled in early 2016.

The terms of the first settlement placed both entities in receivership, to be dissolved upon liquidation of their assets, and imposed judgments of more than $135 million collectively on the two organizations and three individual defendants, much of which was suspended due to the individual defendants’ inability to pay. The individual defendants, who had served as current or former CEOs of the entities, were also banned from engaging in any future nonprofit fundraising, charity management, or oversight of charitable assets. As part of the second settlement, the two other entities were to be permanently dissolved and Reynolds Sr. was similarly banned for life from serving as a nonprofit director, managing charitable assets, or profiting from nonprofit work. The settlement order also imposed a judgment against Reynolds Sr. and the two entities, jointly and severally, in an amount of nearly $76 million, the amount donated to the two entities between 2008 and 2012.

Rather belatedly, the IRS proposed by letter issued in March 2017 to revoke the tax-exempt status of the Breast Cancer Society Inc., of which James Reynolds, Jr. was the president and executive director, under Section 501(c)(3) retroactively beginning with its tax year ending December 31, 2014. The proposed revocation letter describes the extensive family relationships amongst the individuals compensated by the organization, as well the use of charitable assets to pay for personal expenses, including vacation airfare, college tuition payments, and gym memberships. The revocation letter stated that the organization had not met the operational test, which requires an organization to be primarily operated in furtherance of proper exempt purposes in order to qualify for 501(c)(3) exemption, due to the excessive private benefits it had provided to Mr. Reynolds Jr. and his family members, its excessive spending on professional fundraisers, and its inaccurate reporting of questionable non-cash distributions.

The Lesson of Trump and the Boy Scouts

I was really going to try to avoid mentioning Trump in this month’s column, but then he went and spoke at the Boy Scouts of America’s National Jamboree in July. The 2017 National Jamboree, which was the organization’s 20th, had nearly 40,000 participants. Trump was invited to speak and was apparently the eighth president to visit a National Jamboree, in addition to surrogates representing presidents. But the Boy Scouts of America quickly found itself in hot water and subject to public scrutiny after Trump’s lengthy speech veered into highly political, and just rather strange, territory.

A CNN article titled “The 29 most cringe-worthy lines from Donald Trump’s hyper-political speech to the Boy Scouts” quotes Trump as stating during the speech “I said, ‘Who the hell wants to speak about politics when I’m in front of the Boy Scouts?’ Right?” and “By the way, just a question, did President Obama ever come to a jamboree?” He went on to state “But do you remember that incredible night [referring to Election Day 2016] with the maps and Republicans are red and the Democrats are blue, and that map was so red, it was unbelievable, and they didn’t know what to say?” and “Wisconsin hadn’t been won in many, many years by a Republican. But we go to Wisconsin, and we had tremendous crowds. And I’d leave these massive crowds. I’d say, ‘Why are we going to lose this state?’”

The public blowback to the campaign rally-style speech, from both individuals who took issue with Trump’s positions and others who felt that the use of the speaking opportunity to further a political agenda was highly inappropriate regardless of political persuasion, was strong and swift. Of course, as a 501(c)(3) public charity, the Boy Scouts of America is also prohibited from engaging in any prohibited campaign intervention or partisan political activities. A 501(c)(3) may invite politicians to speak at its events, but there are certain considerations when doing so, particularly where the individual is also a candidate for office (note that Trump has already taken steps to initiate the process for declaring his candidacy for president in 2020). Those factors include whether the individual is chosen to speak for reasons unrelated to her candidacy; whether the individual speaks only in a non-candidate capacity; whether the individual or a representative of the organization mentions her candidacy; whether any campaign activity occurs in connection with the candidate’s attendance; whether the organization maintains a nonpartisan atmosphere at the event; and whether the organization clearly indicates the non-candidate capacity in which the politician in appearing. 501(c)(3)s also must generally avoid providing support for a particular political party.

While Trump seemed to have primarily dwelled on an election that has already occurred, rather than a future election, there is little doubt that his speech obliterated any nonpartisan atmosphere that may have otherwise been created at the event. Nonetheless, I think it would be highly unlikely for the IRS to pursue the Boy Scouts of America in any way based on Trump’s speech. The organization’s bigger concern is likely a public relations one.

In response to the backlash, the chief of Boy Scouts of America issued a statement a few days later titled “From the Chief: Our Perspective on the Presidential Visit.” In the very carefully crafted statement, and after describing the character-building experiences otherwise occurring at the Jamboree, the chief acknowledged that these “real moments of Scouting” had “been overshadowed by the remarks offered by the President of the United States.” He went on to state “I want to extend my sincere apologies to those in our Scouting family who were offended by the political rhetoric that was inserted into the Jamboree. That was never our intent. The invitation for the sitting U.S. President to visit the National Jamboree is a long-standing tradition that has been extended to the leader of our nation that has had a Jamboree during his term since 1937. It is in no way an endorsement of any person, party or policies. For years, people have called upon us to take a position on political issues, and we have steadfastly remained non-partisan and refused to comment on political matters. We sincerely regret that politics were inserted into the Scouting program.”

It remains to be seen whether the organization will experience additional fallout for the speech, or for its tepid apology that followed, but it will likely serve as a reminder to other nonprofits of the importance of carefully considering in advance the potential ramifications of forming any public associations with controversial figures.