April 3, 2012

Brad Pettit, Senior Attorney, National Legal Research Group

Corporate and tax law attorneys frequently are asked to assist clients who have formed or want to create an organization that will serve the public good.  Section 501 of the Internal Revenue Code recognizes the desirability of such organizations by according tax-exempt status to "[c]orporations, and any community chest, fund, or foundation" that is "organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition . . . , or for the prevention of cruelty to children or animals."  I.R.C. § 501(c)(3) (emphasis added).  The Treasury Regulations further indicate that in order to be exempt from taxation under § 501(c)(3), an organization must be both "organized and operated exclusively for one or more of the purposes specified in such section."  Treas. Reg. § 1.501(c)(3)-1(a)(1).  According to the Regulations, "[i]f an organization fails to meet either the organizational test or the operational test, it is not exempt [from taxation]."  Id.

A.         Organizational Test

The Treasury Regulations provide that an organization is organized exclusively for one or more exempt purposes only if its articles of organization (1) limit the purposes of the organization to one or more exempt purposes, and (2) do not expressly empower the organization to engage, other than as an insubstantial part of its activities, in activities which in themselves are not in furtherance of one or more exempt purposes.  Treas. Reg. § 1.501(c)(3)-1(b)(1)(i).  The Regulations go on to caution that

An organization is not organized exclusively for one or more exempt purposes if its articles expressly empower it to carry on, otherwise than as an insubstantial part of its activities, activities which are not in furtherance of one or more exempt purposes, even though such organization is, by the terms of such articles, created for a purpose that is no broader than the purposes specified in section 501(c)(3).

Id.  § 1.501(c)(3)-1(b)(1)(iii).  As part of an organization's application to the IRS for tax-exempt status, it must submit a detailed statement of its proposed activities.  Id. § 1.501(c)(3)-1(b)(1)(v).

B.         Operational Test