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80–340 2013

PUBLIC CHARITY ORGANIZATIONAL ISSUES, 

UNRELATED BUSINESS INCOME TAX, AND 

THE REVISED FORM 990 

HEARING 

BEFORE THE

SUBCOMMITTEE ON OVERSIGHT 

OF THE

COMMITTEE ON WAYS AND MEANS 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED TWELFTH CONGRESS 

SECOND SESSION 

JULY 25, 2012

Serial No. 112–OS14 

Printed for the use of the Committee on Ways and Means 

( 


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COMMITTEE ON WAYS AND MEANS 

DAVE CAMP, Michigan, Chairman 

WALLY HERGER, California 

SAM JOHNSON, Texas 

KEVIN BRADY, Texas 

PAUL RYAN, Wisconsin 

DEVIN NUNES, California 

PATRICK J. TIBERI, Ohio 

GEOFF DAVIS, Kentucky 

DAVID G. REICHERT, Washington 

CHARLES W. BOUSTANY, JR., Louisiana 

PETER J. ROSKAM, Illinois 

JIM GERLACH, Pennsylvania 

TOM PRICE, Georgia 

VERN BUCHANAN, Florida 

ADRIAN SMITH, Nebraska 

AARON SCHOCK, Illinois 

LYNN JENKINS, Kansas 

ERIK PAULSEN, Minnesota 

KENNY MARCHANT, Texas 

RICK BERG, North Dakota 

DIANE BLACK, Tennessee 

TOM REED, New York 

SANDER M. LEVIN, Michigan 

CHARLES B. RANGEL, New York 

FORTNEY PETE STARK, California 

JIM MCDERMOTT, Washington 

JOHN LEWIS, Georgia 

RICHARD E. NEAL, Massachusetts 

XAVIER BECERRA, California 

LLOYD DOGGETT, Texas 

MIKE THOMPSON, California 

JOHN B. LARSON, Connecticut 

EARL BLUMENAUER, Oregon 

RON KIND, Wisconsin 

BILL PASCRELL, JR., New Jersey 

SHELLEY BERKLEY, Nevada 

JOSEPH CROWLEY, New York 

JENNIFER M. SAFAVIAN, Staff Director and General Counsel 

JANICE MAYS, Minority Chief Counsel 

SUBCOMMITTEE ON OVERSIGHT 

CHARLES W. BOUSTANY, JR., Louisiana, Chairman 

DIANE BLACK, Tennessee 

AARON SCHOCK, Illinois 

LYNN JENKINS, Kansas 

KENNY MARCHANT, Texas 

TOM REED, New York 

ERIK PAULSEN, Minnesota 

JOHN LEWIS, Georgia 

XAVIER BECERRA, California 

RON KIND, Wisconsin 

JIM MCDERMOTT, Washington 


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C O N T E N T S 

Page 

Advisory of July 25, 2012 announcing the hearing ............................................... 2 

WITNESSES 

Panel 1: 

Hon. Steven T. Miller, Deputy Commissioner for Services and Enforcement, 

Internal Revenue Service, Testimony ................................................................. 5 

Panel 2: 

Ms. Eve Borenstein, Borenstein and McVeigh Law Office LLC, Testimony ...... 33 

Mr. Thomas K. Hyatt, Partner, SNR Denton, Testimony .................................... 49 

Mr. John Colombo, Albert E. Jenner, Jr., Professor, University of Illinois 

College of Law, Testimony .................................................................................. 60 

Mr. Donald Tobin, Associate Dean for Faculty and the Frank E. and Virginia 

H. Bazler Designated Professor in Business Law, The Ohio State University 

Moritz College of Law, Testimony ...................................................................... 91 

SUBMISSIONS FOR THE RECORD 

American Bankers Association ............................................................................... 118 

Center for Fiscal Equity .......................................................................................... 125 

Economic Research Institute .................................................................................. 129 

Elizabeth Boris, Thomas Pollak, Charles McLean and Jeffrey Falkenstein ...... 134 


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PUBLIC CHARITY ORGANIZATIONAL ISSUES, 

UNRELATED BUSINESS INCOME TAX, AND 

THE REVISED FORM 990 

WEDNESDAY, JULY 25, 2012 

U.S. HOUSE OF REPRESENTATIVES, COMMITTEE ON WAYS AND MEANS, SUBCOMMITTEE ON OVERSIGHT, Washington, DC. 

The Subcommittee met, pursuant to call, at 9:30 a.m., in room 

1100, Longworth House Office Building, Hon. Charles Boustany 

(Chairman of the Subcommittee) presiding. 

[The advisory of the hearing follows:] 


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HEARING ADVISORY 

Boustany Announces Hearing on Public Charity 

Organizational Issues, Unrelated Business Income Tax, and the Revised Form 990 

Wednesday, July 25, 2012 

Congressman Charles W. Boustany Jr., MD (R–LA), Chairman of the Subcommittee on Oversight of the Committee on Ways and Means, today announced 

that the Subcommittee will hold the second in its series of hearings on tax-exempt 

organizations, this time examining the revised Form 990, reasons for the increasing 

organizational complexity of public charities, including unrelated business income 

tax issues, and their effect on transparency and tax compliance. The hearing will 

take place on Wednesday, July, 25, 2012, in room 1100 of the Longworth 

House Office Building, beginning at 9:30 A.M. 

In view of the limited time available to hear witnesses, oral testimony at this 

hearing will be from invited witnesses only. However, any individual or organization 

not scheduled for an oral appearance may submit a written statement for consideration by the Committee and for inclusion in the printed record of the hearing. A 

list of invited witnesses will follow. 

BACKGROUND: 

Over the last two decades, public charities have grown increasingly more complex 

in their organizational structures and operations. Contributing to the complexity is 

the prevalence of profit-generating arms and investment activities within the taxexempt organizational structure. Tax-exempt organizations are governed by a variety of rules to ensure compliance with Federal tax law and limit abuses, including 

rules that subject business income from for-profit activities to income tax (the unrelated business income tax, ‘‘UBIT’’), unless explicitly exempted. These issues, among 

others, may affect how a public charity chooses to organize and operate. 

To address increased complexity and to promote greater transparency and compliance within the sector generally, the Internal Revenue Service (‘‘IRS’’) released a redesigned Form 990, Return of Organization Exempt from Income Tax, in 2008. The 

principal goal behind the redesigned Form 990 was to facilitate improved IRS compliance efforts. The Form was also intended to provide all interested parties with 

a clearer picture of a tax-exempt organization’s activities, including those that further its exempt purpose and related party transactions. In an October 6, 2011 letter 

to the IRS, Chairman Boustany sought to assess whether the goals for the newly 

redesigned Form 990 have been achieved, the challenges the IRS faces with respect 

to compliance areas such as UBIT, and how the information required on the new 

form is being used. The hearing will, in part, follow up on this inquiry. 

In addition to the importance of continuing oversight by this Subcommittee of the 

IRS and the tax-exempt sector, the Committee is working on comprehensive tax reform. Thus, the hearing will also provide an opportunity to discuss how current 

issues for public charities may inform the Committee’s ongoing tax reform efforts. 

In announcing this hearing, Chairman Boustany said, ‘‘Given the size and scale 

of the operations of public charities, which in 2008 had over $2.5 trillion 

in assets, it is critical that the Subcommittee continue its review of the taxexempt sector. Indeed, over the last two decades, the organizational structures of public charities have become increasingly complex, creating compliance and transparency issues. This hearing is an excellent opportunity 

for the Subcommittee to hear from the IRS and experts in the tax-exempt 

community. Their insight will allow the Subcommittee to better understand what is driving organizational complexity, and to learn about the 

new compliance efforts by the IRS and the UBIT rules.’’ 


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FOCUS OF THE HEARING: 

The hearing will focus on organizational and compliance issues related to public 

charities, including the increased complexity of public charity organizational structures, the rules governing profit-generating activities giving rise to unrelated business income tax, and whether the newly redesigned Form 990 is promoting increased compliance and transparency. 

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS: 

Please Note: Any person(s) and/or organization(s) wishing to submit written comments for the hearing record must follow the appropriate link on the hearing page 

of the Committee website and complete the informational forms. From the Committee homepage, http://waysandmeans.house.gov, select ‘‘Hearings.’’ Select the hearing for which you would like to submit, and click on the link entitled, ‘‘Click here 

to provide a submission for the record.’’ Once you have followed the online instructions, submit all requested information. ATTACH your submission as a Word document, in compliance with the formatting requirements listed below, by the close 

of business on Wednesday, July 25, 2012. Finally, please note that due to the 

change in House mail policy, the U.S. Capitol Police will refuse sealed-package deliveries to all House Office Buildings. For questions, or if you encounter technical 

problems, please call (202) 225–3625 or (202) 225–2610. 

FORMATTING REQUIREMENTS: 

The Committee relies on electronic submissions for printing the official hearing 

record. As always, submissions will be included in the record according to the discretion of the Committee. The Committee will not alter the content of your submission, 

but we reserve the right to format it according to our guidelines. Any submission 

provided to the Committee by a witness, any supplementary materials submitted for 

the printed record, and any written comments in response to a request for written 

comments must conform to the guidelines listed below. Any submission or supplementary item not in compliance with these guidelines will not be printed, but will 

be maintained in the Committee files for review and use by the Committee. 

1. All submissions and supplementary materials must be provided in Word format and MUST 

NOT exceed a total of 10 pages, including attachments. Witnesses and submitters are advised 

that the Committee relies on electronic submissions for printing the official hearing record. 

2. Copies of whole documents submitted as exhibit material will not be accepted for printing. 

Instead, exhibit material should be referenced and quoted or paraphrased. All exhibit material 

not meeting these specifications will be maintained in the Committee files for review and use 

by the Committee. 

3. All submissions must include a list of all clients, persons and/or organizations on whose 

behalf the witness appears. A supplemental sheet must accompany each submission listing the 

name, company, address, telephone, and fax numbers of each witness. 

The Committee seeks to make its facilities accessible to persons with disabilities. 

If you are in need of special accommodations, please call 202–225–1721 or 202–226– 

3411 TTD/TTY in advance of the event (four business days notice is requested). 

Questions with regard to special accommodation needs in general (including availability of Committee materials in alternative formats) may be directed to the Committee as noted above. 

Note: All Committee advisories and news releases are available on the World 

Wide Web at http://www.waysandmeans.house.gov

f 

/. 

Chairman BOUSTANY. Welcome to this morning’s hearing on 

public charities. This hearing is second in a series of hearings exploring tax-exempt issues and IRS compliance efforts. The focus of 

today’s hearing is on 501(c)(3) public charities, the largest category 

of tax exempt organizations. 


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In particular, for public charities, we are focused on transparency, compliance efforts, organizational complexity and commercial activities. Over the past several decades, public charities have 

become increasingly complex organizations. While universities and 

hospitals are notable examples of this, complexity has not been limited to these types of organizations. A number of factors have driven this trend, including the Federal tax law itself and the expansion of the types of exempt and commercial activities that public 

charities engage in. 

About a decade ago, there was a growing recognition that the 

Form 990, the Federal return used by most tax-exempt organizations, was not collecting the kind of information needed by the IRS 

or the public to understand the activities of this increasingly complex sector. To ensure a greater level of transparency across the 

sector, the IRS substantially redesigned the Form 990, rearranging 

how information is reported and expanding the breadth of information requested to draw out critical issues, such as related party 

transactions, governance and commercial activities. 

We will discuss today how the Form 990 was changed, whether 

those changes have promoted compliance and transparency. Today 

we have two panels that will help the Subcommittee explore public 

charity compliance issues, such as the redesigned Form 990 sector 

transparency, organizational complexity and commercial activities. 

This exercise also will provide important information to the Subcommittee as it begins to look to the future and think about 

changes that will help tax-exempt organizations work most effectively to meet their goals. Now I am pleased to yield to my friend 

and colleague, the Ranking Member of the Subcommittee, Mr. 

Lewis, for purposes of an opening statement. 

Mr. LEWIS. Thank you, Mr. Chairman, for yielding. 

This is the Subcommittee’s second hearing on tax-exempt organizations in this Congress. Today we will examine public charities 

and their complex structures. 

Public charities serve as an important role in our society. They 

often fill the gap between what the government can provide and 

Americans’ basic needs. These charities feed our hungry, care for 

our sick and preserve our culture and the arts. 

As public charities become larger and more complex, I am concerned that they may be engaging in activities that are not part of 

their charitable mission. Some may be using for-profit subsidies to 

engage in business that is not related to their charitable mission. 

Some may be used in related organizations to engage in certain activity indirectly that they could not engage in directly. 

As we move toward tax reform, we should consider whether these 

rules are working as intended. I look forward to hearing from our 

witnesses today about these issues. I would like to learn more 

about how the Internal Revenue Service oversees nearly 2 million 

tax-exempt organizations with a budget of about $100 million and 

about 860 employees. 

I also look forward to hearing how the new Form 990 helps both 

the agents and the public oversee the activities of charitable organizations. And Mr. Chairman, I yield back my time. And thank you 

very much again for holding this hearing. 

Chairman BOUSTANY. Thank you Mr. Lewis. 


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Chairman BOUSTANY. And next—I would like to say, first of 

all, we have two very distinguished panels today, who will be excellent witnesses as we delve into these issues. Today’s witnesses 

have extensive experience studying or working with tax-exempt organizations, and their experience will certainly be very, very helpful as we examine the current state of the tax-exempt sector. Our 

first panel will be Deputy Commissioner Steven Miller. 

The Committee has received your formal statement, Mr. Miller. 

And as deputy commissioner for services and enforcement, we 

know that you are dealing directly with all these issues, the complexity of it, and so we are very eager to hear your testimony and 

to follow up with questions. 

So, Mr. Miller, you may proceed. 

STATEMENT OF STEVEN T. MILLER, DEPUTY COMMISSIONER 

FOR SERVICES AND ENFORCEMENT, INTERNAL REVENUE 

SERVICE, WASHINGTON, DC. 

Mr. MILLER. Thank you. 

Good morning, Chairman Boustany, Ranking Member Lewis, 

Members of the Subcommittee. My name, as indicated, is Steve 

Miller, Deputy Commissioner at the IRS. 

At the request of the Subcommittee, my testimony this morning 

will offer an overview of one segment of the tax-exempt community, 

specifically the 501(c)(3) charitable sector, and our role in regulating that community. Let me begin with some observations. 

First, the charitable sector deserves to be commended for its vital 

role in our society. Second, on the whole, we believe the charitable 

sector is or tries to be compliant with the Internal Revenue Code. 

Finally, the sector is incredibly diverse in size and function, ranging from store-front soup kitchens to large complex hospital systems. This means our approach in regulation has to be flexible. 

Currently there are more than 1 million section 501(c)(3) organizations. In the tax-exempt area, almost more than in any other 

area we cover, we serve more as a regulator and less as a revenue 

authority. In light of this, we have a balanced program which ensures that congressional intent is honored and that the public confidence in the integrity of the charitable sector is maintained. Our 

program is carried out, as Mr. Lewis says, by around 860 employees. 

Our approach in regulation is comprised of education, the determination letter process, Form 990 filing and a robust examination 

and review program. 

Let me touch on a couple of these. In our Determination Letter 

Program, which is in many respects a continuation of our educational efforts, we review the intended operations of organizations 

seeking exempt status. We receive more than 50,000 applications 

a year for charitable status. Our specialists review them and, 

where appropriate, work individually with the applicant to ensure 

the organization understands and meets the requirements of the 

Code. 

Most exempt organizations also have an annual filing requirement and must file one of the Form 990 series returns. The Form 

990 is a unique and essential part of our regulatory process. It is 

an information return made widely available to the public. We and 


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other stakeholders use the information to review the operations of 

the organization. The 990 is also utilized by nearly 40 states to satisfy at least a part of their filing requirements. Given our limited 

resources, the Form 990 is particularly important. It allows the 

public to review, rate, compare and otherwise make their own decisions about organizations. Thus it promotes transparency and accountability. 

There has been much discussion of the Form 990 revision which 

we began in 2004. The basic format and content of the form had 

remained essentially the same since 1979, while the community 

had grown dramatically in size, variety and complexity. After two 

drafts were released to the public over several years and after hundreds of comments were received and acted upon, we made the 

form effective with a generous transition rule beginning with tax 

year 2008. The process continues as the law changes and as we 

continue discussions with stakeholders. 

The last aspect of our work I will mention is our robust and 

multi-faceted post-filing compliance program. We constantly seek 

more efficient and effective ways to conduct examinations or other 

reviews. And we continuously refine our selection criteria to help 

apply compliance resources where they are most needed. 

I will wind up by talking about some of our challenges. First, 

given the size, breadth and growth of the sector we have a great 

deal of ground to cover with the available resources we have. Secondly, this is a difficult area to regulate. That is because the law 

deals most often in general principles and not specifics. The lines 

are not bright. While this leaves a great deal of flexibility for organizations and how they operate, it also makes it harder to judge 

where noncompliance begins or to give the organizations the certainty that they need to operate within clear lines. Third, with 

some key exceptions, the current law gives us limited options when 

we find noncompliance. We are often left with the question of 

whether to revoke an organization’s tax exemption. Revocation is 

a draconian step, one that may not be proportionate in any given 

case. 

Finally, the IRS role may at times not match the public’s expectations. For example, it is difficult for the IRS to assess the quality 

of an organization’s performance or measure its comparative worth. 

Thus it may be difficult for us to take action with respect to an organization that the public believes is not spending sufficiently on 

charity or is not doing a preferred type of charitable work. An example, the IRS cannot differentiate between an organization that 

gives out candy to flood victims versus one that distributes food or 

clothing. The IRS is neither equipped nor is it our role to make 

such determinations. The best we can do is make all the facts 

available for others to see and make their own decisions. That concludes my comments. Thanks for the opportunity to testify. 

Chairman BOUSTANY. Thank you, Mr. Miller. 

[The prepared statement of Mr. Miller follows:] 


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TESTIMONY OF STEVEN T. MILLER 

DEPUTY COMMISSIONER SERVICES & ENFORCEMENT 

INTERNAL REVENUE SERVICE 

BEFORE THE OVERSIGHT SUBCOMMITTEE 

HOUSE WAYS AND MEANS COMMITTEE 

ON THE OVERSIGHT OF TAX-EXEMPT ORGANIZATIONS 

JULY 25, 2012 

Good morning Chairman Boustany, Ranking Member Lewis, and Members of the 

Oversight Subcommittee. Thank you for the opportunity to appear this morning. 

My name is Steven T. Miller, and I am the Deputy Commissioner for Services & 

Enforcement for the Internal Revenue Service (IRS). 

Exempt Organizations is an office within Tax Exempt and Government Entities 

(TE/GE), one of four operating divisions created after the enactment of the IRS 

Restructuring and Reorganization Act of 1998 (RRA). Its responsibilities include 

charities and other tax-exempt organizations. 

At the request of the Subcommittee, my testimony this morning will offer an 

overview of one segment of the tax-exempt community, specifically section 

501(c)(3) organizations and our role in regulating that community. I will highlight 

the general law that applies to these organizations and the key administrative 

processes we employ in our work with this sector. 

Let me begin with two observations. First, the charitable sector deserves to be 

commended for the vital work it does throughout America, and indeed throughout 

the world. Second, on the whole, we believe the charitable sector is, or tries to 

be, compliant with the Internal Revenue Code. 

Demographics of the Tax-Exempt Community 

Internal Revenue Code section 501(c)(3) describes a subset of the entire taxexempt sector. Section 501 (c)(3) organizations include those organized and 

operated exclusively for religious, charitable, scientific, educational, and other 

specified exempt purposes. They are eligible to receive tax-deductible 

contributions, and they are subject to certain operating restrictions. 

Currently, there are more than one million section 501 (c)(3) organizations. This 

includes public charities and private foundations. In tax year 2009, section 

501(c)(3) public charities held assets valued at approximately $2.7 trillion, and 

had annual revenues of nearly $1.5 trillion. Private foundations held assets 

valued over $500 billion, and had annual revenues of $ 52 billion. These 

numbers do not include churches because they generally have no registration or 

filing requirements. 
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General Law Governing Section 501(c)(3) Organizations 

The Internal Revenue Code specifies certain types of organizations that are 

exempt from federal income tax. ' The most common are charitable, religious 

and educational organizations, civic associations, labor organizations, business 

leagues, social clubs, fraternal organizations, and veterans' organizations. 2 

Not all non-profit organizations are tax-exempt under federal law. 3 To be taxexempt, the organization generally must meet specific requirements of the Code, 

such as being described in a paragraph of section 501 (c) of the Code4 

With limited exceptions, section 501(c)(3) organizations must apply to be 

recognized as tax-exempt. 5 They do this by filing a Form 1023, Application for 

Recognition of Exemption Under Section 501 (c)(3) of the Internal Revenue Code, 

with the IRS.6 Churches and certain church-related organizations, very small 

organizations, and certain other organizations do not need to apply for taxexempt status under section 501(c)(3).7 

We consistently receive about 60,000 applications for tax-exempt status each 

year. Most are requesting status under section 501 (c)(3). 

If the IRS approves an application, we issue a "ruling letter" or a "determination 

letter.',8 

Contributions to section 501(c)(3) organizations are generally deductible on the 

donor's federal income tax return, if the donor chooses to itemize deductions.9 

Contributions to most other types of tax-exempt organizations do not qualify for a 

charitable contribution deductionW 

Section 501(c)(3) organizations are the largest category of exempt organizations. 

These organizations are organized and operated exclusively for religious, 

charitable, scientific, educational, or other specified purposes and no part of their 

net earnings may inure to the benefit of any private shareholder or individual, no 

substantial part of their activities may be carrying on propaganda, or otherwise 

attempting to influence legislation (except in certain Circumstances), and which 

do not participate in, or intervene in, any political campaign on behalf of (or in 

1 IRe § 501 (a); Treas. Reg. § 1.501(a). 

2 IRe § 501 (e); Treas. Reg. §§ 1.501(e)(3)-1 through 1.501(e)(21 )-1. 

'Treas. Reg. § 1.501(a)-1(a)(2). 

4 Treas. Reg. § 1.501 (a)-1(a)(1). 

5 Treas. Reg. §§ 1.501(a)-1(a)(3); 1.508-1. 

sid. 

7 1Re § 508(e)(1); Treas. Reg. § 1.508-1(a)(3). 

8 Treas. Reg. § 1.501 (a)-1(a)(2); Treas. Reg. § 301.6104(a)-1. 

9 IRe § 170; Treas. Reg. § 1.170-2. 

10 But see IRe § 170(e)(3). (4), (5). 

2 
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opposition to) any candidate for public office. 11 The regulations divide this 

statutory language into two requirements. To qualify for exemption under section 

501(c)(3), the organization must be: 

• Organized, and 

• Operated exclusively for one or more exempt purposes. 12 

The organizational requirement is that a section 501 (c)(3)'s organizing 

documents (articles of incorporation, trust documents, articles of association, 

etc.) must: 

• Limit its purpose or purposes to those described in section 501 (c)(3), 13 

• Not expressly empower the organization to carryon, otherwise than as an 

insubstantial part of its activities, activities which are not in furtherance of 

one or more exempt purposes,14 and 

• Dedicate its assets to exempt purposes, for example by ensuring that 

upon dissolution its assets will be distributed to another charitable 

organization or government entity.'s 

The operational requirement is that a section 501 (c)(3) organization will be 

regarded as operated exclusively for one or more exempt purposes only if it 

engages primarily in activities which accomplish one or more of the exempt 

purposes specified in section 501 (c)(3). An organization will not be so regarded 

if more than an insubstantial part of its activities is in furtherance of a non-exempt 

purpose. 16 

In addition, a section 501(c)(3) organization cannot: 

• Participate in political campaigns on behalf of, or in opposition to, any 

candidate for public office, 17 

• Perform lobbying activities as a substantial part of its overall activities,'8 

• Allow its earnings to inure to the benefit of any private shareholder or 

individual,19 

• Operate for the benefit of private interests, such as those of its founder, 

the founder's family, its shareholders, or persons controlled by such 

interests,20 or 

• Operate for the primary purpose of conducting a trade or business that is 

not related to its exempt purpose21 

11 IRe § 501 (c)(3) 

12 Treas. Reg. § 1.501 (c)(3)-1 (a). 

13 Treas. Reg. § 1.501(c)(3)-1(b) (1). 14 ld. 

15 Treas. Reg. § 1.501(c)(3)-1(b)(4). 

16 Treas. Reg. § 1.501(c)(3)-1 (c)(1). 

"IRe § 501(c)(3); Treas. Reg. § 1.501(c)(3)-1(b)(3) (ii); § 1.501(c)(3)-1(c)(3). 

"IRe § 501 (c)(3); Treas. Reg. § 1.501(c)(3)-1(b)(3) (i); § 1.501 (c)(3)-1(c)(3). 

19 IRe § 501 (c)(3); Treas. Reg. § 1.501(c)(3)-1(c)(2). 

20 Treas. Reg. § 1.501(c)(3)-1 (d) (1)(ii). 

21 Treas. Reg. § 1.501(c)(3)-1(e). 

3 
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The most common types of section 501 (c)(3) organizations are charitable, 

educational, or religious. 

The term "charitable" is used in section 501 (c)(3) in its generally accepted legal 

sense. While the regulations and other sources list charitable purposes, other 

purposes may also fall within the broad definition of "charitable" as developed by 

judicial decisions. 22 "Charitable purposes" may include the following purposes 

identified in the regulations: 23 

• Relief of the poor, the distressed, or the underprivileged, 

• Advancement of religion, 

• Advancement of education or science, 

• Building or maintaining public buildings, monuments, or works, 

• Lessening the burdens of government, 

• Reducing neighborhood tensions, 

• Helping eliminate prejudice and discrimination, 

• Defending human and civil rights, and 

• Combating community deterioration and juvenile delinquency. 

An educational organization is one involved in:24 

• The instruction or training of the individual for the purpose of improving or 

developing his capabilities, or 

• The instruction of the public on subjects useful to the individual and 

beneficial to the community. 

Religious organizations include churches and other organizations organized and 

operated exclusively for religious purposes. 

Public Charity or Private Foundation 

Every organization that qualifies as tax-exempt under section 501 (c)(3) is 

classified as either a public charity or a private foundation. Under Section 508, 

organizations (other than churches, certain educational organizations, and 

certain trusts) are automatically classified as private foundations, unless they can 

meet the criteria for being a public charity listed in Section 509(a).25 Whether a 

section 501 (c)(3) organization is classified as a public charity or private 

foundation is important because different tax rules apply to each. For example, 

the deductibility of contributions to a private foundation is more limited than the 

deductibility of contributions to a public charity.26 In addition, private foundations 

22 Treas. Reg. § 1.501(c)(3)-1(d)(2). 

231d. 

24 Treas. Reg. § 1.501(c)(3)-1(d)(3) (i). 

~: Treas. Reg. §§ 1.508-1(b): 1.509(a)-1: 1.509(a)-2. 

Treas. Reg. § 1.170-2. 

4 
11 


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are subject to stricter federal regulation and may be subject to excise taxes not 

imposed on public charities. 27 

One common distinction between public charities and private foundations lies in 

their sources of financial support. 28 A public charity typically has a broad base of 

public support, whereas a private foundation generally is supported by just a few 

individuals, such as members of a family.29 

To be classified as a public charity, either because it performs specific types of 

activities identified in the Code (e.g. churches, schools, hospitals, etc.) or 

because of its public support, an organization must meet one of the tests set out 

in the Code and accompanying regulations. 30 

Common organizations meeting the definition of public charity under Section 

509(a) include: 

• Churches, 

• Schools, 

• Organizations that provide medical or hospital care, 

• Organizations that receive a substantial part of their support in the form of 

contributions from publicly supported organizations, governmental units 

and/or from the general public, and 

• Organizations that normally receive not more that one-third of their 

support from gross investment income and after-lax unrelated business 

income, and more than one-third of their support from gifts, grants, 

contributions, or membership fees and gross receipts from activities 

related to their exempt functions. 

Role of the IRS 

Congress has established in the tax law certain requirements that organizations 

must meet to be entitled to the privilege of tax exemption. It is the IRS's 

responsibility to administer those requirements. 

The IRS has a balanced program for regulating the charitable sector. Within the 

IRS, the Tax Exempt and Government Entities division (TE/GE) has the 

responsibility to administer and enforce these requirements. Doing so 

accomplishes a number of important public purposes. It ensures that 

Congressional intent is honored. It helps maintain public confidence in the 

integrity of the charitable sector. And it prevents the erosion of the tax base by 

identifying and stopping those who misuse the privilege of tax-exempt status. 

The IRS approaches this responsibility with a program that emphasizes both 

service and enforcement. The program is carried out by the 868 employees of 

27 Chapter 42 of the Code [i.e., IRC §§ 4940-4946]. 

28 IRC § 509(a)(2); Treas. Reg, § 1,509(a)-3. 

29 Treas. Reg. §§ 1.509(a)-1; 1.509(a)-3. 

30 IRC §§ 170(b)(1)(A)(vi) and 509(a)(2); Treas. Reg. §§ 1.170A-9; 1.509(a)-2; and 1.509(a)-3. 

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TE/GE's Exempt Organization function (EO). EO's efforts in this area fall into 

four categories: determinations or rulings on applications for tax exemption, 

public education and outreach, guidance, and post-filing compliance. 

Application for Tax-Exemption 

TE/GE's application program for organizations seeking exempt status is 

particularly important. In this program, prospective exempt organizations submit 

information to the IRS about their purpose and structure. Determination 

specialists review the applications and, where appropriate, work individually with 

the applicant organization to help them understand the requirements for tax 

exemption and any necessary changes. Unless the organization is later selected 

for examination, the determination process is often the only time the IRS is in 

direct contact with the organization. 

The application process therefore represents an important opportunity for the 

IRS. It is the time when the IRS has the chance to insure that the charity is 

organized as required by law, that the organization is operating properly, and that 

the IRS has the information it needs about the organization. The determination 

letter process also presents an important educational opportunity for the 

applicant to learn of its responsibilities and filing obligations as a tax-exempt 

organization. 

Most organizations seeking recognition of exemption from federal income tax 

must use specific application forms prescribed by the IRS. Primarily, these are 

Form 1023, Application for Recognition of Exemption under Section 501 (c)(3) of 

the Internal Revenue Code, and Form 1024, Application for Recognition under 

Section 501(a). 

Customer Education & Outreach 

TE/GE conducts an active education and outreach program for the charitable 

sector. This effort is designed to keep exempt organizations compliant by 

keeping them alert to the requirements of the law and by giving them the 

opportunity to have their questions answered. 

We also accomplish this through a balanced program that provides both "online" 

educational materials that are available 24/7, as well as "real time" events such 

as workshops, seminars, on-line webinars, speeches, and phone forums. 

Our "online" effort involves extensive use of electronic media. A free e-mail 

newsletter, EO Update, reaches over 188,000 subscribers (up 23 percent from 

FY2010). Our numerous publications and other materials are increasingly 

distributed online. And the EO website (www.irs.gov/charities) plays an 

important and growing role as a resource for tax-exempt organizations. EO's 

homepage had 2 million visits in the first five months of calendar 2012 - a 

monthly average of 335,000 visits. 

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The web site includes web-based information tools called "Life Cycles." Each Life 

Cycle provides practical information about each of five stages organizations 

typically go through during their existence: starting the organization; applying for 

tax-exempt status; filing required returns and other documents; maintaining the 

organization; and terminating the organization. We provide Life Cycles not only 

for public charities and private foundations, but also for other tax-exempt 

organizations such as social welfare organizations, labor organizations, 

agricultural and horticultural organizations such as farm bureaus, and trade 

associations and other business leagues. Another popular tool we offer is 

StayExempt.org, a web-based version of our day-long workshop for small and 

mid-size exempt organizations. 

The exempt organizations community is using these tools. In the year ended 

June 30, 2012, for example, we recorded more than 119,000 visits to the public 

charity life cycle site, over 50,000 visits to the private foundation life cycle site; 

and over 142,000 visits to StayExempt.org. 

We provide education and outreach to exempt organizations through "real time" 

events such as workshops, seminars, online webinars, speeches, and phone 

forums. In FY 2011, we reached 41,252 customers through our real time events 

- a 28 percent increase over FY 2010. We conducted 30 day-long workshops, 

held at different colleges and universities, for small and medium size section 

501 (c)(3) organizations. 

In addition to providing general education about the responsibilities of tax-exempt 

organizations, advising charities about changes in the tax law helps them stay 

compliant. For example, the Pension Protection Act of 2006 requires automatic 

revocation of exempt status of organizations that fail to file a Form 990-series 

return for three consecutive years. We conducted extensive outreach on this 

issue, and launched SelectCheck, a searchable online database to help the taxexempt community and the public track organizations' tax-exempt status. 

Post-Filing Compliance 

While we provide an upfront evaluation of a charity's exempt status and support 

exempt organizations with customer education and outreach, we also must have 

a process to review these organizations as they operate. We therefore maintain a 

robust and multi-faceted post-filing compliance program. We are organized and 

staffed in a way that allows us to respond flexibly to different types of noncompliance in different areas. We constantly seek more efficient and effective 

ways to conduct examinations, and continuously refine our selection criteria to 

help us apply compliance resources where they are most needed. 

IRS Exempt Organizations agents conduct reviews of exempt organizations in 

various ways: 

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• "Review of Operations Office" reviews: The Review of Operations Office 

(ROO) carries out its post-filing compliance work without needing to 

contact taxpayers. A ROO review is not an examination; the ROO looks 

at an organization's Form 990, website, and other publicly available 

information to see what it is doing and whether it continues to be 

organized and operated for tax-exempt purposes. The ROO looks at a 

random sample of new organizations after they have operated for a year 

or two, and also follows up with older organizations that we have 

examined and with whom we have entered into a closing agreement to 

resolve compliance issues. If it appears from a ROO review that an 

organization may not be compliant, the organization is referred for 

examination. Separately, the ROO conducts the statutorily mandated 

community benefit reviews of tax-exempt hospitals. 

• Compliance checks: In a compliance check, we contact taxpayers by 

letter when we discover an error on a taxpayer's return or wish to obtain 

further information or clarification. A compliance check is an efficient and 

effective way to maintain a compliance presence without an examination. 

We also use compliance check questionnaires to study a specific part of 

the tax-exempt community or specific cross-sector practices. 

• Examinations: Examinations, also known as audits, are authorized under 

Section 7602 of the Code. For exempt organizations, an examination 

determines an organization's continued qualification for tax-exempt status. 

We conduct two different types of examinations: correspondence and 

field. 

o Correspondence examination: In a correspondence examination, 

the examiner conducts the audit through correspondence with the 

organization's officers or representatives. These audits are often 

limited in scope, focusing on only one or two items on a return. On 

occasion, if the issues become complex or if the organization does 

not respond to correspondence efforts, the IRS may require 

representatives from the organization to bring their records to an 

IRS office. We may also convert a correspondence examination 

into a field examination. 

o Field examination: In a field examination, the examiner conducts 

the audit at the organization's place of business. Generally, these 

exams are the most comprehensive. There are two distinct types 

of Exempt Organizations field examinations: 

1. Under the Exempt Organizations Team Examination Program, 

examinations are conducted by a team of IRS specialists. The 

IRS typically uses team examinations for the largest exempt 

organizations. 

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2. Under the Exempt Organizations General Program, an 

examination is usually performed by an individual revenue 

agent. 

The post-filing compliance program is aimed at detecting and deterring 

noncompliant behavior. We have strengthened this program by broadening our 

approach and shifting resources into it. In FY 2003, we had 394 examinations full 

time equivalents (FTE) and closed 5,754 returns. In FY 2011, we had 531 

examinations FTE, and through a combination of enforcement projects and 

traditional examinations, closed 11,699 returns, more than doubling the 2003 

figure. We also completed 3,194 compliance checks. We are strengthening the 

program by using results from completed examinations, new data from the 

redesigned 990, our studies of customer segments, and the application of 

research techniques to distinguish between those who are willfully noncompliant 

and those who make errors while attempting to follow the rules. We then apply 

our examination resources accordingly. 

Reporting Requirements 

Most exempt organizations must file one of the Form 990-series returns - the 

990, 990-EZ, 990-N, or the 990-PF31 There are certain exceptions, such as for 

churches and their related organizations. 32 

Form 990. For tax year 2010 and beyond, an organization that is not a private 

foundation must file Form 990 if it does not meet the criteria for filing the Form 

990-EZ or Form 990-N. 

Form 990-EZ. An organization that is not a private foundation with annual gross 

receipts of less than $200,000, and total assets less than $500,000 for the tax 

year may file Form 990-EZ instead of Form 990. Form 990-EZ is a shorter and 

simpler version of Form 990. 

Form 990-N. Organizations that are not private foundations with annual gross 

receipts that are normally $50,000 or less may file Form 990-N instead of filing 

Form 990 or Form 990-EZ. The Form 990-N, also referred to as the "ePostcard," is filed electronically. Filing is very simple and requires no specialized 

computer equipment or software. The Form 990-N asks for: 

• The employer identification number (EIN), 

• Tax year, 

• Legal name and mailing address, 

• Any other names the organization uses, 

• Name and address of a principal officer, 

31 IRC § 6033. 

32 IRC § 6033(a)(3). 

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• Website address, if the organization has one, 

• Confirmation that the organization's annual gross receipts are normally at 

or below the threshold, and 

• If applicable, a statement that the organization is going out of business. 

Form 990-PF. Private foundations must file the Form 990-PF. 

Organizations with $10 million or more in total assets that file at least 250 returns 

during the calendar year (including income, excise, employment tax, and 

information returns) are required to file Form 990 electronically. 

Organizations that are required to file a Form 990-series must file Form 990, 990-

EZ, or the 990-N by the 15th day of the fifth month after their tax year ends. For 

example, May 15 would be the due date for an organization with a December 31 

year-end. Organizations exempt under section 501 (c) with gross income of 

$1,000 or more from a regularly conducted unrelated trade or business also file 

the Form 990 - T, Exempt Organization Business Income Tax Return. 

The Form 990-series returns are unique and useful for four key reasons. First, 

the Form 990, Form 990-EZ and Form 990-N are information returns, not tax 

returns. The primary reason tax-exempt organizations file a return is to provide 

information on their programs and activities. We use this information to verify the 

organization is operating in accordance with its stated tax-exempt purpose and is 

not violating rules and regulations governing tax-exempt status. 

Second, tax-exempt organizations are required to make their returns widely 

available for public inspection. Organizations must allow the public to inspect the 

Forms 990, 990-EZ, 990-N, and 990-PF they have filed with the IRS for their 

three most recent tax years. Exempt organizations are also required to provide 

copies of these returns when requested, or make them available on the Internet. 

They are also available from the IRS. 

Third, exempt organization returns are used as multi-jurisdictional forms: nearly 

40 states require exempt organizations to file some or all parts of a Form 990-

series return to satisfy the states' filing requirements. 

Finally, these information returns promote transparency and accountability, which 

strengthens the relationship that an exempt organization has with its 

stakeholders and funders. 

Form 990 Redesign 

The Form 990, Return of Organization Exempt from Income Tax, is a key 

element of our compliance program. The IRS undertook a comprehensive 

redesign of Form 990 that was effective beginning with tax year 2008. 

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We began redesigning the Form 990 in 2004, The basic format and content of 

the form had remained essentially the same since 1979, while the community of 

tax-exempt organizations had grown dramatically in size, variety, and complexity, 

The prior Form 990, with its emphasis primarily on revenues and expenses, 

assets and liabilities, had grown outdated, It was primarily a series of yes/no 

check boxes and numbers, but did not provide an accurate portrait of what an 

exempt organization was actually doing, Nor did it reflect the full scope, 

activities, or dynamics of modem, sometimes multi-leveled tax-exempt 

organizations, The form needed to be updated to meet the needs of the IRS and 

the public to understand the activities of tax-exempt organizations, and to confirm 

that these organizations were continuing to operate consistently with their taxexempt purposes, 

In redesigning the Form, the IRS followed three guiding principles: 

• Promote compliance with the tax law, 

• Promote transparency, and 

• Minimize burden (where consistent with the first two principles), 

The redesign was a comprehenSive, collaborative effort in which the IRS sought 

and received extensive input from the public, We met with nonprofit 

associations, state charity regulators, public interest groups, policymakers, and 

various representatives of the tax-exempt community, We redesigned the Form 

990 based on input from both our own internal stakeholders (e,g" our 

Examinations and Submission Processing functions) and these external groups, 

Once we developed a draft redesigned form, we released it to the public, 

including the exempt sector, and asked for comment To help all filers become 

familiar with the Form, we released two drafts of the 2008 Form 990, and a draft 

of the instructions, in the year and a half before we published the final Form, We 

accompanied these drafts with educational resources showing how the Form had 

changed, and including tips for completing it Over the course of a year and a 

half, we held seminars and provided speakers for interested parties, We 

explained the new format (a core form and schedules), what we were asking for 

and why, and we solicited comments, We wanted to know from affected 

organizations and practitioners whether the draft form's questions were relevant, 

reasonable, and feasible to answer. 

We met with stakeholders, who had provided comments to make sure we 

understood them, and we had conversations about what we - and they - were 

trying to accomplish, Where recommended revisions furthered our goals of 

transparency, compliance, and/or minimizing taxpayer burden, we revised the 

form, We considered every comment that was submitted, and made many further 

changes based on them, The final Form 990 took effect in the 2008 tax year. 

The redesign is evolving, and we continue to receive comments from the sector 

and to refine the form, 

11 
18 

f 

Chairman BOUSTANY. I failed to mention earlier that your full 

testimony will be made part of the record. 

You very succinctly outlined a number of challenges, both with 

some of the generalities of a law that create problems, as well as 

the rapidly growing nature of this sector, both in terms of size and 

complexity. The revision of the Form 990 was a multi-year process 


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19 

involving comments from hundreds of stakeholders. Clearly, it was 

a very important initiative of the IRS and the taxpayers. Can you 

describe the compliance issues that gave rise specifically to the revision of Form 990? Can you outline some of those? 

Mr. MILLER. Certainly, Chairman. 

In talking about how we dealt with the 990, as I mentioned in 

my testimony and is in my written testimony in more detail, we 

had not modified the form in any realistic way since 1979. In 1979, 

organizations were much simpler, they were much smaller. There 

was great diversity still, but it was a very different world. As it is 

in the corporate world, the world of nonprofits truly has changed 

over time. We did not have a good enough vision into things, such 

as compensation, things such as related organizations. What did 

the entire organization look like, in fact. We did not have a great 

deal of information on the largest of the organizations, colleges and 

universities, hospitals. 

So there were several areas that we did not have sufficient information really to regulate in and that as we revised the form decided to try to—— 

Chairman BOUSTANY. So these were some of the areas that 

were targeted from a compliance standpoint? 

Mr. MILLER. These were areas that we saw huge amounts of resources in the sector dedicated to, and we did not have a good 

enough vision into what was happening there. 

Chairman BOUSTANY. With regard to the Form 990, are you 

satisfied with the progress, the type of information coming in, and 

from an administrative standpoint, has it been something that has 

worked both ways? In other words, you are able to collate this data 

and use it effectively? 

Mr. MILLER. So I think it has been a success. I also think it is 

an ongoing effort. I absolutely don’t want anyone to come away 

from this thinking that we are done, that we haven’t—what we 

did—I will do it in three parts. 

First, was it necessary? I think it absolutely was, and I don’t 

think you will get any argument about that. 

Second, did we engage in an extensive discussion with the industry? Absolutely did. It started in 2004 for a 2008 return, put out 

two drafts, significantly modified the second draft specifically for 

the comments that were made. So I think if you talk to folks they 

will say, yes, it was a participatory process. Are we done? Is there 

too much burden on some of it? Probably, is the answer to that, unfortunately. It has got to be a living document, and we need to talk 

to folks and look at what they are saying in terms of have we gotten it right. Because I think we have, but by no means is the discussion over. 

Chairman BOUSTANY. Thank you. Now I would like to pivot to 

a different issue and look at some of the compliance challenges 

with regard to unrelated business income tax. The unrelated business income tax rules are an ongoing source of confusion and certainly a challenge from a compliance standpoint. Can you describe 

for the Committee the types of compliance challenges the IRS faces 

in enforcing UBIT and how the redesigned Form 990 addresses 

some of those concerns? 


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Mr. MILLER. So this is probably less about the redesign than it 

is about a general rules here. We have several problems and issues 

in addressing the Form 990–T, which is actually the form that gets 

used here. There are three generalized requirements for what is 

unrelated, and it starts with is it regularly carried on? Is it a trade 

or business? These are things that we sort of can deal with. The 

third one, is it substantially related? And that is a remarkably difficult and soft sort of issue to deal with. Is it related to have a gift 

shop sell postcards of things that are in the museum that is attached to it? These are the sorts of issues that we actually have 

to parse through in dealing with that particular issue. Other issues 

also exist in the area. A key issue is exactly what expenses are 

taken against the unrelated business income, especially where 

there are indirect expenses being taken. Those are things that are 

very hard I think for the taxpayer to do and very hard for us to 

do as well. So those would be the two things that are mainly our 

issue: What is substantially related, and how do you deal with expenses, in particular indirect expenses? 

Chairman BOUSTANY. Is there any move on the part of IRS to 

start looking at revising some of those regulations, looking at those 

definitions and the complexity there? 

Mr. MILLER. I think it would be good if we had the resources 

to do that. I don’t think that right now we are looking at that. It 

is not at the top of our list of things that we can get to, to be honest with you. 

Chairman BOUSTANY. From your standpoint, do you think—is 

there anything Congress needs to do from a legislative standpoint 

to provide more clarity with regard to some of those areas that are 

murky? 

Mr. MILLER. I am more than happy for us to talk to staff on 

that issue. I don’t know of anything off the top of my head. As I 

said, substantially related is just a very difficult, difficult concept. 

Chairman BOUSTANY. Right. And I know there is a multi-step 

process as you work through the Form 990 and sort of working 

through your entire compliance process. How does the IRS determine whether an audit related to UBIT is warranted? 

Mr. MILLER. So we will be looking at the Form 990 itself to see 

what an organization is doing. And then we receive about 40,000 

to 50,000 Form 990–Ts. And that is where a particular organization will outline all of the necessary information that it has done 

in order to calculate whether it owes unrelated business income 

tax. We will be looking at both of those in order to make that determination. 

Chairman BOUSTANY. Were there any particular red flags that 

an auditor would—you know, that would prompt an auditor to take 

a closer look at a public charity, for instance? 

Mr. MILLER. I don’t off the top of my head know what a red flag 

would be in this area, and I am not sure I would throw it out for 

public discussion. 

Chairman BOUSTANY. I understand. All right. Thank you. That 

is all I have. 

Mr. Lewis, you are recognized for questions. 

Mr. LEWIS. Thank you, Mr. Chairman. 

Mr. Miller, thank you for being here today, and again welcome. 


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I must tell you that I am deeply concerned about the IRS’ ability 

to oversee about 2 million tax-exempt organizations when your 

budget has been cut. Public charities alone have over $2.5 trillion 

in assets and $1.5 trillion in revenue each year. I understand that 

the funding and number of employees for the exempt organization 

division have been cut this year. Are you trying to do more or the 

same with less? Could you explain to the Committee? 

Mr. MILLER. Certainly, Mr. Lewis. Across the service, we have 

had to face decisionmaking with respect to a declining budget over 

the last couple of years. Probably at its height, in recent years, the 

exempt organizations division had about 950 people, 940, 950 people. We are down to about 860. We will be down from there by the 

end of this year. 

We are trying to maintain current levels as best we can, but it 

has been a challenge. Now we are getting smarter, I hope, with the 

types of things that we do, and we have efficiencies that we are 

doing. But it is a challenge, as it is across the service. 

Mr. LEWIS. Could you tell me how many tax-exempt organizations exist? 

Mr. MILLER. We have—I think the latest data that I have publicly available is about 1.85 or something like that million organizations, 1.3 of which are 501(c)(3) organizations. Now, those are 

somewhat dated numbers, but that is roughly right. 

Mr. LEWIS. Now you have less money, right, you have less 

money? 

Mr. MILLER. We do. 

Mr. LEWIS. Less resources, fewer employees to monitor and 

oversee the sector. Given the IRS budget constraints, how does the 

IRS oversee this sector—or do you think you are doing the best 

possible job with less money and less employees? Is something falling through the cracks? Are we missing something? 

Mr. MILLER. Mr. Lewis, I would be obviously remiss if I didn’t 

take you up on the opportunity to ask for more resources, which 

we could certainly use. 

Do I believe we are missing something? I don’t believe so. I believe we have to be efficient in the way we do business. But we certainly could use more resources. This sort of toggles back, Mr. 

Chairman, to your discussion of the Form 990. We have always 

been somewhat understaffed in this area. That has not changed. 

We are a little more understaffed than we were. We have always 

relied upon the transparency of the annual reporting to leverage 

other folks taking a look, finding problems, coming to us with the 

problems. That has always been a help to us and an essential part 

of our regulatory regime in the exempt organizations area. 

Mr. LEWIS. Thank you very much, Mr. Commissioner. 

Thank you, Mr. Chairman. 

Chairman BOUSTANY. I thank the gentleman. Lest anybody 

thinks this is quite as simple as just simply improving resource allocation, I think we also have to mention the complexity of tax law. 

And in the spirit of moving forward with the tax reform, I am hopeful that our Full Committee in a bipartisan way will be able to 

move forward with the tax reform to lend greater clarity to the Tax 

Code, but also simplicity that will make compliance easier. With 

that, I will yield to Ms. Jenkins. 


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Ms. JENKINS. Thank you, Mr. Chairman, and thank you for 

holding this hearing. 

Thank you for being here Mr. Miller. What is the process for an 

organization that applies to be a public charity? I am aware that 

you submit a Form 1024 and that begins the application on a review process. But what are the specific steps an applicant can expect. 

Mr. MILLER. So, actually, if you are talking about a public charity it would be a Form 1023 that has to be filed by all, with the 

exception of very small organizations and churches and church affiliates. But an organization would prepare the Form 1023, which 

basically outlines its prospective operations. What are its budgets 

going to be? What are its activities likely to be? Who is going to 

run the organization? What are they going to be paid? All of these 

things so that we can take a look to see whether they meet the requirements. Those are filed with us in Cincinnati, Ohio; Covington, 

Kentucky, and are reviewed in our Cincinnati office by specialists. 

Some are very easy. If they are small organizations, they don’t get 

a very detailed look. We look, we say, okay, this seems right. Some 

may be very simple but are being done by folks who don’t really 

have experience. Those may take a little longer because we will 

work to have them understand exactly what their obligations are 

and what their rights and responsibilities are as a tax-exempt organization. Some come in and they are doing things that either are 

close to the line, impermissible, unclear as to which of those two 

that they might be and those may take a longer time still, and they 

will be referred to specialists in Cincinnati and elsewhere that will 

take a look to justify it and see whether or not the organization 

qualifies as a public charity. 

Ms. JENKINS. Okay. Has the revision of the Form 990 led the 

IRS to approach the application process any differently? 

Mr. MILLER. I don’t believe so. I will say that our advisory Committee, which is a batch of specialists outside of the IRS, has come 

back and said, what you have done with the 990, you probably 

should do with the 1023. And so at some point, we probably will 

take a good hard look. We did redesign the 1023 in advance of the 

990. It is probably time to take another look at it. 

Ms. JENKINS. Okay. Once an organization is approved as a public charity, can you explain how the IRS ensures that the organization remains in compliance and how do you ensure that the organization continues to engage in activities that further its exempt purpose? 

Mr. MILLER. So the primary way of our doing that would be 

through the Form 990, through the annual filing requirement of 

the organization. And I mention there is a series of possible forms. 

The very smallest organizations, which have less than $50,000 in 

receipts in a year, they are filing a postcard with us, an electronic 

postcard, with like six items as to, okay, how do we contact you 

and where are you. It is sort of a fact of filing so that we can maintain our records in an intelligent fashion. There is also a 990–EZ 

which is a shorter form of the 990, which if you have less than 

$200,000 in gross receipts or half a million in assets, you will be 

filing that with us on an annual basis. And then there is the Form 

990 that was the subject of the large scale redesign for larger orgaVerDate Mar 15 2010 23:57 May 10, 2013 Jkt 080340 PO 00000 Frm 00026 Fmt 6633 Sfmt 6602 I:\WAYS\OUT\80340.XXX GPO1 PsN: 80340

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nizations. And that really is the way we can take a look at these 

organizations across the country and see whether they are meeting 

the requirements. 

Ms. JENKINS. Okay. Thank you. 

Mr. Chairman, I yield back. 

Chairman BOUSTANY. Thank you. 

The chair now recognizes Mr. Kind for 5 minutes. 

Mr. KIND. Thank you, Mr. Chairman, and thanks for holding 

this hearing today. I think it is very important because it is such 

a fast moving area of IRS jurisdiction and oversight that I think 

it is incumbent on the Committee to pay a little more attention to. 

I appreciate your willingness to do so. 

Mr. Miller, almost 2 million tax-exempt organizations; obviously, 

Representative Lewis expressed concern about funding and resources and personnel in order to deal with such large numbers, 

and now we are starting to see a lot of tax-exempt organizations 

engaging in blatant political activities. I mean, how much is the 

IRS capable of reviewing these type of activities to make sure that 

these organizations are complying with the law, they are meeting 

their charitable purposes and that, given the plethora of other taxexempt organizations that you have to keep an eye on as well? 

Mr. MILLER. Well, we do maintain, and again, we are talking 

about public charities here, we do maintain a process by which we 

take a look at organizations that are either referred to us or come 

up in the papers as having done these sorts of political activities 

in the 501(c)(3) area. Those referrals, that information, will make 

its way to our Dallas office, which is the examination function, 

where a team of three individual careerists will take a look and determine, is there enough here to start an audit or not? So we do 

maintain a program in that area. 

Mr. KIND. A lot of the casework that I see, I don’t know if my 

colleagues share this observation, but it is dealing with smaller 

charitable organizations back home trying to obtain tax-exempt 

status and helping them navigate, make sure they are legally compliant and doing everything that they need to do. Given the lack 

of resources that Mr. Lewis just pointed out, are you still able to 

provide sufficient service for the smaller charitable organizations 

and helping them comply with the law and everything that they 

need to do? 

Mr. MILLER. So we are trying, is I think a fair answer to that 

question. Could we do more? Absolutely. We are trying by putting 

more of our work on our Web site so that organizations can reach 

out. I would like to do more small, small organization conferences. 

Right now, that is not really the most efficient use of the resources 

that we have. But our Web work is good. We have also begun to 

partner with local educational institutions, universities and such, 

to try to have them take the lift and bring small organizations together so that we can get our word out that way as well. So we 

are trying. 

Mr. KIND. Also, the redesigned 990 now has a new schedule R. 

Why was that necessary and how does that help you perform your 

functions? 

Mr. MILLER. So the R, unless I am mistaken, is the related entity schedule. And that was essential we think because we needed 


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to see—we needed to have a window into what the entire organization looks like. A hospital system is more than an individual corporation. A college and university is more than the very college or 

university itself. It is an endowment. There are numerous things 

around that organization that we sort of needed to take a look at. 

I will say it is probably one of the areas that we should be talking 

to people about. Is it too much information or too many people having to do that? 

It is worth the discussion. It is one of the areas that we are beginning to hear maybe there is burden there that we can alleviate. 

But the concept is essential because the largest organizations, you 

need a complete window into what the organization looks like, 

what the web of organizations is. 

Mr. KIND. All right. Great. Thank you. 

Thank you, Mr. Chairman. 

Chairman BOUSTANY. Thank you, Mr. Kind. 

Before I go to Mr. Marchant, I have a quick question I would like 

to ask you, Mr. Miller, in follow-up to Ms. Jenkins’ questioning. 

And that is, can you comment on whether the thresholds make 

sense with regard to the different forms? I mean, or should that be 

revised? 

Mr. MILLER. So I am open to the discussion. 

It was placed there basically in conjunction with the discussion 

with the States who are using these numbers as well, but it is one 

of the things we ought to talk about. So originally, there was no 

filing requirement for organizations with $25,000 or less in gross 

receipts. The Pension Protection Act of 2006 modified that and 

said, no, everybody has to file. We moved that group up to $50,000. 

And we also modified the other numbers a bit as well to try to provide some relief from what we knew was going to be a somewhat 

more burdensome 990. We are open to the discussion as to whether 

those thresholds are correct. 

Chairman BOUSTANY. Fair enough. 

Mr. Marchant, you are recognized. 

Mr. MARCHANT. Thank you, Mr. Chairman. 

In my discussion this morning, I would like to focus on some of 

the smaller local groups that are claiming tax-exempt status. And 

these are groups that are unapologetically politically involved. I 

mean, in fact, they were formed around that idea. What would a 

small group in a suburban town that might have 60 to 80 Members, what is the most likely organizational tool that they would 

file in order to be tax exempt? 

Mr. MILLER. Are these organizations coming in as 501(c)(3)s, or 

would they be coming in as 501(c)(4)s? 

Mr. MARCHANT. I think that is my question. What would be 

the most efficient as far as compliance goes? 

Mr. MILLER. So if they are really doing politics, Congressman, 

they really can’t be a charitable organization under the Internal 

Revenue Code. 

Mr. MARCHANT. So would they be a tax-exempt organization? 

Mr. MILLER. So they could be one of a couple of things. They 

are permitted to have some politics in their business if they are a 

501(c)(3) social welfare organization, although they need to primarily be engaged in other than politics. They can do some work 


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if they are a labor union to qualify that way or as a trade association. Those are also able to do some politics. 

But really, if all they are going to be doing is politics, then they 

probably should be a political organization, that we would describe 

under section 527, a PAC. 

Mr. MARCHANT. And so if they don’t file for the 527 PAC designation, many of these groups are now contacting our offices. I can 

speak for myself. I have been contacted by several of the groups in 

my district. And they feel like they are being harassed. I don’t have 

any evidence that that is the case. But they feel like they have 

been harassed and feel like the IRS is threatening them with some 

kind of action or audit. What kind of a letter or action is taking 

place at this time that you are aware of? 

Mr. MILLER. So if we are talking about social welfare organizations, (c)(4)s, 501(c)(4)s, then we did receive quite a few. We received an uptick, an increase in the number of (c)(4) organizations 

that were advocacy organizations, they were advocating on various 

things, which is a fine thing for a 501(c)(4) to do. It is politics that 

isn’t really considered to be appropriate 501(c)(4) behavior past a 

certain threshold because they can do politics. And what is politics 

also, Congressman, is, you know, it may not be what you and I 

would think of politics as; it is politics under the Internal Revenue 

Code, which is really campaign intervention. It is endorsing or arguing against a particular candidate for public office, that is politics. 

So you know I am aware that there is an uptick of organizations 

that came into us for exemption. So it was the determination letter 

process, not the examination process. 

I am aware that some 200 501(c)(4) applications fell into this category. We did group those organizations together to ensure consistency, to ensure quality. We continue to work those cases. 

My understanding, Congressman, is something over 50 of the 200 

have received exemption already, more will. But many of these organizations fall into the category that I was talking about with 

Congresswoman Jenkins, where they are very small organizations 

and they are not quite sure what the rules are, and so we are 

working with them to ensure that they understand what the rules 

are. It is my hope that some of the noise that we heard earlier this 

year has abated as we continue to work through these cases. 

Mr. MARCHANT. Yes, we have had many constituents call, and 

there is a lot of blog activity. There is a lot of activity on the Internet talking about potential legal fees in the hundreds of thousands 

of dollars in fines in this group. So what is the potential if a group 

crosses over the line from being advocacy, advocating certain policy, over into the endorsement, the campaign endorsement realm? 

Mr. MILLER. So if they are coming in for application to be recognized as a social welfare organization, and they don’t receive that 

recognition, then they would just not be a tax-exempt organization. 

Mr. MARCHANT. So what about organizations that have already 

received the recognition but somewhere along the way have shifted 

their emphasis to where—is there an audit process? 

Mr. MILLER. There would be an audit process to determine 

what was their primary activity. Was their primary activity good 

501(c)(4) work, societal benefit, community benefit, social welfare 


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or something else. And the something else could include much 

more than politics. It is just non—and so if we found that they 

were not primarily engaged in social welfare activities, we would 

revoke their exemption or work with them, as we do oftentimes, to 

move forward in an improved way. 

There also would be under the tax rules some possible tax based 

on the lesser of net investment income that they had or the political expenditure itself under the Code. 

Mr. MARCHANT. Thank you, Mr. Chairman. 

Chairman BOUSTANY. Thank you. 

I thank the gentleman. Mr. Becerra, you are recognized for 5 

minutes. 

Mr. BECERRA. Thank you, Mr. Chairman. 

Mr. Miller thank you for being here. Is there a section on Form 

990 that requires a social welfare organization to document what 

portions of that organization’s activity or portions of those activities 

are devoted to political activity specifically? 

Mr. MILLER. Yes, sir, I believe there is. 

Mr. BECERRA. And does the IRS have a bright line in terms of 

how much of that 501(c)(4)’s activities can be spent as political expenditures? 

Mr. MILLER. We do not have a bright line, no. 

Mr. BECERRA. Does the IRS plan to try to provide better guidance to 501(c)(4)s as to at what point that bright line is crossed? 

Mr. MILLER. So we have received obviously some inquiries, both 

from your colleagues and from others in the community, to look at 

the area. I don’t think we have made a decision as to whether to 

do guidance one way or another, but we have agreed to take a look 

and have that discussion. 

Mr. BECERRA. So for any organization that is looking to stay 

within the law and also wants to engage in some aspect of political 

activity, what guidance would IRS give that organization? 

Mr. MILLER. Well, they ought to get professional help, obviously, because this is not a—— 

Mr. BECERRA. We know they need professional help. 

Mr. MILLER. We will move on from that. 

So the general rule, as I was mentioning to Mr. Marchant, the 

rule is that a 501(c)(4) organization must be primarily engaged in 

activities that further and promote community benefit, social welfare. We have been asked to primarily test a bright line, and we 

don’t believe it is. It is not a qualitative test—or rather it is a qualitative test versus quantitative. We would be looking at things like 

expenditures. We would be looking at things like staff time, including volunteer time. We would be looking at what dollars are being 

devoted to this activity, what dollars are being derived from this 

activity, what sorts of assets are being dedicated to this outside of 

fixed assets, what kind of building and equipment. All of those 

things would come into sort of the conversation. And that guidance 

is sort of out there in terms of both court cases and revenue rulings 

to give people sort of a guide way to make that determination on 

their own. 

Mr. BECERRA. Now, what about this whole notion that social 

welfare should be the principal purpose of the activities of some of 

these 501(c)s, (c)(4)s, (c)(3)s and so forth, and the fact that it seems 


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like some of these 501(c)(4)s are stretching what might be considered social welfare to the point where it is blurred and it looks 

nothing like a social welfare activity that most Americans would 

reasonably think can be applied to that term. 

Mr. MILLER. So, again, the general rule would be a 501(c)(4) organization can do campaign work, but it must be primarily engaged 

in social welfare activities, and it can’t operate for the private benefit of a select group. 

To your point, first, there is no bright line, and we would take 

a look at organizations that were involved in politics. 

Secondly, this is an area obviously that for us is somewhat difficult, because for a 501(c)(4) organization, when I talk about how 

do you calculate out the primarily test, you look at the entire year. 

So the fact that an organization is doing something today might be 

relevant to the inquiry, but it is not the end of the inquiry. The 

inquiry is, what are your activities for the year? What did you do, 

and how much of it did you do? So it is almost always going to 

have to be after the year is up that we have sufficient information 

in a 501(c)(4) context to make a determination as to whether there 

is a problem or not. 

Mr. BECERRA. And do you have the resources and staff to try 

to monitor and oversee all the different 501(c)(4)s and how they 

apply that social welfare test? 

Mr. MILLER. We could always use more resources. I believe we 

have sufficient resources if we decide to place them in the places 

we need to place them, is sort of the answer there, Congressman. 

Mr. BECERRA. I will try to decipher that answer. Thank you 

very much. 

I yield back Mr. Chairman. 

Chairman BOUSTANY. I thank the gentleman. 

This hearing is really intended to focus on the public charities 

and the (c)(3)s. I know the activities with (c)(4)s is an issue, and 

it is something we will get to down the line. But right now with 

this hearing, I wanted to keep the focus on the (c)(3) organizations 

and the complexities with regard to organizational structure, UBIT, 

and some of the vagaries that attend those issues and the problems 

that arise as a result. So I appreciate the gentleman’s questioning, 

but hopefully, we will keep it to the public charities. 

Mr. Reed. 

Mr. REED. Well, thank you, Mr. Chairman. 

I was going to continue on that line of questioning, but I will 

back off to another day. 

But I am interested at some point in time if you could, Mr. Miller, get to my office, you referenced three careerists who make 

these decisions on political activity or not. I would like to know 

who they are, how they are appointed, what their tenure is and 

what the process is that they use to adjudicate whether or not it 

is a political activity. Do you mind doing that for me? 

Mr. MILLER. As to the names, I will have to see about that one. 

Mr. Reed, these are careerists, these are lower graded folks who 

are managers, group managers at some point, and they cycle in 

and out. It is not only a—it is not one single three person. 


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What we have tried to do in the area is make sure that one individual at the service can’t start an examination that is a politically 

charged type of examination. 

Mr. REED. But if I understand your testimony, there are three 

individuals that are kind of the sounding board. 

Mr. MILLER. There is a referring committee that as a normal 

course of its business and under established procedures of the Internal Revenue Service receive referrals, evaluate the referrals. 

Mr. REED. That is what I would like to get to. I am new here, 

so how you operate and what the background is. 

Mr. MILLER. I would be glad to walk you through the referral 

process. 

Mr. REED. I really do appreciate that. It is more of an educational exercise for me and making sure that we are aware of it 

and getting up to speed on it. 

But I do want to challenge you on one thing, Mr. Miller—and I 

appreciate the work you do. I totally appreciate what the IRS is 

under and the burden that the IRS faces with managing the whole 

tax issue and revenue job mission that you have for America. 

But many witnesses come up here and they state a conclusion to 

us, and you have stated it again today. You have stated that you 

are understaffed. And my colleagues on the other side have raised 

that issue repeatedly. I want to know from you as a deputy commissioner, a leader of a large organization, how do you determine 

that conclusion? Are there metrics? I mean, is your goal then—and 

then also the flip side of that, what is fully staffed? I can’t imagine 

you are advocating to have 2 million IRS employees added to monitor one for one each of the organizations. So obviously to illustrate 

my point, I am taking it to the extreme. 

So I want to understand what allows you to state that conclusion 

to us as Members of Congress that you are understaffed? What is 

not getting done that should be getting done? And what is your definition of fully staffed? 

Mr. MILLER. So I will start with what I don’t have. I don’t have 

a definition of fully staffed. Congress determines what our full 

staffing is. Are we understaffed? We have enough people to do the 

job we need to do. Could we use more? Absolutely, Mr. Reed. The 

way I would like, and it is not only staffing, right, it is IT money 

as well, I would like, I would very much like, especially for small 

organizations but for all organizations, to modernize the way they 

fill out an application form, to sort of have a 1023 that is online 

that they can fill out easily with help along the way, not unlike the 

tax software that we all sort of use; what does this mean, and there 

will be information right there for them to pull down and get that 

information. I would love to be able to build that system. And I 

would like to be able to say to you that I have better and more robust number of examinations that I am doing relative to the 1.3 

million organizations that are out there. 

So my metrics are difficult, but my metrics would be how many 

people contacted my various education sites; how fast did I do my 

work for people, customer satisfaction again; how many people was 

I able to touch in a compliance fashion to try to influence future 

behavior by the whole of the group and not just the people that I 

touched; and am I doing enough of those? And I would say that it 


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is close, Mr. Reed, it is close on that one. But those are the sorts 

of metrics we would look at. 

Mr. REED. And I appreciate that. So my takeaway is that essentially, from your testimony and just correct me if I am misunderstanding it, is that right now staffing resources, making do, you 

would like to have more, you would love to have more, I believe is 

your testimony, which I can appreciate, but you are making the 

best of what you have and you seem to be hitting the targets of 

the metrics of doing your job. And so is that a clear understanding 

of your testimony? 

Mr. MILLER. So the last bit of it I would say we are getting to 

the point where I think it is taking us a little too long to get to 

determination letter requests. I think we may not be doing everything we need to do in the educational area. And we are getting 

to the point where I would worry about our coverage rate in the 

exam area. But I am not going to quibble with the discussion. That 

is roughly right. 

Mr. REED. Okay. Thank you. I appreciate that, Mr. Miller. 

I appreciate the candor. With that, I yield back. 

Chairman BOUSTANY. Thank you, Mr. Reed. 

Mr. McDermott, you are recognized for questions. 

Mr. MCDERMOTT. Mr. Chairman, I appreciate that you wanted 

to be on (c)(3)s, but some of my colleagues have gone down another 

alley. And I see—first of all, I want to ask a question. 

Chairman BOUSTANY. Mr. McDermott, you don’t have to make 

the same mistake. 

Mr. MCDERMOTT. I think emulation is the high pride of authorship. One of the things that is raised here is, are you doing 

your job? You didn’t mention audits. You sort of obliquely did, that 

is to get people to you know sort of do what ought to be done in 

the future. But if you don’t have a lot of people, you just don’t audit 

people. That is the place where you make cuts, right? 

Mr. MILLER. That and in the determination letter process. 

There is education, there is—— 

Mr. MCDERMOTT. You can’t avoid that. If they call in asking 

questions, you got to answer them, right? 

Mr. MILLER. Well, I would like to reach out more. I would like 

to have people available to reach out to these folks rather than 

wait for the questions. 

And the determination letter process is a customer-driven process. You will come in to me with a 1023 or a 1024. I have to work 

that case. How fast I work it will depend on how many folks I 

have. And as the folks dwindle, that will suffer as well. So it is 

more than just exam, but exam clearly is part of that. 

Mr. MCDERMOTT. And if you have these targets and something 

pops up to be audited, do you audit 100 percent of those people 

whose names come up along because of what something in their account? 

Mr. MILLER. We never did, and we never will audit everybody 

who comes onto our radar screen. We have to make intelligent decisions about how far we can go based on resources and other topics. 

Mr. MCDERMOTT. Do you get back money when you audit? 

Mr. MILLER. So we do get back some money. As I indicated in 

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rive revenue from the sector. We seek to protect the investment 

that the U.S. Government has made in the tax-exempt sector. Mr. 

Lewis spoke about the amount of revenues. Mr. Lewis spoke about 

the amount of resources, the $2.5 trillion in assets that sit out 

there. We are there to sort of ensure not that we take more of that 

$2.5 trillion, but that it is being utilized within congressional intent. 

Mr. MCDERMOTT. When people fight back against you, I 

walked in here and the discussion was about the Tea Party and the 

Richmond Tea Party, and I am looking at the letter that you have 

and these questions—provide a resume for each Member of your 

governing body, and provide copies for all your newsletters, provide 

promotional literature developed by your activist committee, provide a list and description of specific events. What is unreasonable 

about those questions? They say you are being unreasonable in 

asking for these. Do you think those are unreasonable questions? 

Mr. MILLER. So I am not going to speak to the specifics of any 

given case because I can’t. 

Mr. MCDERMOTT. Right. 

Mr. MILLER. We ask questions. And in the cases that we talked 

about, we asked a series of questions. We also went back afterwards and said, by the way, if these questions are too much for 

you, let’s talk. And that is what we did in this case. 

Mr. MCDERMOTT. So these questions, this is kind of a standard 

letter here I have, which you send out to anybody you audit—or 

you are questioning their exemption, is that correct? 

Mr. MILLER. So I don’t know the letter that you are looking at, 

Congressman, so I can’t say. But we don’t send out a standard letter to everyone in any event. 

Mr. MCDERMOTT. It is from the IRS, dated 9–17–2010. And it 

is to this organization, and dear sir or madam. So it sounds like 

it is a kind of a standard letter. 

Mr. MILLER. It might have been standardized to a group of 

cases, sir, but I can’t really speak to this. 

Mr. MCDERMOTT. If they call in and say, this is too burdensome for us, we can’t do it, do you then talk to them orally. Well, 

how do you do that? Get them into the office or over the phone? 

Mr. MILLER. So these are almost always going to be over the 

phone because our folks generally are going to be in Cincinnati, 

and a lot of organizations aren’t and don’t have the ability to either 

hire somebody to wander over to Cincinnati or come themselves to 

Cincinnati. These are almost always a review of paper and additional letters that go out, like the one you are talking about, and 

responses and a discussion on the phone in conference of right if 

we are going in a particular direction. But these are more office audits than they are sort of a field audit. 

Mr. MCDERMOTT. And from that, you make a determination as 

to whether they are doing social activities? 

Mr. MILLER. Whatever the particular requirements are—— 

Mr. MCDERMOTT. Under a (c)(3). 

Mr. MILLER. So under (c)(3), it would be, are they charitable, 

and do they have a charitable purpose? Under (c)(4), we would be 

looking at what they are doing, and does that promote social welfare? Different requirements for different code sections. 


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Mr. MCDERMOTT. And is the standard for promoting social welfare—my time is up. I would like to see the standard. If you would 

send us the standard you use for determining social welfare. 

Mr. MILLER. Surely. We can do that, sir. 

Mr. MCDERMOTT. Thank you. 

Chairman BOUSTANY. I thank the gentleman. 

Mr. Paulsen. 

Mr. PAULSEN. Thank you, Mr. Chairman. 

And thank you, Commissioner, for being here. I want to ask a 

question on a slightly different subject as well because we have 

heard a great deal from the IRS about a realtime tax system. And 

there have been a number of public meetings that have taken place 

on this issue. And many are concerned that this type of a filing system could lead to a very burdensome reporting component, similar 

to what we saw in the 1099 debate that took place not too long ago. 

And I think this would be a nightmare for American companies, for 

businesses, whether you are small or large, and the IRS is going 

to now make this realtime system work. If you are going to make 

this realtime system work, I am sure you are going to want to have 

all the data earlier to collect information than is required today, 

you are probably going to want to have more 1099 data. Just looking at what has been discussed today, it seems that compressing 

the report and timeline and potentially increasing the reporting requirements would make an already onerous process even more onerous or more burdensome. 

And I sent a letter not too long ago, I think the Chairman followed up and sent a letter as well to Commissioner Schulman, 

about the realtime taxes a few months ago. I haven’t heard back. 

But can you help get a response to that in particular in looking at 

that, and do you have some comments on the realtime tax? 

Mr. MILLER. So we will certainly look at getting a letter back 

to you all. On realtime, let me just say a couple of things. First, 

we are very far away from making any decisions that would move 

up or even draw a picture of what this might look like. But the conversation—we can’t be scared of the conversation, because the concept of our having and the taxpayer having the information available earlier, we can’t shy away from that conversation because it 

is an important area. And in a perfect world, all that information 

would be available. It would be available for us to make a decision 

around whether the refund was a good refund or a bad refund 

going out. And it would allow us to go back and say up front, by 

the way, you know, we have information that indicates you should 

have X here versus X minus Y here, do you want to work through 

that and finalize a return? 

But what I would say, again Congressman, is we are very far 

away from any sort of decision as to what exactly this would look 

like. What we are doing at this point is building scenarios as to 

what this might look like for a given taxpayer? We will then engage the public again and throughout this entire process, which 

will be a multiyear process. 

Mr. PAULSEN. So you say you are far away; you are building 

scenarios. Do you believe that the creation of such a system under 

it is authorized right now under the IRS charter? 


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Mr. MILLER. It depends what the system looks like. If we were 

moving the filing date, no, it wouldn’t be. That is a legally set date. 

Certainly there would be discussions with the Hill before we move 

forward with anything that even remotely touched on those issues. 

Mr. PAULSEN. So you believe you need to have congressional 

authorization for those types of changes? 

Mr. MILLER. For some of the changes, absolutely. 

I also want to say, you know, and there has been concern about 

this, this is not in order to send out pre-filed returns, that is not 

really what we are talking about here. And I know there has been 

concern by some in the industry that this is a stalking horse for 

that. It simply isn’t. 

Mr. PAULSEN. Do you have any sort of estimates on what the 

cost would be, because given that we are talking about I had heard 

some conversation and testimony about resources and employees 

and staff and how—the intention—to be—to pay for that or what 

the cost would be on a realtime system for preparing for that as 

well? 

Mr. MILLER. So absent a blueprint of what it would look like, 

we have no way of doing a cost estimate at this point, sir. 

Mr. PAULSEN. Thank you, Mr. Chairman. 

I yield back. 

Chairman BOUSTANY. Thank you, Mr. Paulsen. 

That concludes our questioning, Mr. Miller, and we thank you for 

coming before the Committee once again, and I look forward to future visits, and this Subcommittee particularly looks forward to 

working with you going forward to resolve some of these issues. 

Mr. MILLER. Thank you. 

Chairman BOUSTANY. I would like to call up the next panel. 

Next we have four witnesses on our second panel, all distinguished 

witnesses who will lend some clarity to this debate. We will hear 

from Eve Borenstein. 

Ms. Borenstein is a partner with Borenstein and McVeigh Law 

Office in Minneapolis, Minnesota, and is known as the queen of the 

990. 

So we welcome you. 

Second, we welcome Mr. Thomas Hyatt. Mr. Hyatt is a partner 

with SNR Denton here in Washington and is chair of SNR Denton’s 

health care practice focusing on tax-exempt organizations. 

Sir, welcome. 

Thirdly, Mr. John Colombo. 

Mr. Colombo is the Albert E. Jenner, Jr., Professor at the University of Illinois, College of Law, in Champaign, Illinois. And Mr. 

Colombo has written extensively on tax-exempt organizations. 

Mr. Colombo, thank you for being here today. 

And finally, we will hear from Donald Tobin. Mr. Tobin is associate dean for faculty and the Frank E. and Virginia H. Bazler Designated Professor in Business Law at the Ohio State University’s 

Moritz College of Law in Columbus, Ohio. Mr. Tobin is an expert 

on campaign finance law and previously worked on the Joint Economic Committee. 

Mr. Tobin, welcome. 

You will each have 5 minutes to given us your oral testimony. 

Keep in mind that your full written statements will be made part 


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of the formal record, and so I ask you to keep your oral comments 

to 5 minutes so we can get to questions. 

Ms. Borenstein, we will begin with you. 

STATEMENT OF EVE BORENSTEIN, BORENSTEIN AND 

MCVEIGH LAW OFFICE LLC, MINNEAPOLIS, MINNESOTA 

Ms. BORENSTEIN. Thank you Chairman Boustany, Ranking 

Member Lewis, Members of the Committee. 

I thank you for inviting me to testify today. I do not elaborate 

in my written submission as to why I believe that the redesigned 

Form 990 for the most part makes the right asks of those who are 

afforded tax exemption. 

There are four points I want to offer in that regard now. One, 

because the filing is appropriately not just numbers, organizations 

must be proactive and collect from internal sources the various information the form seeks, as well as prepare written narratives. 

Accordingly, the amount of resources and time that filers expend 

in favor of preparation has undoubtedly increased. This is not a 

bad thing; it is just a fact. 

Two, the information the form provides the IRS is more thorough 

and descriptive than before, allowing the agency to more effectively 

apply its resources toward improved enforcement and education. 

Three, the fact that the filing is widely available makes filers 

transparent in ways they never were before, which is huge. The 

public relations power of that transparency leverages the IRS’s limited resources as the reading audience brings their own potential 

‘‘enforcement’’ forward. 

And four, while the new form does have a sharp learning curve, 

which has burdened the sector, filers are starting to master the 

form, and I am certain further improvement will be evidenced over 

the next few years, particularly if the IRS can help. 

It is this last point that generates the recommendations I make 

in my written testimony. As to charges leveled of being overly burdensome, the new form makes multiple asks that its predecessor 

did not and imposes new architecture for the form—a core form 

with 15 subject schedules tailored to the individual topics that the 

IRS seeks information upon, not all of which are in play for most 

filers. 

But as a result, the form’s instructions comprise a new playbook 

for filers and those who assist them. The need to master this new 

regime has clearly shocked many filers, but many of those had not 

properly understood or appreciated the form’s complexity in the 

years prior to the redesign. Indeed, many filers have misperceived 

the prior form as only a financial statement report to the IRS belonging solely to the domain of the organization’s accountants. 

The new form is clearly a full information return for exempt entities that extends well beyond financial results. It cannot be wholesale handed off to auditors or paid preparers. Completion requires 

meaningful participation by the filer, whose staff or leadership 

must now provide firsthand data on the group’s output and operations, including information that resides outside of the finance 

staff. 

The understanding by groups of all sizes that this is the case and 

that they must have a preparer (either internal and/or external) 


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34 

who is committed to mastering more of the new form’s learning 

curve each year has been evidenced as we have moved from the 

form’s filing season in 2009 to today. 

Ms. BORENSTEIN. In the recommendations section of my written testimony, I make five specific suggestions and note that comments on overlapping burdens of two schedules should be opened. 

I urge this Committee and the tax press to read each of those six 

points not as signs of the redesign’s failure or overreach but as lessons from the field. 

In that spirit, I want to offer three realities that need to be taken 

into account before we start assigning final grades to the Redesigned Form and its results to date. First, the IRS should not 

change the form now, midstream, but instead focus on the few 

areas where it is clear that burden could be decreased and take advantage of the opportunity to better the form by getting those areas 

right. As set out in my recommendation, the first one, this is particularly urgent with respect to helping organizations and users of 

the form understand that the IRS’s semantics and reporting requirements are not necessarily value-laden, especially in regards to 

reporting insider transactions and counting directors as ‘‘independent’’ or not. 

Second, we should not conflate the fact that reporting organizations will be burdened by the resources required to complete this 

annual filing—that is a cost of exemption—with the fact that many 

organizations do not and will not have access to an accountant or 

other professional who is qualified to assist in preparing this filing. 

It is appropriate to keep the preparation challenge situated with 

filers at all times, regardless of whether they have access to competent paid or pro bono professionals. 

And third, the Redesigned Form does a great job of using the 

form’s transparency factor and the certainty of public access by 

funders, whistleblowers, competitors, reporters, et cetera. The form 

sets out affirmative reporting responsibilities that I have seen promote far greater compliance and appreciation of tax mandates and 

charitable precepts than ever before. This is notably evident in the 

management of compensation and certain other governance arenas, 

as well as in portions of the form’s most complicated schedule, the 

Schedule L, where filers are to disclose intersections with insiders. 

That disclosure responsibility has, as it should, generated valuable 

self-reflection by reporting organizations as to the motives and results obtained from such opportunities. 

I can talk about the 990 for hours at a time, but I see my time 

is up. I look forward to answering any questions you may have. 

Thank you. 

Chairman BOUSTANY. Thank you, Ms. Borenstein. 

[The prepared statement of Ms. Borenstein follows:] 


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TESTIMONY OF EVE BORENSTEIN 

PARTNER, BORENSTEIN AND MCVEIGH LAW OFFICE LLC 

PR[NCIPAL, EVE ROSE BORENSTEIN, LLC 

BEFORE THE SUBCOMM[TTEE ON OVERS[GI [T 

HOUSE WAYS AND MEANS COMMITTEE 

UNITED STATES CONGRESS 

JULY 25, 2012 

IN REGARDS TO OPERATIONS AND OVERSIGHT OF TAX-EXEMPT ORGANIZATIONS 

Chairman Boustany. Ranking Member Lc\vis, and members of the Subcommittee, I am 

honored to provide testimony as to the design and efficacy of the chicftool by which oversight 

of the operations. activities and finances of most tax-exempt organizations is prosecuted: the IRS 

Form 990, annual return of organizations exempt from income tax wlder Internal Revenue Code 

Section 501(c).' 

My remarks today will focus on three areas. First, my experience in preparing Fonu 990, 

advising clients about the form, and teaching practitioners and organizational statTabout the 

Form 990 for over 20 years, including most recently over that period which witnessed the 

revolutionary Form 990 redesign implemented for 200g and later tax years. Second, those 

reporting areas for which the Form's 2008 redesign requires additional or new information not 

previously required. Third~ those areas of the Form which I believe require further improvement 

und redesign in order to provide greater clarity and reduce compliance burden. 

There is no doubt that the Redesigned Form 990 is a major improvement over the form's 

prior version. 1n my experience, the Form's new structure is both easier to li)1!O\v and has 

resulted in tilers providing more accurate versions of their activities. Filed Forms 990 now 

include much broader contexlual data (mission, narration or changes in programming, 

explanation of changes in fiscal resources [rom the prior year or of new policics, etc.) than that 

which was ayailable via pre-2008 Forms.' It is widely-admitted, albeit sometimes grudgingly, 

1 My remarks do not address the Form 990-EZ (short form for many smaller exempt organizations), the 

Form 990-T (the annua! return to report and pay the unrelated business income tax), or the Form 990-PF 

(the annual return for private foundations) none of which have been redesigned. 

2 The baseline Form, called the "Core Form" consists of twelve pages filled out by all filers along with a 

Schedule of blank lines, the Schedule 0, where filers narrate additional information called for by the 

Core Form. A sample Core Form and common Schedule ° annotated with tips and explanations that I 

use in my teaching may be accessed at: 
36 


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that the addition of a full page Pare on Govemance. where filers must address yarious aspects of 

their management structure, has been extremely successful in focusing attention upon basic 

"good governance!' precepts and highlighted Board and manager's responsibilities. 

One of the advantages of the Fonn is that by providing all regulators ~ the IRS, the States, and 

the' court of public opinion' ~ more complete information bot11 on the Core Form and through 

some key Schedules, filers are cognizant of the F0D11'S importance not only from a taxadministration perspective but from a public relations perspective. It is clear that one of the three 

goals of the Redesign, "to taJ.".e advantage or the Form's transparency aspects/' has borne fruit 

and given credence to the notion that "sunshine is the best antiseptic." I believe that the laywout 

of the Redesigned 990 and the additional substantive data requested in the ancillary Schedules 

alh.)\vs the IRS to morc efficiently and effectively -'hone in" on l1lers' activities and study 

specific sub-sectors, analyze trends, and more appropriately allocate their limited resources to 

educational efforts and compliance programs. 

EtpertiselErperience with tht? Form 990 

For my entire professional career, my legal practice has focused on advising and 

representing small and mid-size exempt organizations. My clientele does 110t include hospital 

system::" higher education systems (asidt: lrom 990 reviews), or other types of the largest exempt 

organizations (again, aside from 990 revie\vs or specific engagements related to IRS 

controversies). As a result, my experience has been with the size and type of organization that 

comprises the vast majority of organiLations filing the Form 990. 

1 first began to practice tax Jaw in 1985 when 1 joined the tax department of a Big 8 

accounting firm after law schooL There, I was assigned to FOll11 990 preparation, an assignment 

I had requested. For tax years begun in 1985, the Form 990 was tive pages, supplemented by an 

additional Schedule for 501(c)(3) organizations which added three pages. At that time, the 

Fonn's questions focused on virtually c\'cry federal incomc tax mandatc to which the exempt 

sector \vas subject. 

Incremental changes to the Form took place over the next several years. As the Form 

changed, so did my professional opportunities. I opened my own firm and began to represent taxexempt organizations exclusively, on both exemption qualification and tax planning, and on IRS 

examinations of tiled 9908. The 1989 Form added a ParI requiring tilers 10 'self-audit/report' 

the basis by w·hich their revenue streams were or were not subject to the unrelated business 

income tax. That addition \\'as made aftcr the IRS expressed concern that the Fonn provided no 

3 To save space, I have placed the names of Parts and Titles in footnotes. Part VI of the Core Form is 

titled, Governance, Management, and Disclosure. 

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windows into those activities offilers that were generating non-contribution revenues (such 

revenues then potentially being subject to reach of the unrelated business income tax). The 

expansion created new demand for continuing profes~ional education on the FonTI, and I ended 

up being asked to design and teach a 990 course for my home state CPA Society, which was later 

recommended by the Minnesota CPA Society to other State Societies. Over the course of 1991-

1996, my self-authored/instructed whole day 990 continuing professional education (CPE) 

course \vas provided to more than l,200 participants, by 12 State CPA Societies. 

In the latter half of the 19908, the increasing complexity of the Form and its 

accompanying Instructions gre\-v as ifon steroids, \vhich increased my teaching opportunities. 

The number of State Societies that offered my 990 day class grew to 20. The most frequent 

critique of my all-day course at that time was that it was too short and really should be a two day 

course. In 2000, in response to demand from non-preparers seeking instruction on the Form, f 

developed a "half day" ver5ion of a 990 class for "real pcoplc." 990 educational presentations 

were increasingly sought by State nonprofit association& and by CPA Societies sponsoring 

conferences for nonprofits. All ofthat attention \vas directly related to the Form's unwieldy 

growth ill compkxity. 

By 2007, the Form was a total of nine pages, with the additional Schedule required of 

501(e)(3) organizations adding seven more pages. It was widely regarded -- by the tiling sector. 

by public users, by paid prcparcrs, and by the IRS -- as a "disastrous monster" that \-vas 

staggering under its o\vn weight, lacking any coherent design, and suffering from Instructions 

that could barely earn that title. The Form had been amended piecemeal ovor time, mostly at the 

request of Congress, in order to access more nuanced and relevant information from reporting 

organizations. By the time of the 2007 Form's release, it was clear that it was time to redesign 

the Form. 

During 2007 and 2008, the IRS ramped up its efforts to redesign the Forn) and requested 

public comments to advance the Form's redesign. As someone \vhose experience \\'ith the Fonn 

had been informed by the many practical questions participants raised in my 990 classes (by that 

point more thall 2,500 professionals had taken the 8-crcdit ePE 990 class from me) and by the 

nearly 20 years of practice representing organizations of all sizes before the IRS on audit 

examination, I eagerly participated in that comment process. I believe that my affinity [or 

assisting small and medium organizations on understanding compliance mandates, including 

Form 990 preparation challenges. informed my approach. I participated via task forces from 

both the American Bar Association and the American Institute of Certified Public Accountants, 

and also provided personal comments to the IRS on their proposals for the Redesign. Ultimately. 

I played a part in providing close to 600 pages ofthe approximately 3000 pages of comments the 

IRS received. 

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I have continued to provide comments to the IRS on the Redesigned Form and its 

instructions to the present day. I continue to teach on the Form. I nm,,;, offer two all day courses 

(the second day being an "advanced" Schedules class). I do not address the reporting mandates 

faced by nonprofit hospital facilities, leaving that specialty topic to the health care specialists. 

My course patilcipants increasingly come directly from the exempt sector as more medium-sized 

entities choose to sci f-prepare their 990 filing. 

tn all venues of my work with the "Redesigned 990" - via comments to the IRS, teaching 

preparcrs. educating readers, and reviewing prepared Fonns pre-filing for clients - my goal has 

always been to tnake the form and instructions more understandable so that the tiling"s precepts 

are understood by those preparing a form for filing or accessing a form that has been filed. 

Promoting consistent and appropriate inputs on the Form not only enhances the credibility and 

stature of the exempt sector but allO\vs those who regulate the sector to keep up with changing 

trends and tailor enforcement cfforts accordingly. 

If. The "Op[Jorttll1i(v" Sei=ed hy the Redesigned 990 - fxpanded and ;\1ore Tailored 

Disclosures ill Key Arenas Relevant Not Just to IRS but to Multiple Stakeholders 

The Redesigned Form, if tilled out properly by an exempt organization, captures t11r more 

specific and appropriate information in twelve arenas of operations and administration than did 

its predecessor. As a result, preparation oftbe Redesigned Form requires more labor than the 

prior form. However, that result occurs not just because of the new infonnation sought, but 

because the Form n:quires disclosures on multiple non-financial realms. Those di.!mands exist in 

spite of the tact that the Redesigned Form 990's stmcture (a Core Form that all filers complete, 

with narrm'viy tailored-to-subject Schedules that apply in specific circumstances) implies that 

each Part or Schedule square with a "one size fits aU" approach. individual filer's answers and 

inputs are not going to be "uniform" with those of other tilers unless their circumstances are 

exactly the sa111e:~ Trends and similarities will certainly cut across sub-sectors,5 but each tiler 

must approach its own circumstances not only in devising the appropriate answer, but in many 

cases designing a narrative response. 

The Redesigned Form 990 asks the filer to report on virtually all aspects of the exempt 

organization's enterprise - ",hat the filer's programs achieved during the year, what managers 

(and certain other employees) and fiduciaries were in place, \\/bat those managers and fiduciaries 

4 For example, all filers who have an executive committee empowered to act with delegated power of 

the Board would presumably identify that fact and explain the composition of individuals residing 

thereupon in responding to line 1a of the Governance Part of the Form. 

S For example, most private schools and colleges will have some directors who are not in the count of 

"independent directors" because they have children attending the institution who were the recipients of 

financial aid or merit awards paid out during the tax year. 

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were paid, what governance and internal policies were in place by the end of the year, the 

existence of insider transactions, the type and total amount of grants or assistance provided to 

individuals~ information on non-cash contributions received, results from larger fundraising 

activities or events, number of volunteers engaged (this is optional), narration of lobbying 

activities or detail oflobbying dollars disbursed for those under the lobbying election (this only 

for SOl(c)(3)s), and dollar amounts ofrevcl1ucs garnered in conducting the organization's thrce 

largest (and then all other) programs (this only for 50 1 (e)(3)s and (c)(4)s.) This requires tilers to 

access their facts and cull internal in/ormation from multiple sources - staff on the program side 

of the organization, administrative/operations officers, and those who keep the org~U1ization's 

fInancial recordkecping. 

The twelve ncw arenas of expanded reporting rcquired by the Redesigned 990 are largely 

related to operational imperatives that the public expects to be met by the exempt sector. Each of 

these arenas is listed below, separated into new areas and expanded areas of infonnation 

reporting. 

Eight Complete/v .New Arenas 

L Updating the organization's ongoing exemption application record -- accomplished in 

the '''Program Service Accomplishment" Part of the 990 Core Form, Part fIr, via three 

questions: 

Inquiring whether the organization is undertaking any activity not previolLsly 

reported to the IRS upon an exemption application and/or prior-filed 990s 

Inquiring whether the organization has ceased any activities it previously reported 

to the IRS or has significantly changed how it conducts any previously reported 

activities 

• Requiring recitation orthe organization's Board-approved mission statement 

2. FoclLsing attention on the authority and management practices that arc in place as a 

result of the inherent and ultimate authority exercised by the exempt filer"s governing 

Board ~- accomplished by (Core Form) Part VIn and Part XIl7 which ask questions that 

previously \vere absent from the PonTI conee111ing: 

• Board composition 

Board's delegation of authority 

• Accountability to members if members exist (and denoting rights reserved to 

those members) 

6 Part VI is titled, Governance, Management, and Disclosure. 

7 Part XII is titled, Financial Statements and Reporting. 

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• Policies and procedures in place with respect to management practices overall in 

conflict of interest scenarios 

• Whether standard basic practices are employed in setting executives' 

compensation - also asked of in Schedule J, Part 1

8 

• Attention paid by the Board to review of the 990 tiled with the IRS 

How the organization makes public inspection of its 990 available as well as 

\vhether chartering and key governance documents (including audited financial 

statements) are available to the public 

3. Providing information on each "related organization" (parenUsubsidiary/brother-sister 

corporations, supporting/supported organizations, certain partnerships and trusts) 

accomplished via Schedule R regarding related organizations 

4. Providing information on arenas of operation regulated by the States accomplished 

via the follmving Schedules: 

• Schedule G9

, Part T addressing use of "professional fundraisers'< and requiring 

organizations 10 certify they have met registration/reporting responsibilities in 

jurisdictions ,vhere professional fundraiser sohcitation has oecuned 

• Schedule G, Part III - addn:ssing compliance of gaming operations ", .. ith State 

(and local) law mandates 

• Schedule N](J - addresses "substantial contraction" and dissolution, merger, and 

termination of the organization 

5. Providing details on types of non-cash (colloquially referred to as "property'~) 

contributions, including method of valuation - accomplished via Schedule MIl 

6. Providing information on political (i.e., support or opposition of candidates for 

elective office) activities undertaken - accomplished via Schedule e 12 , Part I 

7. Providing information on financial and other undertakings outside of U.S. borders·· 

accomplished via Schedule F 13 

8. Schedule J is titled, Compensation Information; Part II of the Schedule provides input on the same 

managers reported upon (Core) Form Part VII. 

9 Schedule G is titled, Suppiementallnformation Regarding Fundraising or Gaming Activities. 

10 Schedule N is titled, Liquidation, Termination, Dissolution, or Significant Disposition of Assets. 

11 Schedule M is titled, Noncash Contributions. 

12 Schedule C is titled, Political Campaign and Lobbying Activities 

13 Schedule F is titled, Statement of Activities Outside the US 

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8. PTovldlng informatIon 011 tax-exempt bond issuances -" accompl1shed via Schedule K 14 

Fo",. NOW EXPANDED Arenas of Inquiry (numbering continuing trom above) 

9. Requiring due diligence (i.e .• reasonable efforts) to ascertain ifparties \vho are 

themselves 'insiders' or who arc connected to 'insiders' received grants or assistance 

from the organization or had business transactions with the organization and 'hen 

disclosing basic parameters of such intersections - accomplished via Schedule L, Parts 111 

and IV" 

I O. Reporting more revenue sourcing detail on potential types of unrelated business income 

tax-susceplible revenue - accomplished via (Core Form) Part III (solely for 501(c)(3)s 

and 50 I (c)(4)s),joint venture t(leUS overall and specifically including Schedule R, Part 

V[ and Schedule K Parlll column idenlifying 5 [2(b)(13) controlled entilies, and 

Schedule G, ParllTl 

II. Compensation to managers (Board members, Officers, "Key Employees," and the five 

highest compensated employees whose taxable income IS at six figures or greater) is now 

reported using a consistent period and methodology (and details compensation paid by 

the filer and ils related organizations) at (Core) Form Parl VII Section A and Schedule J 

Parl II 

12. Consistent ddinitions for identifying "in charge" employees and Ollieers (current and 

tonner) that are subject to reporting at (Core) Fom1 Parl VII Section A and Schedule J 

Part [[ 

Ilf. How Well has the Opportunity Been Realized (i.e .. How CompletciAccurate are Prepared 

Renlrns)? 

Informing the ans\ver here is the fact that the Form 990 is not a tax return. It is an annual 

information return. The difference between the functions oftho:;.e two types ofretum is huge! 

In the Redesigned Form 990. there are only three pages of the (Core) Form that exclusively 

present linancial statement data. The remaining nine pages, while in some places requiring 

numeric input, speak almost exclusively to topics that are either specitic to exempt organization 

tax mandates or spccific to programs and activities. In other words. the information is not likcly 

to be in the knowledge base of an organi7ation's outside auditor or tax consultant. While these 

14 Schedule K is titled, Supplemental Information on Tax-Exempt Bonds. 

15 Schedule lis titled, Transactions with Interested Persons; Part III is titled, Grants or Assistance 

Benefitting Interested Persons, and Part IV is titled, Business Transactions Involving Interested Persons. 

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nine pages ortlle Core Form (and almost all the ancillary Schedules) do require numeric input, 

the numbers sought are typically to be culled not in line \vith generally-accepted accounting 

principles (GAAP). A truism for those of us who work with CPAs is that a non-profit auditor is 

almost always not an exempt organizations tax person and in many firms it is the case that 

"never the twain shall meet." 

Proper completion of the Redesigned 990 has required a steep learning curve. Filers have 

only recently begun to master the Form. 

Preparers and users of the Form have found, for the 1110St part, that the Form's 

instructions are useful and relatively 'plain English'. However, there is no denying that multiple 

areas of the FOnTI have introduced new and/or complex concepts so that in total a steep learning 

curve exists. Not surprisingly, the pace by \,iihich the filing community has moved ahead in 

advancing on that leaming curve has been slow. Indeed, in my judgment, it is only \vith the 

fourth filing season of the Redesign now in hand that palpable mastery and accurate completion 

of the new Form is being \videly evidenced. 

Self-preparers have had a much easier time in adjusting to the new Ponn than has the 

paid preparer community. Their learning curve progress has been advanced by the fact that in 

most ca~es the staff that doe~ internal preparation actually reads the in~tructions. (My first 

tcaching tip on the Redesigned Foml is to "rcad thc instmctions.") Furthermore, they can apply 

what they tind in the instl1.lctions based on their firsthand knowledge of their own organization. 

The ava; lability in the last decade or software tor such selt'preparcrs jj'om the National Center of 

Charitable Statistics (via the ejiie . .form990.or1( website) has also advanced the ability of exempt 

organizations to do their own returns - that soth .... are (""desktop 990") is not expensive (it is 

practically free to small and medium organizations), allows the user to "pop up" the instruction 

for each entry point of the tiling, save their vmrk, have fail-safe error recognition, and ultimately 

e-tile the return. 

The generally slmver advance on the learning curve by the professional "paid preparer" 

community is not surprising to me, as the quality of work by that community pre-Redesign was 

often impeded by several challenges, including: 

• many CPA finns do exempt organization audit and tax work as a courtesy to their for~ 

profit clients and do not have tax professionals in house who are adequately trained in 

exempt organiJ:ations tax mandates; the incentive to build out sllch expertise in 

smaller CPA Jirms and in finns in most non-metropolitan arcas is lacking Cor multiple 

reasons (i.e., the nonprofit world has limited desire and ability to pay lor what the 

work would cost; it is expensive to train staff on these mandates or \vork with 

associated experts to get the prepared returns properly rcvic\ved: and little incentive 

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exists to commit to training \vhen the tlrm is at risk of losing the individuals trained 

who may have more remunerative fields to ply). 

• the longstanding rnisperception that a corporate tax preparer, or an auditor who 

knO\vs the organization's financial statements, can easily and accurately complete a 

Form 990 

• the reality that those serving multiple clients on tight deadlines \vill nced to 

coordinate access to and input of data from the filer, then must interpret the Fonn's 

instructions in the context of that data (ignoring results that may have arisen from 

other fact scenarios), and then await review and further input from the filer before 

making the return llnal 

And finally, regardless of whether an organization's prepareI' - internal or extcrnal- may 

be qualified to assist in or perform the actual 990 preparation, three other factors have slowed 

progress on the Redesigned 990's learning curve over the course of the tirst two to three years of 

the new foml's existence: 

a. the opaqueness ofthe pre-Rcdesigncd Form's instructions led to an understandable initial 

resistance by most prcparers to pick up and read all the Redesigned Form's instructions. 

The instructions packet is of daunting: length, but there really are 'only' 34 substantive 

instruction pages pertaining to the 12 pages o1't11e Core Form, and most of the ancillary 

Schedules have inslnJctions running 3-5 pages. The Core Forn) instructions include a 

very valuable Glossary in which common terms are set out clearly and succinctly. 

b. a good old fashioned "this can't be" negativc reaction to some orthe Redesigned Form's 

demands fueled a Jot of resistance .... My personal experience with that carping is that 

oftentimes people spend more time whining than they \vould expend in properly learning 

the application that lits their (or their client's) situation, 

c. thc propensity of folks to not read the instructions fully when they do read them. 

Tn teaching ePAs 1 always get a big laugh when J tell people NOT to stop reading when 

they get the answer they want. 

Ultimately, in my t:xperience, the reporting organizations tht:mselves have bt:come more 

willing to tackle the Fonn '5 requirements. This is in great pati due to increasing public 

awareness of the Form and the information that it provides. Many filers are being challenged by 

readers of their 990 filings (particularly funding sources) \\lho nok that data is missing or 

inconsistent. This is in line with the intent of the Redesign, \;vhich is to have the Fonn not only 

foster compliance hy providing information to the regulatory community hut by taking advantage 

ofthe Form's transparency aspects. 

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I II: Wht-'re Can The Form Be Improved? 

There are five h'ishe.s that almost all preparers (and tbose advising preparers) of the new 990 

have. My address of these subjects, and recommendations in each arena, should not be 

interpreted as my belief· that the five arenas in \vhich those wishes vest (with one exception) are 

inappropriate for or otherwise unworthy topics of disclosure, My point is simply that the IRS 

could do a more efficient and effective and less burdensome job of getting lnfon1lation from the 

Schedule L, the Schedule F, the Core Form's Governance Part VI, and overall from small 

organizations. At the end of this section 1 also make some observations on Schedule R's 

reporting on transactions \vith "related organizations" and suggest the IRS seek comments as to 

hO\v some of the Schedule Land R complexity can be attenuated to the end of reducing burden. 

Additional IRS Education on '~Semantics" and Reporting Implications 

There is a need for education of the reporting community as to the meaning of key 

semantics the Form employs. There IS also a need to foster an understanding that the ]RS 

definitions for the Form are not necessarily the same lIsed by others for other purposes. and that 

in many instances what appears to be negative reporting on the Form does not mean that the 

organization is doing anything improper. A classic example of this is the insider transactions 

reporting on Schedule L. which rcquires an organization to disclose many transactions which arc 

common-place, even though the transaction may he advantagcous to the organization. Reporting 

organizations and preparers are concemed that their reporting of Board members (Trustees or 

Directors) who arc NOT "independent," or that their reporting that some of their Board 

members, Officers, or Key Employees are related to each other by "business relationships" or 

'~lamif)' relationships," means that the involved individuals lack competence and appropriate 

capacity to serve the filer. Filers arc similarly anxious if they must report having undel1aken 

business transactions with firms or parties \\'ho are connected to their Board members, Officers, 

or Key Employees, upon Schedule L, Part IV, especially \\·hen the existence of such transactions 

is commonplace and commercially reasonable. Indeed. transactions arc reportable upon Schedule 

L, Part rv regardless ofv,;hether they offer extreme advantage to the organization or afford the 

filer of opportunities that \\-ould not otherwise be available. Nonetheless, many organizations are 

fearful that the mere requirement to report the existence of such transactions on the FOI'm 990 

means that the transaction is improper, and that the involved individual should step down, a 

result that would deprive the organization of a valuable employee or Board member. 

It ,,·ould be beneficial to the sector for the IRS to address this problem by providing 

educational materials explaining that the only obligation (fyom an exemption qualification 

perspective) that a tiler has in disclosing the existence of non-independent directors, managers 

with 'jami(v" or "bw·;ness ,. relotions/1;ps, or Schedule L, Part IV reportahle business 

transactions is to ensure that those insiders (or those connected to them) are not being privately 

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benefited from their influence over the organization. The disclosures are there to focus attention 

on governors' responsibility to protect the tiler from uneven exchanges to the organization's 

detriment and to ensure that transactions outside of the filer's best interests are not undertaken. 

Practitioners attempt to communicate this point, but the voice that should speak on this suhjeet so 

that the message is delivered lmiformly and with authority is that ofthe IRS. This is an area 

where additional IRS educational outreach, rather than revision of the form, would do much to 

solve the problem. 

Simplify Schedule L 

For the vast majority of organizations, Schedule L is the most difficult of all the 

Schedules that Form 990 filers must complete. The difticulties start with the significant burden 

in reviewing the circumstances that. ifin place, would trigger the Schedule's application. Fikrs 

must self-assess if they have: 

• if a 50 I (e)(3) or (c)(4) organization, engaged in a Code Section 4958 excess 

bene'/;! rransaction in the current year or have discovered such a transaction from 

a prior year that was not previollsly reported upon the Fonn 990. Such 

transactions arc those that are undertaken with disquahfied persons that unfairly 

benefit such persons. 

• a loan on the balance sheet to or from a manager listed on the Core Form Pmi VlI 

Section A or to or from a Code Section 4958 disqual(fied person 

• grants or assistance provided to a pool of interested persons that includes 

managers listed on the Core Fonn Part. VI Section A other than jIve highest 

compensated employees, family members orthe pn;eeding, grant selection 

committee memhers and their family members, contributors appearing on Fonn 

990'5 Schedule B, and in some instances those contributors' employees 

• business transactions with the same pool of managers reached by the preceding 

bullet, or their J~unily members, or certain entities connected to any of lhose 

parties by control (in the case of nonprofit corporations, but this is attenuated 

when the other entity is 50 I (c)(3 »), ownership (in the case of other than nonprofit 

corporations) or management involved by those individuals (in the case of 

business or investment entities) and those transactions are above certain 

thresholds 

It would be beneficial to the sector if the Schedule L definitions were simphtied. The 

fact that expelis such as myself have spent tens of hours (if not a hundr~d or more) to be wellversed in the instructions for just two ofthe Schedule L's Parts (those in the tinal two bullet 

points preceding) reflects how difticult it is to have the sector become conversant \vitl1 the 

parameters at play. The instructions require filers to make "reasonable efforLs" to inquire of Lheir 

managers if they are a\varc if they, their family members, or other entities with whom they or 

their family members are connected are getting grants or assistance from the filer, or have 

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engaged in business transactions with the filer. As a result, filers must convey the instructions' 

parameters to numerous insider paJiies in order to properly conduct a "reasonable effort" inquiry 

of managers, Either the IRS should attempt to simplify the present definitions Jor Schedule L's 

Parts III and IV, or it should provide flow-chart materials or similar tools in the InstlUctions to 

help demonstrate the numerous and complex reporting relationships encompassed in these Parts. 

Allow Most Small Organizations to File a Form 990-EZ that Captures 

the Broader Information Sought by the 990's Core Form 

But Does :-/ot Require Full Completion of All the Redesigned 990's Schedules 

The Redesigned 990 overly burdens small charities and small non-501(c)(3) exempt 

organizations, In my experience, reponing organizations whose budget is on average wlder 

Sl,OOO,OOO of revenue per year are not able to self-prepare the Form and are unhkely to have 

access to paid or volunteer professional preparers who are \Yc!l-vcr~ed in the Form's intricacies. 

The present threshold at which the Form 990 is required (and the Fonn 990-EZ may not be used) 

for most filers: gross receipts for the year less than $200,000 and gross assets at year end of less 

than $500,000 - should be altered. To more closely tailor the reponing burden to the size of the 

these organizations, my recommendation would be to a! low exempt organizations with gross 

re('eipts for the year less than S 1 ,000,000 and gross assets at year end of less than $3,000,000 to 

file a FonTI 990-EZ, modihed in key ways, in lieu orlhe 990. Many will argue that this would 

exclude too many organizations rrom the full blown reporting of the Form 990, but r believe the 

response to that would be to utilize the Form 990 Core Form for most of these tilers and modify 

the reach and extent to which the full Form's ancillary Schedules are required, The full blown 

Fonn 990 is too comprehensive for most of the sector's small organizations. 

Eliminate or Streamline Schedule F. Statement of Acth'ities 

Outside the United States 

One of the most significant changes made by the redesigned form \vas the additional 

reporting peliaining to foreign activities and investments. Although many exempt organizations 

do not engage in foreign activities and thus are not subject to this additional reporting, for the 

many that do engage in relatively small amounts of foreign activity, 111e Schedule F repOliing is 

daunting. For organizations with significant foreign activities it is not only difficult but 

extremely burdensome due to having undergone numerous reporting changes yielding evolving 

instructions and nc\v learning curves each year. 

The rules for determining \A/hen an organization is required to complete Schcdule F have 

been altered significantly several times over the four filing years that the Redesigned Form 990 

has been in place, requiring preparers each year to reacquaint themselves with new reporting 

tTiggers that lead to the Schedule's employ, In addition, the Schedule has for the last two years 

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asked if fliers are responsible to report to the IRS upon any of six additional IRS Forms 

involving O\vnership in or transfers with foreign entities. The complexity oCthose tax Fonns is 

\vell beyond the purview of most exempt organizations professionals, indeed of most tax 

professionals overall. FU11hermore, as investment vehicles grow in complexity across the 

commercial sector, it is not lmcommon for exempt organizations to have their reserves or 

endowment fW1ds partially placed in investment partnerships that have some intcrest~ in foreign 

corporations. 

In my experience, organizations of all size are struggling \'-vith both the "triggcrs~' to the 

Schedule F (which determine when the schedule must be completed) and how to complete its 

Parts when they do apply. By way of example, it is not uncommon for U.S. groups working on 

issues that reach across the border to Canada to spend hours of preparation time detaillng the 

expenses and receipts (for example from materials carried to meetings in Canada for which a 

charge is made) of work of theirs undertaken in our neighbor':;, borders (assuming the total of 

same is $10,000). Similarly, secondary schools who conduct student field trips in which a border 

crossing occurs tind that their 990 reporting costs are exponentially higher in years in which such 

programming occurs versus those in which it does not. 

This is one arena nfreporting in which the benefits of the repnrted information do not 

presently outweigh the burden of compiling and gathering the information. The information 

collected by the IRS on Schedule F is unlikely to be of assistance to the IRS or other federal 

agencies with respect to combatting terrorism and/or promoting exempt organizations tax 

comphance. Its completion is not only a burden but a disincentive for organizations to conduct 

programming or partlcipate in activities \vith connection to non-U.S. jurisdictions. For all the 

aforementioned reasons, this Schedule should be eliminated or its scope substantially reduced. 

Eliminate the Statement of Functional Expenses 

In the course of the public's participation on the redesign of the Form 990, one of the 

most C001m011 complaints regarding the Form's burden was the requirement that 501 (c)(3) and 

50 I (e)(4) organizations report expense~ by both type or class of e:\.penditurc, and also by 

fimction. Hmvever, the Redesigned Form did not alter that requirement and it, like its 

precedessor, requires these organizations to report each class of expense they incur allocated 

bet\veen "program services:' '"management and general," and ·'fundraising." The chorus of 

valid comments against this requirement that came in during the redesign process highlighted 

that the infol111ation captured by such "functionahzation" was ill-documented, unbelievably 

subjective, and all-too-often geared to the desire to appease donor~ or meet aspirationa! criteria 

employed by charity watch-dog groups. Aside tj'om the charity watch-dog groups (\vho 

themselves have come around to the position I now assert), there "vas virtual unanimity that this 

requirement should be struck from the Redesigned Fonn. 

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In the course of finalizing the Redesigned Form, the IRS bowed to the requests of State 

regulators and did not remove the columns by which functtonali7ed expenses are reported. The 

States' concern was that many 501 (c)(3) and some 501(c)(4) organizations who solicit in their 

jurisdictions are sul~ject to State la\\/ repOliing requirements, \1,:hich typically include the 

responsibility to report total fundraising expenses or fundraising and managcm~nt expenses 

versus program expenses. Filers who complete the F01l11 990 (but not the 990-EZ) have this data 

"readily available" from their completed Form, but those who do not complete the Fonn 990 

typically must be provided an additional sheet by the State to complete. A point perhaps 

overlooked by the States in seeking the retention of the 990's fUl1ctionalized expense reporting is 

that the Redesigned Form provides more detail on professional fundraisers and fundraising 

events and activities (including expenses incurred) than reflected on the predecessor form. 

Given the lack of bene lit to the IRS of requiring this infonnationlrom all 50l(e)(3) and 

SOl(c)(4) filers, the burden it places on the filing sector to either have contemporaneous 

documentation systems in place or to wldertake laborious post-year end processes, and the 

growing understanding that such reporting brings little value to the table, it is appropriate for the 

IRS to no longer require this information. 

Regarding the Schedule R, One Aspect of Schedule L Reporting, and 

The Complexity of these Two Schedules' Definitions 

Large complex institutions have repeatedly (and validly) opined a further wish - that 

reporting on Schedule R of transactions undctiaken with "rdated organizations" be made 

mechanically simpler. That concern rarely vests with small and medium size organizations. An 

overall observation I would make with respect to Schedule R reporting of related organizations 

transactions that afTects all tilers is that in the instance \\."here a "related organization" is also an 

"interested person" for purposes of reporting business transactions on Schedule L, unnecessary 

duplication results. One way the IRS could encourage compliance and reduce burden in getting 

disclosure of such transactions is to except from Schedule L Part TV's definition of"interested 

persons," all '"related organizations." Altematively. the reporting thresholds bet\veen the two 

Schedules could be synchronized. 

There is no doubt that a public interest is served (and compliance promoted) by having 

filers detail transactions undertaken with parties who arc connected to their insiders. In my 

recommendations 1 note that the TRS should provide education of the sector to emphasize that 

reporting of such transactions docs not imply that the transaction is "bad." I havc further 

recommended that the IRS simplify the Schedule L definitions or provide materials that guide 

preparers through their parameters. To access preparers' experience as we approach the close of 

the fourth tiling season oftl,e Redesigned 990, I would suggest that the IRS seek public 

Page 14 of 15 
49 

f 

Chairman BOUSTANY. Mr. Hyatt, you have 5 minutes. 

STATEMENT OF THOMAS K. HYATT, PARTNER, SNR DENTON, 

WASHINGTON, DC. 

Mr. HYATT. Thank you, Mr. Chairman. 

Chairman Boustany, Ranking Member Lewis, and Members of 

the Subcommittee, I really appreciate the opportunity to testify before you this morning. I have been invited to testify as to the current state of complexity in the organization and operation of nonprofit tax-exempt public charities. As has been reported to this 

Committee, there are some 1.6 million tax exempt organizations 


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50 

known to the IRS, give or take different sources of data. Over 60 

percent of these are 501(c)3 public charities. 

Now while many nonprofit organizations are small organizations, 

small staffs, small budgets, we usually are most familiar with the 

large institutional nonprofits, those with regional and national 

reach. According to the IRS, large hospitals and universities dominate the financial activity of the nonprofit charitable sector. In fact, 

by their stats, 9 of the 10 largest nonprofit organizations by assets 

were hospitals or university-affiliated organizations. It is this class 

of organizations that I describe today. 

Certainly, there can be no denying that these large nonprofit 

public charities are more complex in their structures and in their 

operations than they were say 40 years ago. Today, it is not uncommon to have multiple business entities operating within an integrated system. They may have a central parent organization 

charged with strategic oversight of the system; brother-sister companies subsidiaries and subsidiaries of subsidiaries. These entities 

may include nonprofit corporations, taxable for-profit corporations, 

nonprofit taxable corporation, limited liability companies, limited 

and general partnerships and joint ventures. 

Most institutions understand the cost as well as the benefit of 

operating multiple corporations and they try to err on the side of 

keeping it simple. Still, some organization charts appear to be designed by engineers rather than business planners and would make 

Rube Goldberg proud. 

In addition to directly owned and operated business entities 

there has been a substantial increase in the use of joint ventures 

by nonprofits to achieve their goals. The IRS over time has determined that joint ventures between public charities and for-profit 

businesses in many different forms are consistent with public charity status if they are properly structured and properly operated. 

There are many reasons for the increased complexity of the corporate organizational structures in the modern nonprofit sector, 

often acting in concert. In my statement, I have provided an overview of the key factors as I see them. They include protection from 

liability, operation in highly regulated fields, restrictions imposed 

on public institutions, restrictions imposed by overseers, chapterbased organizations, improved governance, and Federal tax-exempt 

organization law compliance. 

While corporate complexity is a reality in the institutional side 

of the nonprofit sector, in my view, this is not a problem that requires a change in the law to resolve. Rather, it is an environment 

that both invites and deserves continuing scrutiny and transparency to ensure that these public charities are acting in accordance with their tax-exempt purposes and with applicable law. 

There are already important checks and balances in place to ensure that a complex corporate structure does not impede achievement of charitable goals and legal compliance. At the State level, 

this is primarily accomplished through the State Attorney General. 

In recent years, State Attorneys General have been extremely active in overseeing the activities of nonprofit organizations within 

their State. The IRS plays an important oversight role both towards enforcement of the Internal Revenue Code’s tax exemption 


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51 

requirements and implementation of the Form 990 with an increasing focus on transparency and accountability. 

DCMN BURREL 

It should also be noted that the IRS has undertaken a considerable effort in the last few years to learn more about this large institution segment of the nonprofit sector through a series of what are 

called compliance checks. The IRS in 2006 conducted a compliance 

check of hospitals and health systems, and in 2008 a compliance 

check on colleges and universities. 

When a change in the law is warranted, Congress has not hesitated to step in. For example, one type of public charity, the supporting organization, was being used for private benefit in ways 

that the Congress never intended in the Internal Revenue Code. 

Through the Pension Protection Act of 2006, Congress largely 

eliminated this type of abuse, including through the expansion of 

the IRS’ intermediate sanctions penalties authority. 

With that, I will close my oral statement. I, again, appreciate 

this opportunity and would welcome any questions you might have. 

Chairman BOUSTANY. Thank you, Mr. Hyatt. 

[The prepared statement of Mr. Hyatt follows:] 


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U.S. HOUSE OF REPRESENTATIVES 

COMMITTEE ON WAYS AND MEANS 

HEARING BEFORE THE 

SUBCOMMITTEE ON OVERSIGHT 

OPERATIONS AND OVERSIGHT OF 

TAX-EXEMPT ORGANIZATIONS 

Testimony of Thomas K. Hyatt 

Increased Complexity of Public Charity 

Organizational Structures 

July 25, 2012 

Thomas K. Hyatt 

SNR Denton US LLP 

1301 K Street, NW 

Washington, DC 20005-3364 

202-408-3947 

tom.hyatt@snrdenton.com 

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Chainnan Boustany, Ranking Memher Lewis, and Members of the Subcommittee 

on Oversight, I greatly appreciate this opportunity to testify before you today on the topic 

of the increased complexity of public charity organizational structures. I am a patiner in 

the law fim1 of SNR Denton, resident in the Washington DC office, where I head our 

hcalth law practice group. I have been practicing law tor 30 years, focusing on legal and 

policy issues relevant to nonprofit organizations. I currently serve as Chair of the Board 

of Directors of Maryland Nonprofits, a statewide nonprofit puhlic charity that 

strengthens, educates, and engages other nonprolits so that they can success[ully achieve 

their missions. I also serve on the Board of Directors of Appalachian Regional 

Hcalthcarc, a 10-hospital nonprofit rural health system serving indigent communities in 

eastern Kentucky and southern West Virginia. In addition, I am a Senior Fellow ftlr 

Public Policy [or the Association of Governing Boards of Universities and Colleges. 

am the co-author of the legal text, The Law oj' Tax-Exempt Healthcare O/'gani~atiol1s, 

now in its Third Edition. 

I. Complexity in the Organization and Operation of Public Charities 

I have been invited today to tcstify as to the CUlTent state of complexity in the 

organization and operation of nonprofIt, tax-exempt public charities. As has been 

reported previously to this committee, there are some 1.6 million tax-exempt 

organizations known to the Internal Revenue Service.' Over 60% of these arc 501(c)(3) 

public charities. In 20 I 0, public charities received over $1.51 trillion in lotal revenues 

and incurred $1.45 trillion ill total expenses. They were charged ","ith the stewardship of 

over $2.7 trillion in total assets. Nonprofit organizations paid 9.2% of all wages and 

salaries in this country in 2010 and accounted for 5.5% of GOP. While many nonprofits 

are local organizations with small staffs and small budgets, we are usually most familiar 

with large institutional nonprofit organizations and those with regional and national 

reach. According to the Internal Revenue Service, large hospitals and universities 

dominate the financial activity of the nonprofit charitable sector; nine of the ten largest 

nonprofit organizations by assets were hospitals or university-afliliated organizations.' It 

is this class of organizations that I describe today. 

'111ere can be no denying that these large nonprofit public charities are more 

complex in their structures and operations than they were, say, 40 years ago. Today it is 

not Ullcommon to have multiple business entities operating within an integrated system. 

They may have a central parent organization charged with strategic oversight of the 

system; brother-sister companies; subsidiaries; and subsidiaries of suhsidiaries. These 

I National C~nter for Charitable Stati'>tics, Urban Institute, NeCS Core Files 2010. 

http://ncc~.llrban.org!SHltistics/qui~kfacts.cfm. 

2 IRS Statistics of Incom~, Charities and Other Tax-Exempt Organizations. http://www.irs.govipubiirssoi/llesgiftsnap.pdI: 

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entities may include nonprofit corporations, taxable for-profit corporations, nonprofit 

taxable corporations, limited liability companies, limited and general partnerships, and 

joint ventures. Most institutions understand the cost as well as the benefit of operating 

multiple corporations and try to err on the side of keeping it simple. Still, some 

organization charts appear to have been designed by engineers rather than business 

planners. and would make Rube Goldberg proud. 

II. Joint Ventures 

In addition to directly owncd and operated business entities. there has been a 

substantial increase in the use of joint ventures by nonprofits to achieve their goals over 

the last 30 years. A joint venture is generally defined as a business enterprise that is 

wldertakcn by two or more persons in which the parties share protits and losses. Prior to 

that time, the IRS had taken the position that public charities could nut enter into limited 

partnership-type joint ventures with for-profit taxable corporations consistent with their 

tax-exempt status. However, the United States Tax Court overruled that position in 1980 

and the IRS has over time detennined that joint ventures between public charities and [orprofit businesses in many different forms arc consistent with public charity status if 

properly structured and operated. The IRS has approved both whole-entity joint ventures 

and ancillary joint ventures as long as the joint venture participation is serving a 

charitable purpose; the joint venture permits the tax-exempt organization to operate 

exclusively in furtherance of its tax exempt purposes; and undue control is not vested in 

private parties.' 

Joint ventures arc an important (,mn of business operation for nonprofit public 

charities for three primary reasons: 1) they provide the exempt organization with access 

to sources of capital that they are unable to generate themselves; 2) they provide the 

exempt organization with access to expertise from parties who have experience in the 

relevant area; or 3) they provide access for the exempt organization to a service area 

which may otherwise have high economic or logistical barriers to entry. 

Ill. The Need for Complex Structures 

There are many reasons for the increased complexity of corporate organizational 

stlUctures in the modern nonprofit sector, often acting in conceit. The following is an 

overview of the key factors now promoting complexity in the operation of nonprofit 

public charities. 

J See Rev. Rul. 98-15,1998-1 CB. 718; Rc\. Rul. 2004-51, 2004-1 C.B. 974. 

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a) Protection tl'om Liability. One factor is the erosion over the last 70 ycars 

of the doctrine of charitable immunity which provided protection from liability f(lr 

nonprofit public charities. As a result. nonprofit organizations now rely upon the limited 

liability oflhe corporate form for protection of their assets and operations. 

b) Operation in Highlv Regulated Fields. It is not unusual even today to find 

some large institutional charities operating out of a single nonprofit corporation. using an 

oftcn complex internal organizational stmcturc to oversee different groups and service 

lines. However. it is now more common tllr public charities to use multiple business 

entities to facilitate operation in highly regulated fields. such as health care. Because 

hospital operating companies are state-licensed entities. they are subject to numerous 

legal restrictions which can impede their ability to undertake such important tasks as 

expanding operations, raising capital. protecting assets ti'om lawsuits. and growing 

investments. Since the late 1970s. most hospitals have expanded beyond their single 

hospital operating corporation structure into a multi-corporate entity system. A common 

healthcare system organization chart might include a parent holding corporation with 

various subsidiaries including hospitals, home health agencies. cancer treatment centers. 

laboratories, management service organizations, and physician clinics. 

Multi-corporate systcms also enable healthcarc providers to facilitate compliancc 

with sometimes contlicting regulatory schemes. Medicare and Medicaid reimbursement 

requirements. Medicare and Medicaid fraud and abuse requirements, and tax-exempt 

organization requirements imposed by Congress. Health and Human Services. and the 

Internal Revenue Service sometimes dictate that separate corporations be established to 

ensure compliance. 

Colleges and universities also typically employ multi-level organizational 

structures to optimize the operation and governance of mUltiple colleges, schools, 

campuses. and service lines. Healthcare provision and academic pursuits merge in the 

medical school/academic medical center which can create an especially complex 

structure involving separate incorporation of depaltments and faculty practices in order to 

maximize federal reimbursement and to more eflectively manage operations. 

c) Restrictiolls Imposed on Public rnstitutions. Public institutions. such as 

colleges and wliversitics. frequcntly establish onc or 1110re related. nonpublic charitable 

foundations. These foundations enable these public institutions to accomplish projects in 

furtherance of their mission that would not otherwise be possible because of state 

restrictiolls imposed upon public assets. For example, these foundations may establish 

and grow endowments which fund needed campus improvements, fund research and 

faculty development. provide real estate development. and enhance bond issuance. 

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d) Restrictions Imposed by Overseers. Some nonprofit organizations, 

particularly in the higher education space, are subject to requirements imposed by one or 

more accrediting organizations which ensure that these nonprolits are providing services 

in accordance with agreed upon quality standards and best practices. These accreditation 

requirements may provide un incentive to organizations to separately incorporate various 

activities to maintain accreditation. 

e) Chapter-Based Organizations. MUltiple and sometimcs quite complex 

corporate structures are also found in chapter-based organizations which have a regional 

or national network. These organizations may receive recognition of their tax-exempt 

status from the Internal Revenue Service through a group ruling procedure under which 

the national organization oversees and ensures the continuing compliance of the 

individual chapters with IRS requirements, or each chapter may be separately recognized 

as tax-exempt. Such well-known chapter hased organizations as the YMCA, Girl Scouts 

of America, Boys & Girls Club of America, Audubon Society, Elks Club and Little 

League Baseball have multiple corporations carrying on the mission of the national 

organization in many states and often with several corporations in the same state. They 

are usually bound together by chapter agreements, bylaws, and a common vision. 

t) Improved Govcmance. Another important factor promoting a mullicorporate system is the ability to more effectively govern far-ranging services hy having 

separate boards of directors focusing on the discrete tasks of a specific corporation rather 

than using one large board responsible for all matters. This enahles directors to serve on 

boards that can best utilize their expertise. 

g) Federal Tax-ExcmptOrganization Law Compliance. Related nonprofit 

organizations arc commonly uscd to ensure compliance with applicable fcderal tax law, 

most notably the restrictions on charitable organizations with respect to lobbying and 

political campaign activity. Thus, it is coml11on for a charitable organization to have a 

related social welfare organization which can carry on unlimited amounts of lobbying and 

is pennitted to have some level of political campaign activity, such as by operating a 

political action committee. 

IV. Is Corporate Complexity in the Nonprol1t Sector a Problem? 

While corporate complexity is a reality in the institutional side of the nonprofit 

sector, in my view this is not a problem which requires a change in the law to resolve. 

Rather, it is an environment which both invites and deserves continuing scrutiny and 

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transparency to ensure that public charities arc acting in aceordancc with their tax-exempt 

purposes and with applicable law. 

There arc already important checks and balances in play to ensure that a complex 

corporate structure does not impede achievement of charitable goals and legal 

compliance. At the state level, this is primarily accomplished by the oversight of the 

state attorney general. In recent years, state attorneys general have been extremely active 

in overseeing the activities of nonprofit organizations within their state. It is not unusual 

for a state attorney general to become involved at the level of overseeing membership on 

the board of directors, governance practices, compensation of senior leadership, 

transparency of operation, investment of endowments, and expenditures in llirtherance of 

charitable purposes. State attorneys general are effective watchdogs that have a primary 

responsibility with respect to the operation of charities within their states and have sought 

to expand their jurisdiction in this area with legislatures and courts. 

The Internal Revenue Service plays an imp0l1ant oversight role through its 

enforcement of the Internal Revenue Code's tax exemption requirements and its 

implementation ofthe annual information return flled by most tax-exempt organizations, 

the Form 990, with an increasing focus on transparency and accountability. The Fornl 

990, now more than ever, requires transparency with respect to corporate structure and 

relatedness. For example, Schedule R of Form 990 requires disclosure of related 

organizations and unrelated partnerships of a tax-exempt organization, including 

transactions with related organizations. Schedule 1-1, which pertains to hospitals, requires 

full disclosure of mamgement companies and joint ventures that the hospital is 

participating in, including ownership by physicians and members of the board of 

directors. The transparency created through these schedules, albeit at the cost of a 

greater filing preparation burden, sheds light on complex strnctures that will racilitate 

oversight and action by legislators, regulators, courts. donors and tlmders, the media, and 

the public at large. Transparency also helps to ensure that legal compliance is 

maintained, including preserving the separateness of corporations and the observance of 

corporate fonnalities so that appropriate actiYities under one area of the law do not 

become improper activities under another area of the law hecause of aggregated 

operation. 

It also should be noted that the I RS has undertaken a considerable elfort in the last 

few years to learn more about the large institution segment of the nonprofit sectof 

through a series of what it calls "compliance checks." These checks involve gathering 

large amounts of data about all aspects of the institutions' operation, rep0l1ing their 

lindings to the public, and acting on their lindings through their continuing examination 

and enforcement activities. The IRS conducted a compliance check on hospitals and 

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health systems in 2006, with a final rep0l1 issued in 2009, and one on colleges and 

universities in 2008, with an interim report in 2010. 

The Internal Revenue Service and the cOUl1s have also played an important role in 

ensuring that corporate complexity docs not lead to an impennissiblc transition from 

nonprofit tax-exempt activity into commercial activity. Under a legal principle known as 

the commerciality doctrine, the IRS would not recogni/,e tax-exempt status, or could 

revoke exemption, for an organization that has a substantial non-exempt purpose and 

operates primarily in a commercial fashion. Whi Ie most organizations would have 

commercial activity addressed under the unrelated business income rules which are being 

discussed at this hearing, enforcement of the commerciality doctrine ensures that 

unrelated business activity docs not reflect the primary purpose of a complex 

organization or system and, idcally, cnsures that you can tell the difference between a 

nonprofit, chal'itable organization's provision of a service and the same provision of 

service by a for-profit enterprise. 

A potential adverse consequence of a complex corporate structure is an increased 

possibility that a memher of the board of directors may have an conflict of interest as to a 

transaction involving a related corporate entity. This situation requires continued 

vigilance by these organizations with respect to ongoing disclosure of conflicts and 

compliance with the organization's conflict of interest policy and applicable state law. 

This is squarely within the fiduciary duty of care and loyalty responsibilities of any 

director of a public charity, enforceable by both federal and state regulators. 

Governance of multi-corporate public charities is also improving thanks to the 

continuing work of such organizations as the Association of Governing Boards of 

Universities and Colleges, Maryland Nonprofits Standards for Excellence Institute, 

BoardSource, Independent Sector, Coml11onfund Institute, and others to ensure that best 

practices are being developed, shared, and implemented. 

When a change in the law is warranted, Congress has not hesitated to step in. For 

example, one type of public charity, the supporting organization, has in recent history 

been used in ways and for purposes other than those intended by the Internal Revenue 

Code. The complicated statutory provisions for public charities lent themselvcs to 

significant abuse by organizations and individuals other than the charity which was 

supposedly being suppOlied. The Pension Protection Act of 2006 largely eliminated the 

possibility of continuing this type of abuse, including through the expansion of the IRS's 

intermediate sanctions penalties authority. 

7 
59 

f 

Chairman BOUSTANY. Mr. Colombo, you have 5 minutes. 


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STATEMENT OF JOHN COLOMBO, ALBERT E. JENNER, JR., 

PROFESSOR, UNIVERSITY OF ILLINOIS COLLEGE OF LAW, 

CHAMPAIGN, ILLINOIS 

Mr. COLOMBO. Mr. Chairman, Mr. Ranking Member, and Members of the Committee, thank you for the opportunity to speak 

today about commercial activity by charities. 

Over the past 20 years or so we have seen a steady expansion 

of commercial activity by charities. In most cases, commercial activity provides badly needed revenue to expand charitable outputs. 

But the legal issues surrounding commercial activity are complex 

and I think hopelessly confused. 

When a charity engages in commercial activity, it raises two 

main issues. The first is whether the charity loses tax exemption 

as a result. If the charity does not lose tax exemption, then the second issue arises: Whether the commercial activity nevertheless 

should be taxed as though it were a freestanding corporate business. This latter issue is the providence of the unrelated business 

income tax. 

Underlying these issues is a third issue: Does it matter what 

kind of business container the commercial activity is conducted in; 

that is, does it matter whether the business is conducted directly 

by the charity versus in a separate corporation or via a partnership 

with a for-profit enterprise. Under current law, each of these containers can have different tax consequences for the charity. 

With respect to the effect of commercial activity on exempt status, the main policy issue is straightforward: How much, if any, 

commercial activity may a charity undertake without impairing exemption. Unfortunately, the existing legal precedent and Treasury 

regulations are of little help in resolving this issue. The regulations 

and precedent are clear that some amount of commercial activity 

is permitted, but beyond that we don’t know much. 

One part of the regulations, for example, suggest that charities 

cannot engage in more than an insubstantial amount of such activity, while another part of the same regulation states that a charity 

can operate a commercial business as a substantial part of its activities as long as that business is not its primary purpose and the 

business is in furtherance of its exempt purpose. But concepts such 

as substantial and in furtherance of are left undefined. 

Think of it this way. Suppose I incorporate a charity to operate 

a soup kitchen. Everyone would agree that, properly operated, this 

organization is tax exempt under 501(c)(3). But now suppose that 

I decide that to expand my revenue base I am going to can my soup 

and sell it to the public. Is that okay? Does it depend on the size 

of my soup business versus the size of my soup kitchen relief efforts? If so, how is that measured, by gross expenditures, gross revenues, net revenues, number of people working in each activity, all 

of the above? Does it matter how much profit I have and how that 

profit is used? Does it matter whether my soup business is in a 

separate corporate container or is operated as a joint venture with 

a commercial soup company? What if I don’t operate a soup kitchen 

directly but use profits from my commercial activity to make grants 

to other soup kitchens. 

The UBIT has a similar set of problems. The UBIT was designed 

to tax certain commercial activities by charities but not all of them. 


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The main test for applying the UBIT is whether a businesses substantially related to accomplishing the charity’s exempt purpose. If 

so, it is not taxed. If not, it is. In addition, there are specific exemptions for certain kinds of activities—activities run completely by 

volunteers, for example, or activities such as a cafeteria run for the 

convenience of employees or patrons. 

Like the commerciality limitation, the UBIT also suffers from a 

lack of theoretical consistency and practical definition. Though the 

classic rationale for the enactment of the UBIT was to avoid unfair 

competition, the test for taxation doesn’t depend on whether a 

charity is competing fairly or unfairly with the private market, but 

rather whether the business is substantially related to the organization’s charitable purpose. 

We know that substantially related involves more than just providing revenue for charitable purposes. But beyond that, the test 

for relatedness is murky, at best. To go back to my previous example, is my selling soup substantially related to my charitable purpose of providing a soup kitchen for the poor? If a symphony orchestra sells its recordings through commercial channels, is that 

substantially related? What if it has a gift shop and sells CDs by 

popular rock bands? Can it sell musical instruments, too? How 

about an upscale stereo system? How about art? After all, Modest 

Mussorgsky wrote a very famous musical composition called ‘‘Pictures at an Exhibition.’’ So maybe art is substantially related to 

music. 

These questions go to the heart of what we want our charitable 

sector to look like, and in my written testimony I have provided 

both a structure of how we might analyze those issues as well as 

some suggestions on possible reforms. But whether you agree with 

my suggestions or not, it is time for us to reconsider these issues 

from a policy perspective and provide clarity to charities regarding 

these activities. 

Thank you. 

Chairman BOUSTANY. Thank you, Mr. Colombo. 

[The prepared statement of Mr. Colombo follows:] 


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Testimony of John D. Colombo* 

House Committee on Ways and Means, Subcommittee on Oversight 

July 25,2012 

I. Introduction 

In a 2002 article, Stephanie Strom of the New York Times reported that in the 

previous year, the Metropolitan Museum of Art had revenues of $96.6 million 

from its shops, restaurants and parking garage, almost three times the revenue 

generated by admissions and membership fees. 1 That same year, the Yale School 

of Management announced that it had secured grants totaling $4.5 million from 

the Pew Charitable Trusts and the Goldman Sachs Foundation to establish a 

program to help charities develop business plans for entering commercial 

markets.2 A 2003 article in Forbes reported on the wide-ranging business 

activities of "megachurches,,;3 a 2001 article in the Wall Street Journal struck a 

similar note, commenting on how churches across the country were opening 

restaurants, Starbucks franchises and private gyms. 4 Even the academic world 

has noticed the trend: in 1998, economist Burton Weisbrod and several of his 

colleagues published an entire book about the growing commercial activities of 

charities,S and the Urban Institute Press published another book on the subject is 

in 2009. 6 

• Albert E. Jenner. Jr. Professor of Law, University of Illinois. This written testimony is largely 

copied from my article Reforming Internal Revenue Code Provisions on Commercial Activity by 

Charities, 76 FORDHAM L. REV. 667 (2007). 

1 Stephanie Strom. Nonprofit Groups Reachfor Profits on the Side, New York Times, March 17, 

2002. 

2 Yale School of Management Receives Twin Grants Totaling $4.5 Millionfrom the Goldman 

Sachs Foundation and the Pew Charitable Trusts to Foster Business Grml'th Among Nonprofit 

Organizations, SO:M NEWS, Feb. 8, 2002. 

3 "World Changers Ministries, for instance, operates a music studio, publishing house. computer 

graphic design suite and owns its own record label. The Potter's House also has a record label as 

well as a daily talk show, a prison satellite network that broadcasts in 260 prisons and a twice-aweek Webcast. New Birth Missionary Baptist Church has a chief operating officer and a special 

effects 3-D Web site that offers videos-on-demand. It publishes a magazine and holds Cashflow 

101 Game Nights. And Lakewood Church, which recently leased the Compaq Center, former 

home of the NBA's Houston Rockets. has a four-record deal and spends $12 million annually on 

television airtime." Luisa Kroll, MegaChurces, Megabusinesses. available at 

http://www.forbes.comI2003109117/cz_lk_0917megachurch.html. 

4 Elizabeth Bernstein, Ho(v Frappucino!, WALL ST. J .• Aug. 31.2001 at WI. 

5 To PROFIT OR NOT To PROFIT (Burton Weisbrod ed., 1998). 

6 Joseph J. Cordes and Eugene Steurle. NONPROFITS AND BUSINESS (Urban Institute Press 2009). 
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Charities are not just conducting more commercial activities themselves, 

however. It is increasingly common to Ilnd charities engaged in a variely of 

economic activities through for-profit subsidiaries, joint-venture partnerships and 

contractual arrangements. The health care sector is perhaps the most visible in its 

use of complex structures, but they are also found in education and other 

traditionally-charitable activities.' 

Commercial activity by charities, therefore, seems to be an entrenched and 

growing phenomenon. Yet the income tax I1lles surrounding commercial activity 

are confused and contradictory, based on regulations issued in 1951) that no longer 

serve either tax policy or the exempt organizations community. 

One of the more famous recent cases illw,trating a complex strLlcturC! was Geisinger Health Plan 

v, Comm'r, 100 T.e 394 (1993), As explained by the Tax Courl: 

Petitioner [Ci-Hpl O'wncd and operated a health maintenance organization (H\!IO) under 

tht:: PennsylYaniu Health Maintenance Organization Act. Pa, Slat Ann. tit. ..J.O, sees. 1551-

! ."67 (Supp. 1991). Petitioner was one of 11i11e related organizations. The eight other 

organiz.ations, referred to collectively as the Geisinger system and described below, were 

the Geisinger Foundation (the foundation), Geisinger Medical Center (GMC), Geisinger 

Clinic (the clinic). Geisinger VV'yoming Valley Medical Center (G\V\/). Marworth, 

Geisinger Sy'>tem Services (GSS), and two professional lianility trust'>. i-:;}ch of these 

eight entities was recognized by the Internal Revenue Service as an exempt organiLation 

described in ,eetions 170(b)(I)(A)(iii). 5011c)t3), and 509(a)(I). 

The foundation controlled petitiuner and the other entities in the Geisinger system, a~ 

\vell as three for-profit corporations, Th~ ioundation had tile po\\er, under the artides of 

incorporation and hyh.l\vS ofretitioner, GMC, GWV, GSS. the dinic. and Marv.,.onh, to 

appoint the corporate memher~ of those entities, who in turn elected their rebpectivc 

boards of directors. The foundation':, board of directors was composed of civic and 

business leader:.. who \v~re rcpr~scntati\'c of the gen~ral publ Ie in northeastern and northcentral Pennsylvania and \\('re puhlic-spirited citizens. The foundation raised fund:::. for 

1hc Geisinger system's numerous charitable pllfpOSCS and activities. 

Id. at 395-96. 

Although a larg.: perccntagt: of complex structures COIllt: from th.: health car~ sector, they o;:xi~t in 

other sectors as \vell. Sec, e.g., Priv. LtL Rul. 95- 06-0+6 (Nov. 17, 1994) (ruling on a case in 

which a business league exempt under section 50 J(c){6) establishl."!d tirst- and second-tier 

subsidiaries to construct and operak a golfcours~); Gen. Couns. Mem. 39,776 (Jan. 4, 198.9) 

(analyzing a situation in \vhich an exempt university controlled a :,~etion 501(1) orga11iLation that 

in turn controlled a taxable subsidiary). See gClleralzv FRAN( rs R. HII.! & DOl1lil.AS M. MANCINO, 

I,'EDERAL AND S"[ATE TAXATION Or: EXl.JvlPT ORGANIZATIONS. chapter.::!7 (.::!006) (discussing 

exempt organizations' use of complex structures ofre!atcd exempt and taxahle entities); James.l. 

McGovern, The Use (4 Taxable SlIbsidia/:v Curporations hy Puhiic Charities -- A Tax Poih:l' issue 

for 1988, 38 TAX NOIL~ 1125 (198~) (discussing use of taxable subsidiaries by exempt 

organizations ). 

2 
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IT. The Curreut Tax Rules' 

Federal tax rules regarding commercial activity involve two main issues and 

two subsidiary ones" The tlrst main issue is whether the activity jeopardizes the 

charity's tax exemption under Section 501 (c)(3) of the Internal Revenue Code 

("Code''). Commentators have referred to this lirst issue as the "commerciality 

doctrine'~ or "conll11crciality limitation" on exempt status. JO The second main 

issue is whether, if commercial activity does not jeopardize exemption. it 

nevertheless should be taxed. This issue is covered by the Unrelated Business 

Income Tax (UBIT) in sections 511-514 o[the Code that has bcen with us since 

1950. 

To illustrate these main issues, suppose that 1 start a charity whose purpose is 

to run a soup kitchen for the homeless. The revenue for this charity comes 

exclusively Irom donations. Provided that this organization complies with other 

requirements of exemption, there is no question it qualiJles as an exempt chatity 

under 501(c)(3), with both a primary purpose and activity dedicated to rchefof 

the poor. Now suppose that 1 decide that I could expand my soup kitchen 

operation if I had more revenue. So J finance the acquisition of a small 

manulacturing j'lcility to manufacture and can chicken soup that J then sell 

through commercial channels with the intent of using the protlts generated to 

expand my soup kitchen operation. Two questions arise: does the "commercial" 

soup manufacturing/sales operation cause my organization to lose its exempt 

status? If not, mustl nevertheless pay tax on the proJlts from the soup sales'? 

The two subsidiary issues are (1) whether commercial activity undertaken by 

entities related to a charity (e.g., a subsidiary of a charitable parent a sibling forproflt corporation or a partnership in which a charity is a partner) will bc 

"imputed" to the exempt entity for purposes of determining their tax-exempt 

status and (2) how the IRS uses the "private beneJl!" doctrine to police economic 

transactions with for-protit entities or individuals outside the charitable class. 

This part of the article describes the current doctrine applicable to each of these 

issues. Retu111ing to my soup hypothetical, suppose that instead of the charitahle 

organization operating the soup manufacturing, it does so through a contTOlled 

g Parts or this section are copied or adapted from John D. Colombo, Commercial Activity and 

Charitable Tax E'ft3mplion. 44 WM. & MARY L. REV. 487, 491 (:~002) (hereafter Commercial 

Activi~l') and John D. Colombo, Regularing Commercial Acrh'ity b)" t.:rempr Charitics'. 

Res1Irrecting the Commensurate-in-Scope Doctrine, 39 EXEMPT ORG. T,,\X REV. 34 [ (2003) 

(herealler CommctlSurafe-in-5;cope). 

9 See generally, Colombo, Commercial ,-/ctivi(l', supra note 8. ill 491 (2002); JAMLS 1. FI<.:;TtMAN 

AND STEPHfJ\[ SCHWAR1, NONPROFITOHCu\:-.jIl!\TfOt\'S 567-72 (4th ed. 20JO). 

III Colombo. Commi!rcial Activi(l'. supra note 7. at 49]; FI~HM'\N :\ND SCflWARL, supra note 7, at 

572; BRU( J-: R. HOPKr:O-lS, THE LA W OF TAX-ExFMP'/ OR(iANIZATION<.:; 9Q~ [ 14 ([ oth cd. 20 [ 1). 

3 
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for-protit subsidiary. Does this change the analysis? What ifinstead my charity 

enters into a pannership with a commercial soup manufacturer to market a line of 

Colombo's Soup Kitchen soups? Unfonunately, the answers to all these 

questions are extremely dimcult under existing law. 

A. The Commerciality Limitation)'s. the UBIT 

Though Section 501(e)(3) states that an organization will qualify for 

exemption only ifit is "organized and operated exclllsivelv" t()f a charitable 

ptupose, the statute has almost never been interpreted literally. As early as 1924, 

the Supreme Court held that a religious order would not lose exemption because 

of its limited sales of wine and chocolate." Over time, this and subsequent cases 

established what was known as the "destination of income" test for exemption: an 

organization could engage in unlimited amounts of commercial activity as long as 

the revenues from that activity were used for charitahle purposes." Even 

organizations \vhose only activity was running a commercial business \vas exempt 

if it paid over its revenues to a charity." 

The destination of income test was overruled by Congress (at least in parl) in 

1950, when it passed lhe unrelated business income tax and prohibited exemption 

for '"fceder~' organizations. j..J- These laws made revenues from commercial 

activities that were unrelated to charitable purposes taxable, and also prohibited 

exemption for the entity whose sole activity was operating a commercial business, 

even if the revenues were paid over to charity. '5 Bu! Congress said nothing in the 

UBIT and related legislation about whether commercial activity by an 

organization that otherwise had a bona-tide charitable purpose should affect 

exemption. One could argue, in fact, that the adoption of the UBiT was an 

implicit blessing for charities to engage significant amounts of commercial 

I i Trinidad v. Sagrada Orden de Prcdicadores de la Provin\.!ia del Santissimo Rosario de Filipinas, 

263 U.S. 57B (1924). 

I~ Colombo, Cummercia! Acfivi(v, supm note 8. ilt 498-99; FISllM!\-:\ & SCHWA.RZ, supra note 9. at 

570-72; HOPK!NS, slIpra nok 10, at 103-104; HILL AND MA~CII\,O, supra note 7. ~ 21.0 I at page 

21--1, 

I; E.g .. c.r. Mueller Co. v. Commissioner, t 90 F.2d 120 (3d Cir. 1951) (Corporation that mack 

macaroni exempt because [('venues \vt'rc paid to Nc\\· York Uni\'crsity's law school). 

1.J I.R.C'. §§ 502, 5 J [-5 [4. A "feeder" is an entity that operates a commercial business but is 

obligated to pay the net revenues ofiliat business over to an exempt charity. See Ft~HMAN />,ND 

SCHWARl, slipra note 9, at Sr:R-5R9. 

I <; Colombo. Commi!rcial Activi~1" supra note 8. at 500; FI~HM'\N & SCIlWAHL, SlIPI'U note 9, aL 

570-572; HOPKINS, supl'a nok 10. at 103-104; HILL ANI) MA \leINO. supra note 7, at ~ 27.04. 

4 
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activity, since unrelated activity now would be taxed and related activity 

(presumably) was not viewed as a problem.'· 

The final regulations adopted by the IRS in 1959, however, aTe confusing. The 

UBIT uses a "relatedness" test for determining taxability. Under the UB1T, 

commercial activity is taxable ifit is not "substantially related" to the 

organization's exempt purpose. 17 According to the regulations implementing the 

UBIT, an activity is "substantially related" if "the principal purpose of such trade 

or business is to further (other than through the production of income) the purpose 

for which the organization is granted exemption.',,8 The key phrase in this 

regulation is the parenthetical "other than through the production of income." 

That is, it is clear ti'om the UBlT regulations that a commercial activity whose 

purpose is simply to provide a revenue stream for charitable activities is not 

"related" and theretore is taxable. Instead, "relatedness" is a functional concept 

focused on how the underlying nature of the commercial activity integrates with 

the exempt entity's charitable purpose, not on where the revenues irom the 

commercial activity end up. But these regulations say nothing about whether 

commercial activity, related or unrelated. should affect exempt status. 

With respect to the exempt status issue, Regulations § 1.50 I (c)(3)-1 (b)( I )(i) 

states that an exempt charity's organizational document (e.g., articles of 

incorporation or trust agreement) may not empCl\ver it to "engage, other than as an 

insubstantial part of its activities, in activities which in themselves are nN in 

furtherance of one or more exempt purposes."" A couple of paragraphs later, the 

regulations warn that an organization will fail to qualify for exemption "if more 

than an insubstantial part of its activities is not in furtherance of an exempt 

purpose."'" But an even later part of the regulations (1.50 I (c )(3 )-l( e» states that 

16 indeed, Professor Ethan Stone has argued that the UBn was largely a "border patrol" measure 

(a phrase first used by Prokssor John Simon in describing the various tax rules applicuble to 

excmpl organizations) designed to keep charities from \.vandcring too tar from traditional "good 

\\'orks" that defined the charitable sector. Fthan ~tone, Adhering to the Old Line: Uncovering rhe 

Histol~v and Political Function af'tlle L'nrelated BlIsiness income Tax. 54 EMORY L.J. !475 

(2005). Stone's analy~is supports the proposition that "related" business acti\'i(y should have no 

bearing on exempt status, and that Congres,; believed it adequately responded to the "threat" of 

unre!atcd activity by taAing it, rather than revoking exemption because of it. The counterargument here is that if Congress rl.':al!y did view the UBI r as mostly a "border-pntro[" measure, 

then perhaps excessive "unrelated" husincss should cause loss of ("-..;emption due to inappropriat(" 

border-cros~ing. 

j7 l.R.C. § 513(a). For a more extensive discussion of the UBIT rules, sec HILL AND M,\NCINO, 

supra note 7 at chapter 2~; 110PKINS. supra note 10 at chapter 23 

'" Treas. Reg. § 1.513·2(a)(4). 

19 Trc",. Reg. § 1.50 l(c)(3)·1 (b)( J )(1). 

Trcas. Reg. §1.501(0)(3)·I(c)(I). 
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an organization may qualify for exemption even if"it operates a trade or business 

as a substantial part of its activities, if the operation of such trade or business is in 

tlJrtherance of the organization'S exempt purpose and if the orgaJlization is not 

organized or operated for the primary purpose of carrying on an unrelated trade or 

business .... "" It appears from these regulations. therefore, that the two key 

concepts in determining the effect of commercial activity on exempt status (as 

opposed to whether the commercial activity is taxable under the UBIT) is when 

an activity is "substantial"' and when an activity can be said to be "in furtherance 

ot" an exempt purpose. The regulations, pa11ieularly Regulations §1.501(c)(3)-

I (e), seem to say that unrelated business activities that are "in ilrrtherance at" can 

be substantial without endangering exempt status; activities that are not "in 

fuliherance of," however. must be insubstantial in order to retain exemption. 

The regulations, therefore, seem to set forth a fairly straightforward linear 

analysis regarding the etTect of commercial activity on exempt statllS. This threestep analysis is as follows. First, one must identify the organization's charitable 

purpose (if any). Second, one must analyze whether a particular noneharitablc 

activity (e.g., a commercial activity) is "substantial" in comparison to other 

activities of the organization in question. Third, if the commercial activity is 

substantial, then one must analyze whether that substantial commercial activity is 

"in fUltherance of' the organization's charitable purpose. 

The pJ'(lblem is that the regulations under 501 (c)(3) do not tell us anything 

about when a commercial activity is "substantial" or when it is or is not 

considered "in furtherance of" aJl exempt purpose. With respect to the former 

issue, a number of questions arise. Is "substantial" measured quantitatively or 

qualitatively" If the former, what quantitative measures are relevant, and are they 

measured absolutdy or rdative to charitable activity" If absolute, how much 

activity is "substantial'''' If relative, do we compare the gross expenditures on the 

commercial activity vs. the charitable activities? Gross revenues for each? 

Number of employees (or volunteers) in each aetivityry The amount of time spent 

by the employees/volunteers on each activity? The regulations say nothing about 

this." 

2, Treas. Reg. *1.501(c)(3)-I(e). 

~::: Ca~\? lmv i~ equaUy useless. The closest \VI? have to a definition of "substantial" is a case that 

dealt with the concept under the lobbying limitation ("no substantial part" of an exempt 

organization's activities may be lobbying), In Christian Echoes National Ministry, Jnc. v. United 

Slates, 470 F .2d 849 (1 Orh Cir. 1973) the court rci't.l~ed to measure: "substantiality" by a 

mathematical test: "A percentage test to determine whether the activities were substantial obscures 

the complexity of balancing: the organization'S activities in relation to its objectives and 

circumstances." This interpretation or''substal1tial'' (admittedly for a different purpo.,e 

lobbying, rather than commercial actIvity) :.uggests that the questIOn ofsubstantJality is dependent 

on how important the activity in question is to the other charitable activities carried on tiC any). 

Quantitative measures might infonn '-importance" of coursC'. hut \vould not be determinative. 

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With respect to the interpretation of "in furtherance of," the regulations and 

case law arc also completely silent. One possible interpretation of the regulations 

is that "in fllrtherancc ot" is equivalent to "substantially related" under the UBlT. 

Or put the opposite \vay, one might conclude that any "unrelated" activity under 

the U BIT is not "in furtherance of," and any "substantial" amount of unrelated 

commercial activity therefore creates exemption problems23 Certainly, one 

cannot see "'related" activity as creating exenlption problems; if an activity is 

related for UBiT purposes, then by definition it must functionally advance the 

organization's exempt purpose, and hence must be viewed as being "in 

furtherance of' that purpose. But the contrary proposition (that "unrelated" 

activity automatically is nol "in furtherance of') is not necessarily true. In fact, if 

this proposition were correct, then the statement in Regulations § 1.501(c)(3)-I(e) 

quoted abow that an organization may operate a business as long as the "primary 

purpose" is not carrying on an unrelated business makes no sense. Ifany 

"unrelated" business were viewed as not being "in furtherance of," then any 

unrelated business that was "substantial" would calise an organization to lose 

exempt status. A "substantial" business is presumably well Shmi of one that is a 

"primary purpose"; therefore, the reference in Regulations § 1.SOl(c)(3)-1(e) to 

an organization losing exemption when an unrelated husiness becomes its primary 

purpose would be completely meaningless, because any "substantial" unrelated 

business would cause loss of exemption even if that business was not the 

"primary purpose." 

The only sensible harmonization of these regulations, therefore, is that in 

enacting the UBIT, Congress did not intend to alter the "destination of income" 

test for the purpose of granting exemption to an entity in the first instance.'" That 

is, unrelated business activity is taxed, but if the proceeds are used to suppOli 

charitable activities, the organization in question is still entitled to an exemption 

(j,)]" its other income). It is only when the operation of the unrelated business 

becomes the entity's "primary purpose" that it loses exempt status, because at that 

point (obviously) the entity's "primary purpose" is no longer charitable. Put 

another way, ''"in furtherance of' has t\.vo meanings: commercial activity may be 

"in furtherance of" an exempt purpose by being functionally related to that 

purpose (for example, the music school of an exempt university puts on concerts 

lor which it charges admission fees) orby being a source of revenue to expand 

charitable outputs. 

::3 See JeSSlt:ll Pena & Alexander L.T Reid, A Calf/i'Jr R(:.:/orm (?f the Operulirmai Test for 

Unrelated Commercial AClil'ily in Charilies, 76 N.Y.U. L. REV. 1855. 1864 (200]). 

24 St:>.e Ellen P. Aprill, Les.wmsji'om rhe UBIT Debart:>., 45 TAXN()n:~ tIOS, 1107 (1989). 

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Early interpretations of the regulations by the IRS seemed to support the 

notion that even substantial unrelated business activity would not endanger 

exempt status as long as the revenues from that activity (which, of course, would 

be taxable under the UBlT) were used for charitable purposes. In Rcv. Rul. 64-

182," the IRS considered a case in which an exempt organization detived its 

revenues largely Irom renting space in a commercial office building; the revenues 

were used to makc grants to other charitable entities. Concluding that the rental 

activity was "unrelated" for purposes of the UBlT, the Service nevertheless ruled 

that the organization was entitled to retain its exempt status as an organization 

described under section 501(c)(3) because it lVas carrying on a charitable program 

"commensurate in scope" with its financial resources 2 (, 

The background to the 1964 rewnue ruling, however, is morc revealing than 

the ruling itself in interpreting the "commensurate-in-scope" language. Prior to 

approving the 1964 revenue ruling, the General Counsel's olliee referred the issue 

in the proposed ruling to the Exempt Organizations Council for analysis. The 

Council's analysis, attached to General Counsel's Memorandum 32689," 

contained two primary conclusions. First "the amount of expenditures of an 

organization ft)r charitable purposes must be taken into consideration in equating 

business activities with charitable activities" under the primary purpose test of 

reg. section 1.50 I (c)( 3 )-1 (c). Second, if after considering such expenditures, "an 

organization is shown in fact to be carrying on a real and substantial charitable 

program reasonably commensurate in financial scope with its financial resources 

and its income from its business activities and other sources," then the 

organization would be considered as having a charitable primary purposen 

According to the Council's analysis, the primary purpose test "becomes a test of 

whether there is a real, bona fide or genuine charitable purpose ... and not a 

mathematical measuring of business purpose as opposed to charitable purpose."" 

Or in other words, (1) "primary purpose" cannot be determined by a mathematical 

comparison of si7e based upon number of employees, space utiliJ:ed, or similar 

factors - there is no specific mathematical limit on unrelated business activities 

and (2) the dedication of net revenues from an unrelated business to charitable 

purposes is a necessary part of the analysis oUhe effects of unrelated business 

activity on tax exemption, and such dedication itselfis evidence that an 

organization's "primary purpose" is charitable. On the other hand, the Council 

indicated that when the operation of a substantial unrelated business did not result 

in cross-subsidization, the organization was no longer being operated primarily 

"Rev. Rul. 64-182, 1964-2 C.S. 186. 

" Id. 

0' Gen. Couns. Mem. 39862. J963 WL 62497 (lRS GeM) (Oct. 9, 1963J. 

Id. 

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for charitable purposes. 10 By implication, the Council's analysis seemed to be 

that dedication of revenues from commercial activity to charitable activities was 

"in turtherance of' a charitable purpose. 

A later General Counsel's Memorandum further illuminated the 

"commensurate in scope" idea. This memo provides perhaps the best analysis of 

thc doctrine and related issues of any IRS document. Reaffirming the original 

view of the Exempt Organizations Council that there were no "bright line" tests in 

detenl1ining whether unrelated business activity was consi,rent with exempt 

status, the memo stated, 

[AJside from express statutory limitations on business activity, 

such as section 502 and the newly enacted provisions relating to 

private foundations. there is no quantitative limitation on the 

"amount" of unrelated business an organization may engage in 

under section 50 I (c)(3), other than that implicit in the limdamcntal 

requirement of charity law that charity properties must be 

administered cxclusively in the beneficial interest of the charitable 

purpose to which the property is dedicated. 

[Flor some time now it has been increasingly apparent that our 

earlier approach to the problem of permissibility or 

nonpel111issibility of business activities of charities has been based 

on a misconception that somehow in the cnactmcnt of the 

provisions for exemptions of charities Irom income tax, Congress 

intended an implied restriction on the extent of their engagement in 

business activities. In the years past, the Service sought by ruling 

and by litigation to deny the right of charities to engage in 

business, insisting that somewhere, someho\v in the enactment of 

the exemption provisions Congress must have intended to limit the 

classification of exempt charities to those charities not engaging to 

any substantial extcnt in commercial endeavors. 

Exhaustive research of legislative history fi'om the earliest 

enactment of the charitable provisions of our income tax laws fails 

to provide support for such proposition. To the contrary, the 

evidence is clear that the first provision for exemption of charities 

trom imposition o[tax under the Corporation Excise Tax of 1909, 

,I) As summarized by the Counsel's office in GeM 34682, 1971 IRS GeM LEXlS 38 (Nov. 17. 

1971) "the Council's supporting Appendix also indicated that, aside from lhe 'primary purpose' 

requirement of the regulations, the better logic in cases in wh!ch the busmcs!'. activity docs not m 

fact provide any signiticant funds for charitable use is that the organization is not being operated 

exciu'>;vely for charitabk purposes." 

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from which the present income tax exemption provisions derive, 

was accompanied not by any intention to limit exemption to 

charities not engaged in business, but an intention to assure 

exemption of certain charities that were engaged in business."" 

The memo also addressed the issue regarding what should happen in cases in 

which the operation of an unrelated business either produced no profit to 

subsidize charitable activities or in which the profit was purposely reinvested to 

grow the unrelated business, as opposed to dedicated to expanding charitable 

outputs. As to the former case, the memo agreed with the original position ofthe 

Cowlcil that "the bettcr logic in cases in which the business activity docs not in 

fact provide any significant funds for charitable use is that the organization is not 

bcing operated exclusively for charitable purposes.,,]2 With respcct to the latter 

case, the memo observed, 

We think that if an organization devot~s its resources to business 

use which produces a reasonable retum on the investment, but 

refuses to apply any significant part of its proHts or resources to 

any charitable program and the condition prevailed for an 

unwarranted long time, a prima facie case could be made out that 

the organization is not adnl1l1istering its properties exclusively in 

the beneficial intcrest of charity since it is neither accomplishing 

any short range or any long range charitable purpose in respect to 

the beneficial use of its properties.'] 

The memo cautioned, however, that each such case would need to be resolved on 

its particular facts and circumstances. 

Despite what seems to be the clear linear analysis mandated by the 

regulations, the IRS and courts seem to universally ignore this analysis 

(particularly the "'in furtherance of" question) in analyzing cases. Instead, the IRS 

litigating positions and case law seems largely to concentrate on whether a 

particular activity has a "commercial hue" and ifso, whether it is "substantial." 

Positive answers to these questions generally lead to loss of tax exemption. 

though even here the analysis is variable. No one seems interested in asking the 

"in fU11heranee of" question that is clearly posed in the regulations. The result has 

been a legal morass. 

31 G~n. (ouns. Mem. 34M~2, 1971 lRS GeM LEXIS ~8, *263 29 (Nov. 17, 1971). 

~~ [d. at * l8. 

Id. at *23-24. 

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For example, in Scripture Press Foundalion v. US .. 3

• the taxpayer, Scripture 

Press, was /lmned primarily to improve the quality of teaching texts for protestant 

Sunday schools. 35 Soon rhe company found itself highly successful in preparing 

and sclling a variety of religious literature, accumulating over $1.6 million in 

surplus earnings by 1957.-'" As a result, the IRS revoked exempt status for the 

organi,..ation, claiming that it in effect was nothing more than a for-pro lit 

publisher and hence no longer was operated primarily for charitable purposes. 

The Claims COUli agreed with the Service, noting that Scripture Press priced its 

products similarly to for-protit competitors and amassed significant profits. 37 

Though it had an educational program aimed at promoting and expanding Sunday 

School instmction, the court found that expenditures on educational activities 

were "unaccountably small" in comparison to the surplus that Scripture Press 

accumulated alU1Ual1y." Accordingly, the court concluded that Scripture Press 

was not operated "primarily" for charitable purposes." Subsequently, thc Tax 

COUli and federal district cOUl1s upheld the IRS's revocation of exemption in a 

number or other publishing cases:(I 

As a result of Scripture Press and subsequent cascs, by thc early 1980's the 

Tax Court had developed the view that an organization that conducted a 

signiticant activity with a "commercial hue" risked losing exempt stalus, Factors 

which painted an activity with this impermissible "hue" included the presence of 

substantial overall protits: using commercial pricing methods with substantial net 

profit margins and competing with for-profit fin11S in the same sector." In 1991, 

the Seventh Circuit in Living Faith v. Commissioner adopted this basic analysis in 

the context of an organization anmated with the Seventh-day Adventist Church 

34 285 F.2d 800 (el. CI. 1961), cen. denied. 368 U.S. 985 (1962). 

35 Jd at 803. 

ld. at 804. 

3' Id. at 804,05. 

3~ Id 

,') Jd. at 806. 

411 Fides Publishers Ass'n y United State." 26:1 F. Supp. 924 (N.D, Ind. 19(7); Llisian Gllild, Inc. 

v. United States. 292 r. Supp. 219 (D. Mass. 1968), rel,'d, 412 F2d 121. 125 (lst Cir. 1969); 

Incorporated Trmtccs of Gospel \'v'orkcr Society v. United States, 5 J 0 F. Supp. 374, 38 J (D.D.C'. 

198 J). ajl'd, 672 F2d 894 (D.C. eir. 1991): Presbyterian & Reformed Publishing Co. v. Comm'r, 

70 T.t'. 1070 (19R2), rev'L! 743 F.2d 14R (3d Cir.19R4). 

41 Presbyterian & Refom1ed Publishing v. Commi'>sioner. 70 T.C 1070, lmU, atrd, 743 F.2d 148 

(3d Cir. J 982). 

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that operat<:d vegetarian restaurants and health food stores, ostensibly to advance 

church doctrine relating to diet." [n reviewing a Tax COllrt opinion denying 

exempt status to the organization, thc Seventh Circuit identifIed several tactors 

leading to a conclusion that the organization violated the commerciality doctrine. 

These included (1) direct competition with commercial firms, including similar 

locations (in shopping centers) and similar hours of operation; (2) a pricing 

structure designed to produce a protlt; (3) extensive advertising and use of 

commercial advertising materials; and (4) a lack in the record of any showing of 

donations to the organization or significant "relief of the poor:'" 

This analysis, however, is not consistent with the IRS's own regulations. 

Take Scrip/lire Press itself. The proper analysis of this case should have been to 

ask first whether Scripture Press had a charitable purposc. Given that its stated 

purpose was to advance religion via religious publishing, it clearly had a religious 

charitable purpose per Section 501 (cl(3). Next, we would ask whether its 

commercial activities in pursuing that purpose (puhlishing religious books) were 

substantial; the clear answer is this case is yes, given that this was essentially all 

the organization did. We would then follow with the third, critical question 

completely ignored in the Scripture Press litigation, which is whether the 

publishing activity was "in furtherance of' the religious charitable purpose. I 

carmo! sec how one could conclude that religious publishing is not "in furtherance 

of' a religious purpose - in fact, one could make an extremely strong argument 

that religious publishing is "substantially related" under the UBIT, given the 

centrality oCthe publishing activity to achieving the charitable purpose of 

advancing or proselytizing religion. In other words, in analyzing Scripture Press, 

the [RS ignored its own regulations, and the courts followed like children to the 

pied piper. 

On the other side of the ledger, in 1984 the 1l1ird Circuit reversed the 

revocation of exempt status lor a religious publisher in Preshyterian & Rejim1/ed 

4~ Living Fait11 . Inc. v. Commissioner, 950 F.2d 365, 367 Oth CiT. 1(91) (,"According to its 

articles of inc or po rat inn, Living Faith \vus est.ablished fix the purpose ofkeeping with the 

doctrines of the Seventh-day Adventist Church .... Good health, according to Seventh-day 

Adventi:.ts, promote .... virtLluus conduct. and is furthered by u vegetarian diet and abstention from 

tobacco, alcohol, and caffeine.") 

..j.' Jd. at 373-75. ;\n even more recent case (decided literally weeks ago) is Asmark Institute, Inc. 

v. Commissioner, No. 11-1553 (6th Cir, 201:2). In this case, the Sixth Circuit used a "commercial 

hue" analysis to conclude that an organi73tion \\hich provided consulting services to farm'> and 

agribusine:.ses on a J~t'-ror-service basis was not an ewmpt(.;harity under 501~c)(3). The court':. 

one-page analysis of the commercial activity issue (on page 10 oHhe slip opinion) completely 

ignores the three-step analysis set 1'Ol1h above. While 1 suspect the result in the case is correct. it 

vvould be nice if courts and the IRS \vould occasionally engage in some actual reading of the lawpalticularly when the la'\-\' is the IRS's own regulations! 

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Puhlishing v. CommissioHl?r,44 a case substantially similar to Scripture Press. The 

taxpayer in Presbyterian & RefiJrmed Publishing was a highly profitable 

nondenominational religious publisher that priced its products at market. Though 

the Tax Court upheld an IRS revocation of exempt status on the ground of 

impermissible commercial hue based primarily on the large profits generated by 

the taxpayer's publishing business," the Third Circuit reversed, noting that 

"success in terms of audience reached and influence exerted, in and of itself, 

should not jeopardize the tax-exempt status of organizations that remain true to 

their stated goals.,,46 A charitable organization, according to the Third Circuit, 

should be able to make money to expand its audience and influence, and doing so 

does not make the organization any less charitable. 

Similarly, the Tax Court itsc1fapproved exemption in several "resale shop" 

cases - situations in which a non pro lIt enterprise primarily operated a business 

selling crafts produced by a pal1icular group. In the late 1970's, for example, the 

Tax Court approved exemption for an organiLation that imported, purchased and 

sold artist's crafts," an organization that purchased and sold products 

manufactured by blind individuals," and an organization that operated two public 

art galleries." A Federal appellate court also reversed a lower court ruling 

upholding a revocation of exemption on commerciality grounds when the 

taxpayer, a publishing company, showed that it had no "operational profits."'" 

Even the IRS itself has approved charities engaging in activities with 

decidedly commercial hues - for example, hospitals and educational organizations 

can operate health clubs that charge fees similar to for-profit competitors without 

" 743 F.2d 148 (3d Cif. 1984) 

4.' 79 T.C. 1070 (1982) . 

.j.(i /d. at 158 . 

. p Aid to Ani:.uns. Inc. Y. Comm'r. 71 T.e. 202 (1978). The organization claimed that its 

charitable purposes were (1 ) "helping disndvant..'1ged artisans in poverty stricken countries to 

~ubsi"t and to preserve their craft; and (2) furnishing <;.ervices to iax~exempt museums by 

providing mUSetm1 stores with representative handicrafts from dl:.udv3ntagcd countries," ld. at 

209 . 

. 18 Industrial Aid for the Blind v. Comm'r 73 T.e. 96 (1979). Tht: charitable purpo~(.:' \Vas to 

provide .:'111ployment for the blind and thus came within the regulations' statement that a charitable 

purp()~e includes "relierofthe poor and distressed or underprivileged." Id. at I 00-101. S'I..~e "freas. 

Rcg.1.50J(c)(3)-I(d). 

49 Goldsboro Art League v. COnlln'r, 75 T.e. 337 (1980). 

'il rJisian Guild, Inc. \ .. United States. 412 F.2d 121, 125 (I st Cir. 1469). 

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endangering exempt status, although the income from these activities may in part 

be subject to taxation under the URIT. 51 Some recent private rulings, moreover, 

have reverted to comlnensurate-in-scopc analysis, approving exemption for an 

organization that published textbooks for religious schools, even though revcnues 

trom the publishing business counted for <lver half of the organization's total 

revenues and enjoyed 75% profit margins; " for an organization that helped 

developmentally disabled children, despite receiving 98% of its gross income 

from bingo gan1es;53 and for an organization formed to give financial assistance to 

needy women that produced 66% of its revenues from the operations of a gin 

shop and lea room. 54 Nevertheless, the IRS has continued to push the 

5: See general(v. Virginia Richardson, Roderick Darling and Marvin Friedlander_ Health Cluhs in 

INTERN.,\L REVENUE SERv1CE. EXEMPT ORGANIZATlONS CONTiNUING PROFESSIONAL EDl.'CATTON 

(CPE) TLCl !NICAL IN~ll{UC nON PRoeJRAM H)R FISCAL Yl:AR 2002 (2001) (operation of health 

club by university or hospital generally does not affect exempt status; income fi·om membership.., 

sold to general public .. as opposed 10 students and faculty or patients and staff·· generally ta:...ablc 

under UBlT). 

52 Tech. Ad\,. Mem. 9636001. 1996 PLR LEXIS 1026 (January 4,1996). The organinltion started 

its publishing activities to supply its own schools with t~xtbooks, but soon expanded to provide 

religiou<:.-oriented textboob to ",chools worldv,:lde. Revenue~ from the publishing business 

eon~tituted over half the total gross revenues of the organization, and its prolit margins were as 

high as 75%, though expenditure::. on the publishing business \vere le~~ than half the organi/ation's 

total expenditures. Finding: that the publishing aetivitie& \\"cre viI1ually indistinguishable from 

those of a commercial religious publisher and that they \vere not "substantially related" to the 

educational activity of operating its own religious schools, the Service conduded that the profits 

ol'the activity were subject to the UBIT. At the same time. howcver, the Service concluded that 

the obviously-substantial nature of lht: publishing bu!:>iness did not endanger the Laxpayt:r'" c:xempt 

status because "there is no evidence that any of the funds generated by [the publi&hing business] 

were not properly used to further the organization's education purposes in some manner." [d. at 

*25. Accordingly the taxpayer was entitled to exemption '·because it is carrying on an exempt 

progrmn commensurate ill scope with its financial rc!:>ources." Jd. at *25-26 . 

.;~ Tech. Adv. Mem. 971 1003 (Nov. 8, 1995) reprinted in 16 Exempt Org. Tax Rev. 626 (1997) . 

. )'ee D. Ben~on Tesdhal. Letter Ruling Alert: IRS Applies Lihcral Pr;mary PlIrpose and 

Commensurate Tests, 16 EXEMPT ORG. TAX REV. 617 (1997). The organization represented that 

50% of ib time and resources 'were dedicated to bingo games, although over 95% of its gross 

income was used for bingo operation<;; expenditures on charitable adivities ranged from about 

I S% to 3.5% during thl? years in question. Neverthelcss. tilC IRS summarily dismissed the notion 

that thi~ organization had any ··commensuratl:" problems, noting that fpr 30 yc:ars the organizatiPI1 

had becn assisting developmentally disabled children and sp~nt over 40% of its time and resources 

doing so. Accordingly, the commensll/"Hte~in-scope test "would not be applicable since the 

Association has a substantial charitable program in addition to its rundraising activities." Id. at 

628. In the ruling, the IRS noted that although income from bingo games was speeilically 

c.\cludt'd from the UBIT in LR.C. Section 513(0, that exclusion "y,·as not intended to result in 

exemption ror organizations \vhose primary activity is the conduct of bingo. Bingo remains an 

activity unrelated to exempt purpose.., and alone cannot 'lUpport exemption .. "). Ed. at 627 

';4 Pri\'. Ltr. Rul. 200021056, 2000 PRL LEX!S 562 at *:;3 (Feb. 8. 2000). The Service inlhis 

ruling reasoned that an unrelated business that is used [lS a '·fundraiser" for an overall charitable 

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'''commercial hue" test in iitigation,55 and several recent applications f()r exempt 

status have been rejected by the IRS on grounds that the organization's activities 

'were no diftercnt from commercia! enterprises.56 

In short, the Treasury Regulations, IRS interpretations and litigating positions, 

and court cases all seem to be inconsistent in judging "hen commercial activity 

should result in loss of exempt status. In particular, neither the IRS nor the courts 

have analyzed consistently the main issue raised by the regulations: when 

(unrelated) commercial activity will be considered "in thrtherance at" an exempt 

ptupose as opposed to simply "primarily" operating an unrelated busine,s. 

B. Complex Simc/ures 

The conflict between '"relatedness" and "in furtherance of' is not the only 

inconsistency in the commercial activity realm. IRS positions on how complex 

structures alTeet exempt status are also contlicting. In general, the IRS adheres to 

the view that corporate entities "stand on their o\vn" for tax exclnption purposesfhat is, the activities (charitable or commercial) of one corporate entity will not be 

imputed to a related entity lor either good (obtaining exempt status) or ill 

(revoking exemption). This "separate corporate identity" rule is a long-standing 

feature of corporate tax law, where treating an entity as a bona-fide, separate 

business container is necessary to protect the corporate tax base. 57 When it 

purpose was operated "in hmherance of' a charitable purpose and did nor constitute a substantial 

nonexempt purpose. Id. ("One \vay in which a trade or husiness may be in furtherance or exempt 

purposes is to raise muney for the exempt purposes orthe organization, not\yithstanding that the 

adual trade or business activity lllay be ta'mble und..:r sections 511 through 513.") Similarly, in 

Field SClv"ice Advice memo 199910007 (Nov. 24.1998); 19q8 FSA LEXIS 15. the Service 

concluded that an organization operating a sports tournament \\"hose net proceeds were tllmed over 

to another charity mel the commensumte-in-scope requirement. For additional analysi~ or the 

checkered histnry of the cnnlfnen~urate-in-~cnpe test, see ~·.Vc!yll Brody, A Toxing Time/or Bi,~hoJi 

Estate: What is the I.R.S. Role in Ch(Jri~v Govemance?, 21 U. HA W. L. REV. 537.575-76 ([ 999). 

5~ E.g., Airlie Foundation v. I.R.S., 283 F. Supp. 2d 58 (D.D.Cl003) (organization that rented 

conference facilities to other charitic:'. and helped \vith conference logi&tics not cxempt because its 

activities were condllcted in a commercial manner). The most recent example is 

'0 E.g., Pri\'. Ltr. Rul. 200704041, 2006 PLR LEXIS 2448 (Oct. 30, 2006) (organization that 

prO\ ided dov,n payment assi~tance to HUD-qualified home buyers not exempt; "The manner in 

which you operate your dO\vn payment assistance program indicatcs that you facilitate the sales of 

homes in [l. manner that is indistinguishable from an ordinary trade or business."); Priv. Ltr. Rlli. 

200651037,2006 PLR LEXTS 2020 (Sept. 28. 2006) (organization funned to sell ikms for 

individuals and transfer proceeds to charity of individual's choice was perionning sen'ices as 

agent for donN "which are characteristic of a trade or business and ordinarily carried on hy forprofit commercial businesses."), 

'7 Moline Properties v. Commissioner, 319 U.S. 436 \ 1943). in Mo/ine Properties. the taxpayer 

argued that a corporation \vhich sold certain real estate should be disregnrded. and the proceeds of 

sale taxed directly to the corporation's ~ole shareholder. The Suprt:me Court ruled that the tax 

system must respect the separate identity of a corporation li.mned for a valid business re[lSOllS, thus 

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comes to joint ventures conducted in a partnership tl)fm (or in a limited liability 

company taxed as a partnership), however, the IRS position is that the partner is 

deemed to be in the same trade or business as the partnership - that is, the partner 

is deemed to be conducting directly the business of the pm1nership." This 

"aggregate" view of partnerships is also a long-standing rule of general tax law. 

In one sense, therefore, the IRS has been perfectly consistent in adopting for 

tax exemption the same rules that apply in general tax law regarding the 

"separate-ness" of entities. 1n a larger sense, however, these rules mean that the 

cHects of a particular business aeti vity on exemption and the potential that such 

activity will be taxed can be dramatically altered by the form of the "container" in 

which the husiness is conducted. For example, under current rules, an exempt 

entity could sit at the top of an extcm,ive for-profit corporate business pyramid, 

and the corporate isolation rule would mean that the exempt parent would be 

essentially immune fTom claims that the overall activities of the "group" were not 

charitable."'" By comparison, a charity that operated a substantial business 

protecting the integrity of the corporate income tax. In General Counsel's Memorandum 39326 

(Jan. 17, J 985), the I RS applied the Moline Properties doctrine in assessing the exempt ~Iatus of a 

nonprofit parent that o\vned a for-protit subsidiary, conduding that the subsidiary'S activities 

\vnuld not be imputed to the nonpro1it parent. See genera/f.)', Colombo, Commercial Arfh'ity, 

supra note 8, at 515. For an extended discuss-ion of the l\do/in(' Properties doctrine in the context 

of tax I.!xcmption. see HILL AND MANCINO, mpra note 7, at '1 27'()2. 

A subsidiary corporation of an exempt parent can sometimes claim tax exemption as an "integral 

pare or the parent's exempt activitie::.. In general, the IRS position is that the "integral paJ1" test is 

available only to "captive" subsidianes that perform seIY'jc~s exclusively for the exempt par~n1, 

sllch as a sLlhsidiary that generates electrical pmver for ilS parent. Treas. Reg. § 1.502·! (b). for 

general discllssions ofthc integral part doctrine, scc John D. Colombo, The lHC Cases: A Catch22/or lnteKral Part Doctrh1e, A Requiem j(Jr ReF. Rill 69-545.34 E>..l.:I\,wI ORt..J. TAX Rl:.Y. 401 

(2001); Iln.l AND l\t1,.\NCfNO, 'wpra note 7 at,! 27.0..J. 

5X S<?c. e.g., Rev. Ru1. 9B-IS. 199R-l e.B. 718, 720-7~1. 

5~ One private ruling bsued in 2004 suggests (in th~ mode ufthe "commensurate in scope" 

doctrine discusscd above) that an exempt parent lllust sOllleho'w usc revenues or assets of its forprofit subsidiaries to hllther its charitable purpose. or else it may run atlnll of the primary purpose 

test. In TAM 20041704{}, the IRS e""mnin~d whether large accumulations ofva!ue in a fur~protlt 

subsidiary of an exempt church would result in loss ofexcmpt status. While the IRS mlcd that it 

v.ould 110t unJn the particular facts presenkd, its ~malysis suggc::.ts an ungoing obligation fix an 

exempt parent to lise revenues/asset:':. from a fix-profit subsidiary to expand charitable outputs, a la 

the commensurate in scope doctrine. Tn this private ruling the IRS stated; 

In post-audit years, it appear5 that the subsidiary grc\v rapidly -- perhaps beyond X's 

expectations. It is now \ ... orth several times X's investment in the subsidiary, although it 

apparently had 110t earned an operating profit through * * *. Thi,> gnmth presents a 

cOlltinuing obligatio11 on X to translate this valuable assd into funds, and Lise those funds 

for the expansion of its charitahle religious activities. For example, X may have to give 

consideration to selling some of the subsidiary'S assets, or selling a portion of the stock of 

the subsidHlry, to an unrebted party. The proceeds of such transaction'> mu'>t be used to 

fund or expand X's charitable or religious activitieS. The subsidiary shOllld give highest 

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enterprise via a partnership would place its exempt status at risk under the current 

version of"the commerciality doctrine described above."o At the same time, an 

cxempt organization that isolated a pmticular business activity in a corporate 

container for regulatory or liability reasons would lose any possibility of arguing 

that the business was "rdated" to the exempt organization's charitable purpose, 

since the parent's charitable activities could not be attributed "do\.\TIstream" to the 

subsidiary corporation."l At one time, even the Treasury itself questioned the 

wisdom of these rules,"2 although there are no current legislative proposals to 

change them. 

C. Private Ben(!jir 

The final issue that comes up repeatedly in the commercial-activity sphere is 

the private benefit doctrine. Even trying to summarize the private benefit doctrine 

is hazardous, but rrom a variety oflRS rulings and litigated cases, one might 

conclude that private benetit is a bene lit (usually economic) that nows to some 

person or entity outside the charitable class as a result of serving the charitable 

priority to repaying X's inv~stl11cnt loans once it b~gins generating Gash floVi: or earnings 

and proiits, so that these funds can be used for X's charitable or religious activities. X 

cannot be' allowed to foclls its energies on expanding its ~ubsidiary's commercial busim:ss 

and assets, and neglect to translate that financial :,uccess into speci1ic, definite and 

fea.:;ible plans for the expansion of its charitable religious activities .. 

The b.et that the assets arc being accumulated in a ror-prollt company under the rormal 

kgal control of X doc"i not excu:,c X fi'om using such assets ror charitable religious 

purposes. 

Tech. AdV'. Mem. 200437040, 2004 PLR U":XIS 612, *25-*26 (June 7. 20(4). 

(,0 See text at notes I 9~56, supra. 

fJl For example, \ve kno\\ from recent case 1a\\- that a contract-Illodel health maintenance 

organi7atinn (HMO, will find it dilTicult to obtain cAemption under 50 I (c)(3) i flhe HMO business 

is in a separate corporation. See, e.g., IHe Health Plans v. Comm'r, 325 F.3d 1188 (lOt:' Cir. 

2003). [t is not clear, hov..ever, \vhether revenues from an HMO that \Vas operated as a '"division" 

ora nonprofit corporatioll that operated an excmpt acute-care hospItal·would be taxable or not: 

one could certmnly ~!rgtle that such revenues are "stlbstanlial1y relaled" 10 the hospital's exempt 

purpo<;e nfprnviding health care for the general henefitofthe community, although some older 

IRS rulings suggest that if a hospital receives revenues from persons other thml hospital patients, 

such revenue:. \\ouJd be "unrelated."' See, e.g., Gen. COUIlS, Mem. 39830 (Aug. 30. 1(90) 

{suggesting that an HMO might be considered an unrelated business in the hands of a hospital 

corporation since the HMO provides services to persons not patient:. oj' the hospital}. 

fJ:: As part ofhcarings on Ihe UBIT in the late 1980's (hereafter, "the Pickle ht"!arings") the 

Oversight Subcommitte~ of the llous\! Ways and Means Committee circulated a draft reran that 

recommended aggregating the activities of a parent nonprofit and any 80%-owned subsidiary for 

purposes of applying the "primary purpose" test of exemption. See gCJ1eral(";', lilLi, AND 

MANCINO, supra note 7. '[27.03[4]: Apl'i1l. supra note 24, at t 106; Evelyn Brody, Business 

Al'tivitic,,,' o.fNonpro/if Orgol1i=ations· Ll!.gu/ Bo/./ndmy Problems in CormLs AND S·/ EURLL, slIpra 

note 6. 

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class. Whether such a benefit creates exemption problems is judged on a 

balancing test. The best statement we have from the IRS regarding the doctrine 

comes from a 1987 Genc,"l Counsel's Memorandum, which stated: 

An organization is not described in section 50 I (c)(3) if it serves a private 

interest more than incidentally ... 

A private benefit is considered incidental only if it is incidental in both a 

qualitative and a quantitative sense. In order to be incidental in a 

qualitative sense, the beneiit must be a necessary concomitant of the 

activity which benefits the public at large, i.e., the activity can be 

accomplished only by benefiting certain private individuals .... To be 

incidental in a quantitative sense, the private benefit must not be 

substantial after considering the overall public bcndit conferred by the 

activity.(j} 

Although the IRS has used the private benefit doctrine in a wide variety of 

contexts, it has been a particular fixture of IRS analysis of commercial 

transactions undertaken by exempt charities with for-profit entities or individual 

investors. Thus the IRS has applied the concept to partnerships hetween hospitals 

and doctors;"" 10w-incol11e housing partnerships with private investors;"' '"downpayment assistance" programs in which a charity acts as an intermediary between 

a real estate developer and a potential charitable client66 and similar 

transactions."7 Because orthe breadth of the doctrine as currently applied by the 

IRS, any significant economic transaction between an exempt charity and a nonexempt entity or individual outside the charitable class is subject to private henefit 

attack, and the balancing approach means that the line between permitted and 

problematic private benefit is unclear.68 

I'd (jen. Cnuns. Mem 39598 (Jan. 23,1987). 

,,·1 E.p,.? Gen. COllllS. Mem. 39862.1991 IRS GeM LEXIS 39 (NO\'. 22. 1991). 

65 See, e g., Jerry O. Allen and Alan D. Duffy, Solving the Lm1'-income Tax Credit Ilousing 

PLlrrnership Dilemma, 49 EX!]\1PI ORG. TAX RI:v. 319 (2005); J. Christine Ilarris, Tax-E,empfio/1 

And Lmv-]ncol1lc Housing Ventures: frrllconcilable D{!ferences? 47 EXEMPT ORG. TAX REV. 329 

(2005); J. Christine Harris, Tax Lnr Professors Sc~J' Recent Joint Vellture Ruling Doesn't Break 

Ground In Housing, 47 {-"XI--J\lP r ORG. TAX REV. 2 1 C~O{)5); MidH\(~1 I. Sanders and Celia A. 

Roady, EO Practitioners SlIggest Way To Expudite E...-emptiol1s For LOH'~Inc()me f-fou,H'ng Orgs .. 

37 t:XLMPI ORC<. TAXRJ.:-v. 127 (2002). 

(,(i E.g., Rev. Rul. 2006~27. 2006~21I.R.B. 915. 

07 See generally, John D. Colombo, In Searl'h (!!,Private Benejit, 5g FLA. L. REV. 1063 (2006). 

oX In 2004. the IRS did clarify that certain "ancillary" partnerships between an exempt charity and 

a l'or~profit company would not create private benefit problems, though the ruling is largely devoid 

or analysis and leaves open as many questions as it ans\\ers. Rev. Rul. 2004~51. 2004~12 LR.H. 

97.:1.. See generally, Colombo, supra note 66. at 1077~ 79; J. Christine Harris. Tax LOll' Prrdi!ssors 

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Ill. Making Tax Law Coherent 

A. A Taxonomy o[Commercial ActivilV and the Policy Ohjectircs of 

Regulating II 

Part ll. above recounts the inconsistent positions the IRS and courts have 

taken with respect to whether commercial activity should affect exempt status. In 

order to get a handle on the issues involved and how best to revise federal tax law 

on this Ii·ont. it may be helpful to think about how different kinds of commercial 

activity impact policy objectives relating to such activity. 

In some prior writing, I identified several policy concerns with charities 

conducting commercial activities. Those concerns are (1) avoiding unfair 

competition between exempt and for-profit entities, (2) limiting erosion orthe 

corporate tax base by having charitable organizations buy taxable activities that 

become non-taxable in the charity'S hands, (3) limiting the extentto which the 

attention ofrnanagement is '''di\'erted'~ from charitab1e activities into running forprofit businesses, (4) promoting economic etliciency, (5) guarding against "oversubsidizing" charitable activities by letting charities "self-subsidize" t1u'ough the 

acquisition of commercial businesses and (6) limiting the business risk exposure 

of charitable assets that might accompany running a business from the same 

"container" (corporation or trust) that houses charitable asscts 69 Some of these 

policy concerns are more significant than others. For example, economists have 

almost uniformly rejected the notion that charities engage in unfair competition, 

at least ifthal phrase is limited to predatory pricing techniques or inappropriately 

using exempt revenues to subsidizc commercial activity.7l) Similarly, exposing 

charitable assets to business risk can best be handled through insurance and 

proper diversification; tax law should have little to say about this policy issue.') 

On the othcr hand, protecting the corporate tax base, limiting managerial 

diversion, promoting economic efficiency and limiting possible oversubsidization of charitable activities (which could he viewed as simply a subset of 

promoting economic erticiency) do seem to be significant concerns. 

Say R('celli Joint Vemure Ruling Doe.m'{ Brt'{(k Ground inl/ousing, 47 EXEMPT ORG. TAX REV. 

21 (2005). 

(0') Colombo, Commercial Acti .... i'y, slIpra nok 8. at 529~546. 

70/d. at 530. See a/so, Michael S. Knoll, The UBfT: Levelillg and Uneven Playing Field or TiJt;ng 

a Level One, 76 FORDHAM L. RFV. 857 (2007) (questioning \'./hether there is any economic 

advantage to a nonprofit engaging in a commercial busmcss. 

" Id. at 544-46. 

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Commercial activity also has its benefits, however. The obvious benet1t is 

that it permits charitable organizations to expand (or maintain) their outputs in an 

environment in which the availability of direct government grants may be 

shrinking and competition tor both the available government money and private 

donations is increasing exponentially along with the sheer numbers of exempt 

charities. 72 In some cases, moreover, commercial activity may permit i.l charity to 

earn a return on capital investments made primarily for charitable purposes, but 

which by their nature may be under-utilized for purely charitable outputs. Thus a 

conclusion that commercial activity by exempt charities is unifonnly "bad" is not 

correct. 

Instead, it may be usetul to try to categorize the kinds of commercial activities 

charities engage in and analyze whether the concerns with commercial activity 

outweigh the potential benetlts. In general, one can separate commercial activity 

into five categories: 

Categorv 1: commercial activity that is also the primaty exempt activity; 

Category 2: commercial activity that is functionally related to the 

organization's exempt purpose (e.g., "substantially related" activity under 

the UBlT); 

Calegory 3: "unrelated" commercial activity that exploits excess capacity; 

CategOl)' 4: "unrelated" commercial activity that does not exploit excess 

capacity but the revenues trom thc activity are directed to charitable 

outputs, and 

Cmegol)' 5: "unrelated" cor~lmercial activity that becomes "empire 

building" for its own sake. 7

' 

Scriprure Press, discussed above, is a classic example of a Category I case, 

hecause religions puhlishing was the taxpayer's only activity. Other examples 

exist, however. There is little doubt that a nonprofit hospital, selling health care 

services tor a tce at prices virtually idcntical to for-protit hospitals in similar 

markets is engaged in commercial activity that is also its primat·y activity; in this 

case, however, the specit1c commercial activity has been approved (under the 

correct ancillary conditions)'" as a primary charitable activity. Low-income 

housing partnerships arc another example of a charitable organization engaging in 

;::! See Burton A. Weisbrod, The nonprojit mis<;ion and its financing: Growing links between 

nonpn?/its and the ~'est oj the economy_ in To PR01'IT OR NO! 1'0 PROFH, supra note 5, at 1, 2-7. 

See Colombo, Commercia! Actil'ity, supra note 8, at 525-529. The "empire building" concern is 

\\o'hat led Treasury to propose an aggregation rule for determining if a pal1iculClr nonprofit bad a 

"primary" charitable purpose in the Pickle bearings in the late 1980's. See note 62, supra; Brody, 

supra note 62, at 32 

74 See, e g., THe Health Plans_ Inc. v. Comm'r, 325 F.3d 1188 (2003); John D. Colombo, The 

Failllrt! olCommunity Benej/r, 15 HLALTH MA mIx 29, 30-37 (2005). 

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a commercial enterprise (building and renting housing) as its primary charitable 

activity. In these cases, therelore, the key question is whether the activity 

undertaken by the nonprofit will be considered charitable in itself. I f so, there is 

nothing more to discuss; if not, then the organization presumably falls into the 

category of Treasury Regulations 1.501(c)(3)-I(e)(I) of operating an "unrelated" 

business as its primary purpose, and thus fails the tests for exemption." 

Categories 2-5 involve inherently difTerent circumstances. In each ufthese 

categories, the charity has a substantial charitable activity of some kind that exists 

alongside the commercial activity. In Category 2, the commercial activity is one 

that is functionally related to the charity'S exempt purpose - activity which would 

be "substantially related" under the current UBIT. Such related activities may be 

a concern for tax-base erosion, but little elsc. Since the activities arc functionally 

related to the exempt purpose they bear littlc risk of managerial diversion (afier 

all, management is engaging in these activities as an integral part of their exempt 

activities). Moreover, as Professor Hel1lY Hansmann has noted, these activities 

raise few, if any, economic efficiency problems since one would assume these 

activities involve some kind of economics of scope (e.g., the capital asset has 

already been purchased or employees are already trained to do these activities).76 

~5 This category is one where confusiOn over the diflcrcnce between charitable purpose and 

charitable a{.;livities is most problematic. One might argue, for exampk that a l1unprofit pharmacy 

has a charitable purpose to promote health: sec. e.g., Rev. RuL 69-545. 1969-.2 CUl1l. Bull. 117 

(promotion or health tor the general benefit orthe community is a charitable purpose), rl' none of 

its activities can he dac;sified as charitable. ho\.\ever, then it seems obvious that its primar)' 

purpose is not charitable but something else. See. e.g., FederatIOn Pharmacy SCI'-viccs v. Comm'r, 

625 r.2d ;;;;04 (f~th eir. 19~O) (nonprofit pharmacy n(l( exempt hecause activity of selling drugs at 

cost to elderly and poor is a commercial activity, not a charitable one; pharmacy not eligible for 

exemption). Similarly, this conflation of charitable purpos~ and charitable activities can explain 

the different results in the 5;cripture Press and Pres.vhyrerian and Reformed PlIhlL'illin;; Ca<;cs 

discussed "hove. In S('ripturc Press, tilt.: Claims Court appeared to view religious publishing as 

not being a charitable activity, at least \\hCIl conducted \yith a "commercial hue," despite the fact 

that publishing religious texts \\ould seem to functionally advance a charitable purpose of 

promoting religion. In contrasL the Third Circuit in PreshyreriLm and Reformed Puhlishing 

clcarly did vicw religious publishing as a charitable activity that promoted a religious purpose. 

In PLR :!008!lW23 (released Feb. 6, 200fo:). the IRS came as clo<;e as it has in 40 years to properly 

analyzing Ih~ effect of commercial activity on exempt status, In this ruling, the Service analyzed 

the ca~e of an organization primarily selling certain type~ ohecurities f(Jr a fec: to htcilitate e~tatt' 

planning. Yvith about .5% (one half 01' one percent) orthe fees going tu charilY, The IRS 

concluded that the security sales were inherently commercial, and that the .5% ot'revenues going 

to charity did not pass muster under the "commensurate in scope" doctrine. This ill tum meant 

that the taxpayer's "primary purpm,c"' was operating an unrelated business, because the securities 

sale activity wa~ not "in furtherance or' a charitable purpose. The ruling created something of a 

stir among charities atler the then-head o1'TE/G£, Mike Miller, opined thai the commensurate test 

might be m.ed to regulate how charities v.·ere using their resources. 

7~ I Ienry Hansmann. l..h?fair Competition and tht! Unrt:'/ated Business in('ome Tax, 75 VA. L. RtV. 

61l<, 626-28 (1989). 

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For example, one would expect that the music school that puts on concerts by by 

lor-pro1lt groups already has personnel experienced in concert planning and 

execution. There may be some risk of undue "self~subsidization" by charities if 

these related activities arc tlnancialiy successful, but given that these activities are 

by de1lnition a functional part of the charitable program, the chances of these 

activities becoming serious money-makers likely are small. 

In Category 3, charities undertake "unrelated" commercial activities because 

they have excess capacity from capital investments made for charitable purposes. 

The classic example here is a university that rents its stadium facilities to a 

professional football team for the summer or that leases unused supercomputer 

time to for-profit research groups." Commercial activities falling within this 

category also should not raise exemption problems. In this kind of case, we 

should positively encourage charitics to avoid letting assets simply lie fallow. 

Doing so is a waste of invested capital. There may be some concern that we not 

encourage charities to consciously "over-invest" in capital facilities or in 

employees simply to use them in commercial businesses, but to the extent that 

investments are made at a level necessary to conduct charitable activities. ea111ing 

a profit through maximum utilization of that investment would seem to be a 

desirable and efficient outcome. Moreover, ifthe capital investment is made in 

the first instance to pursuc charitable activities, thcre is little reason to think that 

there is much risk to the corporate tax base (since the activities for which the 

investment was made likely would not have been undertaken by the private 

market). Managerial diversion also would bc limited, because if the capital assets 

used in the commercial activity were primarily meant for charitable purposes, any 

commercial activity by definition will be subordinate to commercial use. For 

example, the cmpty athletic stadium is only available to rent when the university's 

teams are not using it - generally, this means the summcr only. Ditto for the 

unused supercomputer time - commercial use will by necessity be suhordinate to 

academic use. 

In Category 4, charities undertake commercial activities that do not exploit 

economies of scope, but generate returns above the market rate on stocks and 

bonds that in turn will be used to expand charitable outputs. The church that 

opens a Starbucks franchise probably has no significant economies of scope to 

exploit in that activity, but may (in some cases correctly) conclude that investing 

in the Starbucks will produce a rate of return significantly higher than a 

diversified portfolio of stocks and bonds. There may be programmatic reasons as 

well: luring fanner church-goers back to Sunday services with the promise of 

good coffee, or trying to expand the number of patrons ofthe local museum by 

baving alter-hours cocktail parties. 

77 St!.e Hansmann, supra note 76, al627. 62:>:. 

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These Category 4 activities raise mixed issues. On the one hand, it seems that 

we should not impede the ability of charities to develop alternative resources to 

expand charitable outputs. Other commentators have noted the modern pressures 

on fllnding sources for charities;73 if investing wisely in certain commercial 

activities produces a premium rate of return for charities to expand charitahle 

outputs, that seems as though it would be a generally good thing. Engaging in 

rhese activities, therefore, likely should not affect exempt status as long as the 

revenues timn the commercial activity are used to subsidize charitable outputs. 

Yet there are some countervailing concerns. Unlike category 2 or 3 activities, 

those in category 4 are far more likely to rcsult in managerial diversion, since the 

commercial activity is not subordinate to any charitable use of the underlying 

assets. The church that runs a Starbucks to supplement the collection plate will 

almost certainly need to invest signillcant managerial time in running the 

Starbucks. Category 4 activities also raise questions of protecting the corporate 

tax base, economic etliciency and over-subsidization, pal1icularly if these 

activities are not subjected to the general corporate income tax. If these activities 

are not taxed, charities can cam a premium rate ofretum on them simply because 

rhcy can avoid rhe corporate-level tax, not because managerial or other 

ef1iciencies produce a premium rate ofreturn.79 Thus, failing to tax these 

activities would encourage charities to invest money In direct commercial 

activities even if such activities would be Hworse" investments on an after-tax 

basis than a diversitied pm1folio. This incentive would in turn result in more such 

activities undertaken by charities, withdrawing those assets from the corporate tax 

basc (the tax-base protection issue), and would result in charities essentially "selfsubsidizing" their operations even if doing so resulted in an oversupply of the 

particular charitahle good or service that the commercial activity was subsidizing. 

The proper policy response to category 4 activities, therefore, would seem to be to 

tax them, but not have them affect undcrlying exempt status. 

Finally. in Category 5, charities become involved in commercial activities that 

take on a life of their own, where revenues are largely reinvestcd in the activity 

itself, instead of being used to subsidize expanding charitable outputs. In a 2004 

Technical Advice Memorandum dealing with an exempt church that owned a Corprolit subsidiary, the IRS raised precisely these empire building concerns, 

cautioning the exempt parent that it '"cannot be allowed to focus its energies on 

expanding its subsidiary's commercial business and assets, and neglect to 

7X See Weisbrod, supra note 72. 

7') Corporations pay entity-level tnx on their earnings at a maximum rate of 35%, whereas 

proprietorships and partnerships (or LLC's that choose to be taxed as partnerships) pny no entitylevel tax. That means that in theory, a corporation must earn a higher pre-tax return on equity to 

compete \\ilth other investments !ll the market on all afti~r-ta\ basis. 11' a charity could acquire a 

corporate business and avoid th~ corporate-level tax, it would be able to cnpture this higher pre-tax 

rate of return for itsclfsimply as a result of the ownership change. 

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translate that financial success into specific, definite and feasible plans t(lr the 

expansion of its charitable religious activities,"xo One might arf,'lle that Division 1 

college basketball and football programs may also present these problems, at least 

in individual cases. Recent headlines such as Alabama's hiring of Nick Saban for 

$32 million owr eight years" surely make one wonder wheth';;' Alabama is 

rationally seeking to maximize football revenues to subsidize other charitable 

(e.g" educational) outputs, or whether running a successful Division 1 football 

program has simply become an end unto itself. In these cases, management of the 

charity may need a f()rceful reminder of its underlying mission - and there is no 

more forceful reminder than the threat of losing tax exemption." 

B. Suggested RejcJrms 

The above analysis suggests some reforms that may be worthy of 

consideration. First, the problem with Category 1 cases is really a problem with 

defining appropriate charitable activities, not a problem of'the relationship 

between charitable activities and commercial ones. What is necessary here is that 

the IRS adopt a consistent approach to analyzing Category I cases. Perhaps that 

consistent approach could he something along the following lines: if an 

organization's sole activity (ignoring de minimis activities) is one that is 

commercial, exemption will be deni~d. One can imagine that the "commercial 

hue" test adopted by the courts would have a place in this analysis as a method of 

determining whether the sole activity is a commercial one or not. 

Of course, this approach would create a few problems with some existing 

organizations. If publishing religious texts in a manner similar to commercial 

publishers is not charitable, then one wonders why operating a hospital in a 

manner similar to for-protit hospitals justifies exemption. I certainly have no 

problem with the [RS taking the position that no commercial activity can support 

exemption standing alonesl (e.g., aparttrom cases in which the commercial 

revenues are used to support some other charitable activities), but if that is going 

to be approach, it needs to be applied consistently. 

"' Tech. Adv. Mem. ~00437040, ::-004 I'Ll< LEX[S 6[c, '25-*26 (June 7. 2004). 

R; Sec, Jodi Upton. Saban's contract could bring congressiollal inquiry, USA Today, available at 

http://www.usatoday.com/sports/co!legc/t{)otballisecl2007-01-03-saban~col1tract ___ x.htm 

l(2 Of coursc, if one bclic\'cs that big-time colleg.e football and basketball programs arc themsclve~ 

charitable activities, then this namp!e is really a Category 1 ca'>e, not a Category 5 case. An issue 

that arises with the analysi::. in the text is e>"3ctly hm\- one distingui::.he::. between a "commercial" 

activity and a "charitable" activity that produces revenue. For a discussion of this issue. see text at 

notes 91-92. il1/m. 

83 J have in the past suggested that lax exemption i" appropriate only in cases of combined market 

failure and government failure; if a "charity" is engaged in an activity that i-s simply participating 

in a private market, there is nl.1 mark.et failure and nl.1 need for exemption. See genera!!) .. JOll!\; D. 

COLO,'vTBO AND MARK A. HALL, Trw CHARITAl1L[ T:\x EXFMPTJON (1(95). 

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Catgories 2, 3, 4. and 5, on the other hand, all presuppose that the organization 

in question has some charitable activities apart from its commercial activity. Of 

these, only Category 5 activity should result in loss of tax exemption. These 

"empire building" cases present the greatest threat of managerial diversion and of 

nonpmlits becoming lor-profits in disguise. Accordingly. exemption should be at 

risk only in cases in whieh the commercial activity is not functionally related to 

the organization's exempt purpose and revenues from commercial activity are not 

used to suhstantially cross-subsidize charitable outputs. Put another way, the IRS 

needs to make clear that the key concept in the regulations on this issue - the "in 

furtherance of' concept - can mean either that the activity is functionally related 

to an exempt purpose (e.g., "substantially related" as delined in the UBlT) or else 

that the activity provides revenues to subsidize other charitable outputs (in effect, 

a retention for exemption purposes of the "destination of income" test). As noted 

below, this approach is completely consistent with taxing commercial revenues 

under the current or an expanded U8IT; the "in lurtherance or' concept relates 

only to exempt status. 

A second suggested reform, therefore, is for either Congress or the IRS to 

lormally reSUlTect the 1964 version of the commensurate in scope doctTine; that 

is, either an amendment to Section 50 t or new regulations or a new Revenue 

Ruling that makes clear that as long as revenues Irom commercial activities are 

being used to conduct a substantial charitable program, the activity will be 

considered "in furtherance of" an excmpt purpose and the organization's tax 

exempt status is not at risk. One possible refinement to the commensurate in 

scope test would be to provide a safe-harbor provision for exactly how much 

subsidy a commercial business must provide to charitable activitics to avoid 

exemption issues. [have previously suggested that one might use the short-term 

or mid-term Applicable Federal Rate as a safe-harbor rate of return filr this 

pUl1Jose - li1f example, if the short-term AFR is 4%, then a charity would know 

that if a commercial activity provided at least a 4% return used to subsidize 

charitable activities, the commensurate-in-scope test would be met automatically, 

and no exemption issues would arise from operating this commercial activity." 

A third reform would be to jettison the relatedness test for the UBlT and 

impose tax on all commercial activities by charities, whether related or not." 

84 Colombo, C()mmenmrate~in-Scope, supra note 8, at 351. 

8~ This proposal is not neV-i. The ide3 of replacing the '-'>Uhstanlially related" test \\'ith a 

'\:ommerciality" test ~Iretche~ back at least to th..: Pi1:kle hearings by the Oversight Subcommittee 

orthl2 Hous.e \Vays and Means Committl:'c in the late- 1980's. Brody, :iUpra note 6:2, at 3:2-34. See 

a/so, James Bennett and Gabriel Rudney, A Commerciali(\" Test to Resolve til(;' Commercial 

Nonprf~tit Issue, 36 TAX NOTF:S 1095 (1987). The proposed rationale for this relonn at the time, 

howcycr, \\as to prevcn! "unfair competition" by nonproJit chanties, which to the smail business. 

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There are several reasons tor this approach. First, the analysis in Part lII.A. 

indicates that while commercial activity in categories 2, 3 and 4 should not atTect 

exemption, such activities (particularly those in category 4) do present some 

signitlcant risks to the corporate tax base, of managerial diversion, and of 

economic inefficiency and excessive self-subsidization. Taxing all commercial 

activities obviously would more completely protect the corporate tax base than 

the current system, since no commercial activity (cven if it is "related") would 

escape taxation. Second, taxing all comnlercial activity would promote economic 

efliciency, because charities could not earn a premium rate of return on a 

particular activity simply by avoiding the income tax that would otherwise be due. 

Under this proposed system, a charity presumably would choose to invest in a 

direct commercial activity only if the after-tax rate of return it could earn would 

be greater than the market rate on a diversified portfolio of investment assetsthat is, the charity would have to make a decision that it could earn a premium 

rate of return by efficient operation of the commercial enterprise, and not just by 

avoiding taxes.'" It is likely, therefore, that ifal1 commercial activity were taxed, 

charities would concentrate on commercial activities for which they enjoy some 

economics of scope with respcct to either capital investments or employees or 

which had some other kind or synergy with their charitahle programs, which in 

turn would also help curb empire-building tendencies and avoid managerial 

diversion issues." Finally, this approach would actually simplify the law - we 

would no longer rely on tortured interpretations of the phrase "substantially 

related" to detern1ine if a commercial activity is taxable or not; and ifall such 

activities arc taxable, the "container" used to conduct them would be irrelevant. 

The fourth potential reform follows ITom the second and third. Ifcommercial 

activity is essentially unlimited provided that it is used by the exempt organization 

as a source of tunding tor charitablc outputs and if all commercial activity is 

community, rcally meant "any competition." A~ noted in the text, several other policy concerns 

present better rationales far taking thi& step. 

so See Hansmann, supra note 76. at 627. Taxmg all commercial adivity also should satisfy Susan 

Rose-Ackerman's concern that the cunent system dl~tarts economic activity by encouraging 

nonprofib to invest more in related than unrelated activity. Susan Rose-Ackerman, [:'nfidr 

Competition and Corporate incom!!. Taxation, 34 Stan. L. Rev. 1017. I 038 (l9K~). RoseAi..'kerman suggested getting rid pj'the UBIT becall~e ofthi~ distortion, but '\uhjecting all 

commcrcial activity to tax should also eliminate this problem. 

Making all commercial activities sub,it!ct to taxation. rather than just "unrelated" activities, 

might also reduce the ability of chmities to "game the system" by allocating costs from charitahle 

and related businesses to "unrelated businesses:' thereby reducing loftcn eliminating) any tax 

liability for unrelated activities. See, Evelyn Brody. Charities in Tax Rej<)tftl: Threats to 

.)'uhsidies Overt and COI'ert, 66 TEN\;. REV. 6R7, 733 (1999): Jost:'ph 1. Cordes & Burton A. 

Weisbrod, DijJerenlial Ta.YClfion (!Fiv'onnprojlt.s and fhe Commerciaiization oj ,\'onpro.f/I Revenues, 

il1 To PROnf'ORNO'j 1'0 PRUFlL supra note 5, at 97-100; Robert J. Yetman, Tax-M01iratcd 

Erpense Allocatiolls by Nonpndit Orxan~ari()ns. 76 ACCT. Rn!. ::!97 (200 I). 

26 
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Colombo - Oversight Commillee Testimonv Juiv 25, 2012 

taxed, then there is no tax reason to distinguish between the activities of different 

pieces or a complex enterprise tor tax exemption purposes. That is, whether a 

specific nonprofit within a related group of organizations meets the "primary 

purpose" test for exemption should be tested based upon the aggregate activities 

ofa complex group, not on an entity-by-entity basis." Either the group as a 

whole would have a "primary" charitable purpose (and operating commercial 

businesses to fund this primary purpose would be perfectly OK under my 

proposals) or it does not. Exemption should follow this group analysis, and not 

rest upon arhitrary distinctions regarding the kind of economic container in which 

specilic activities are carried out. Note, however, that ifthe first and second 

reforms suggested above are adopted. then the IRS should give exempt status 

rather freely: any nonprofit organization that can make a credible claim to a bonafide, substantial charitable purpose should be granted exemption, since all of the 

commercial activities of that organization would be subject to taxation in any 

event. k9 

Finally, the IRS desperately needs to better-define the role of the private 

benefit doctrine in policing exempt organizations, particularly in the realm of 

revenue-generating activities carried on in paltnership with for-prolit 

organizations or private investors. These transactions often are used to expand 

charitable outputs or as revenue-generators for exempt activities, and therefore 

should not automatically be subject to private benefit attack. I have recently 

suggested that private benefit should be used by the IRS to guard against 

transactions in which charities arguably "waste" charitable resources, primarily in 

transactions in which a charity "outsources" core services or enters into long-term 

contracts with for-protit entities than confer a competitive advantage on the forprofi!."O Limiting private bendit in this manner would make cIear that economic 

transactions with for-profit entities that enhance a charity's ability to serve its 

charitable class (a feature of many partnership transactions that the IRS has 

viewed dimly in the past) are not exemption problems. 

The reforms suggested here, however, arc dependent on a final issue: being 

able to distinguish revenue-producing charitable activities from commercial ones. 

Ifa nonprofit theater sells tickets to the public, is the ticket revenue from a 

8.8 Once again. thi::. proposal is not nev,' and harkens back to the Pickle hearings of the late 19S0's. 

The Treasury propo~al at that lime suggested aggregation for 80%I-owncd subsidiaries: sec note 

62, supra. 1 have suggested a far broader test of aggregation based upon the "supporting 

organizlltion" tests in LR.C. § 509(a)(3). Colombo. Commercial Activity, S/fpra note 8, at 565. 

lIl) I do (Jot mean to suggest here that for-pro lit entities in a complex structure would somchovi: be 

converted for tax purposes 10 nonprofit status. RatheLl mean only that any nonprofit 

organizations in a complex structure 'would be tested for it::. "primary purpose" hased upon the 

acti\, [Iics oflhc group as a \vholc, and nOI on their individual activities. 

00 John D. Colombo, In Search qfPrimte BenefiT, 58 Fla. L Rev. 1064, to88-1090 C~006). 

27 
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Colombo - Oversighl Commill"e Teslimony Julv 25. 2012 

"commercial activity'''? How about sales of drinks and food to theater patrons') 

For the answer, we should tum back to the main policy issues surrounding 

commercial activity, including protecting the corporate tax base, managerial 

diversion and economic cftlciency. In particular, it scems that if these arc the 

main problems with charities engaging in commercial activity, then an activity 

should not be labeled '"commercial" unless it is competing with substantially 

similar for-profit goods or services. An activity that would not be conducted in 

the for-profit market is not a worry for the corporate tax base, because no tax 

would be collected on that activity in any event. Nor would such an activity seem 

to be a managerial diversion concem - in lact, it seems that nonprofits should be 

providing exactly those services not part of the for-profit market. Finally, if the 

for-protit market can't or won't produce a particular good or service, then by 

definition there is no marc efficient way to produce it than through the 

government or the nonprotlt sector, and if the government won't do it, that leavcs 

only the nonprofit sector. Thus whether the theater's ticket sales are a 

"commercial activity" or not should depend on whether the theater is producing 

the same kinds of plays as for-protit theaters and hence is competing in the forprofit theater market. Food and drink sales, on the other hand, arc easy to classify 

as "'commercial" since all sorts of for-profit restaurants, vending machine 

companies and so tl1flh are in that same business."1 For cases in the middle, the 

"commercial hue" analysis developed by the courts and the IRS (but 

inappropriately applied to the decision to grant exemption)92 might be a good 

starting point for analyzing whether a particular activity is, in fact, a 

"'cOInmcrcial" one. 

TV. Summary 

As a policy matter, how the law regulates commercial activity by charities 

goes to the very heart of what the charitable sector wi 11 look like in the future. 

'I; orcourse, as with all other legal test:>., there will he inevitable disagreement at the edge!'. ror 

example, are Division 1 college football and bas.ketball "cummercial" under thi~ test? They 

certainly produce substantial revenues for their schools. but whether they compete with 

"suhstantially similar" for-profit good", and <;ervice'l (e.g., professional for-profit sports) is all open 

que:;.tion. The Supreme COl.irt, for example, has suggested in the antitrust context that NCAA 

football does 110t compete with professional football. See N.C.A.A. v. Board of Regents, 468 U.S. 

85.101-102 (1984). Tax law \vm.lid not necc:'.sarily have (0 adopt precedents from antitrust Ja\"\. 

for this purpose. Particularly in light of the policy concerns oCmanagerial div~rsion and e(onomic 

efficiency, one could argue that the test for \vhat is a commercial activity in the tax exemption 

\-vorld should be somewhat broader than \-vhat the euurts may liud to be competing products in the 

amiin/st field. Viewing markct~ and competing good:'. narrm\"ly in antitrust lay.,. genera!!y has the 

efkct of protecting competition, \\'hich is the purpose ofantitfUst law. Drawing similar narrow 

line'; in exemption law doe~ not similarly advance the policy concerns noted ahove "\vith 

commerclal activity by charities. 

0::: See text at notes 4 I -43, supra. 

28 
90 

f 

Chairman BOUSTANY. Mr. Tobin, you have 5 minutes. 


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91 

STATEMENT OF DONALD TOBIN, ASSOCIATE DEAN FOR FACULTY AND THE FRANK E. AND VIRGINIA H. BAZLER DESIGNATED PROFESSOR IN BUSINESS LAW, THE OHIO STATE 

UNIVERSITY MORITZ COLLEGE OF LAW, COLUMBUS, OHIO 

Mr. TOBIN. Thank you, Mr. Chairman. 

Chairman Boustany, Ranking Member Lewis, and Members of 

the Committee, thank you for the invitation to testify today. 

Charities are not just using affiliated entities in the for-profit 

context. They are also affiliating with other tax exempt organizations, mainly social welfare organizations and political organizations. I want to give you just a brief explanation of how these organizations interact. 

Public charities are exempt from tax under 501(c)(3) and donations to the charity are deductible by the donor. Public charities 

are not allowed to intervene in a political campaign and can only 

engage in an insubstantial amount of lobbying. Social welfare organizations are organized under section 501(c)(4) and must be operated exclusively for the promotion of social welfare, according to 

the statute. Although the statute uses the term ‘‘exclusively,’’ 

Treasury regulations allow social welfare organizations to intervene in political campaigns as long as the organizations’ primary 

purpose is social welfare. Amounts spent by organizations on political campaign-related activities are not considered a social welfare 

function. The income of social welfare organizations is tax exempt 

but donations are not tax deductible. 

Then we have political organizations, which are exempt under 

section 527 and are primarily involved in influencing elections. 

Contributions to 527 organizations are not deductible and political 

organizations are required to disclose contributions and expenditures. 

Public charities are allowed to create affiliates in order to engage 

in these different types of activities and the Form 990, Schedule R 

is important in helping the IRS and others understand the various 

activities that tax-exempt organizations are engaged in and their 

various associations. It also helps ensure that the important policy 

goals of each section is honored. 

First, we have the subsidy that is received by public charities because the donors get to deduct their donations and we want to 

make sure that isn’t transferred improperly to a (c)(4) or a 527 political organization. 

Second, there needs to be a continued outlet for constitutionally 

protected speech, and the affiliated entity helps ensure that continued outlet exists. The congressional goal of having disclosure of 

amounts spent on political activity shouldn’t be obfuscated. 

Now when operated correctly, affiliated entities support these 

policy goals. Affiliations between public charities and social welfare 

organizations help cordon off the subsidy to public charities while 

allowing organizations to lobby and engage in other activities with 

non-subsidized dollars. 

So first we want to look at the restrictions that are on public 

charities because they are very important. The restriction on lobbying and political campaigning by 501(c)(3) public charities is essential for maintaining the special role that charities play in our 

National life. Providing public charities with a subsidy to lobby and 


ccoleman on DSK8P6SHH1PROD with HEARING
92 

intervene in political campaigns would put that special status at 

risk. 

The restrictions on lobbying and political intervention for public 

charities ensure that tax deductible donations are not used to promote political campaigns. It requires organizations that wish to engage in lobbying or political activity to be on the same footing as 

other citizens. Absent a ban on such activities, public charities 

could easily be used as a tax-subsidized vehicle for political campaigns. 

Now these affiliated entities can be formed in very different 

ways. You can have a public charity with a social welfare organization, which in turn has a political organization. You can have a social welfare organization with an affiliated public charity and an 

affiliated political organization. And you can have loosely affiliated 

entities who aren’t actually organizationally connected but have an 

affiliation. The key is that the public charity is not allowed to subsidize the activities of the other organizations. We have had problems in this area in how we deal with them. 

The first is that this area is incredibly complicated. The rules on 

affiliated entities are very complex. The second is we have had very 

aggressive assignment of tasks between affiliated entities that may 

be inconsistent with our policy goals. Third, the IRS has limited resources to enforce, and when it does, it is often accused of enforcing 

on political grounds. Finally, the results of investigations by the 

IRS are not made public so it is hard to know what standards are 

being applied. 

I have some suggestions for the future. We could examine the 

possibility of creating a public complaint and resolution process. 

We could consider allowing the results of audits of exempt organizations to be made public. We could streamline the rules regarding 

associated entities to reduce some of these regulatory burdens. And 

we could create disclosure provisions that are consistent, or near 

so, among tax exempt organizations. 

I very much appreciate your invitation for me to be here today, 

and I am happy to answer any questions you might have. 

[The prepared statement of Mr. Tobin follows:] 


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STATI'.MEN" O~ kOfESSOR DONA~I}B, TOUIN 

ASSOCIATE DEAN FOR FACliLTY AN I) fRANK F- ANI) VIRGINIA II. 8AZI,foR 

DESIGNATED PROFESSOR IN BUISNESS u.W 

MOlllrl COI,LF.GE OF I ..... W. TilE 01110 STATE UNIVEkSl'rY 

B!;FORfo 

TilE COMMITIf.E ON WA VS ANI} M!:ANS 

SUBCOMMITTEE ON OIlEIlSIGllT 

l:-;CREASED COMPLEXITY OF PUBLIC CllARITIfS 

Thank yo<> f"" .... itwilatioo to l<$Iify tod>y ...... ,,,,,on5<d «>mpbity of public 

ell",;';" orpnized ondo, §SOI«)(J) .. ~ ... 10"$ to . ffil;"t<! ~.'mpl orpni, ... iom ""'h .. 

~301(.)(.) social .. <If." "'Pniza<ioru and 112l politiu.lorpni .. tiom. ""blio ,I\lrit ... ~ no 

Iool!<f i"" tho loc.1 5Wp ~;"hrn. no,...,. school. .. local ooll<&<. l'IIblic <hotit .... "',~ 

.xpand,," 'hoi' .. 'i,' ..... twAA in .... Unitt<! S", .. and .brood. They "'" ..... "'t '-' 

""",i"ic"od ""ys to pMli<ipa1< ;n tho ""brio Sphere and looked., ,"""i" .... )'. to twAA 

i .............. impact and the .... "n"". To oe«>mplish tho;o .. ,k .. ""bric chari,;" "''''' ,Uff'o«! 

to i""" .. inily compr.. orptiLational >lNdur-n i"" I":\;"1 for-j>f<>f], ..... idiarie>. join' ",,"orcs 

"' jth ror-profi' .n,;'i ... and . ffiliate<l orpniwiom. 

Tho «>mpl .... orpoi''''ional """"",, 110, _ bern limi'<d 10 . ffil"'iom with f .. -profl, 

<n, i,i .. , l'IIblio ,hari," ...... Iso •• "" .. inily """lI «>mplu .".."" ..... " .. with _ .... 

u""'P orpniLatioo, to i"" ....... ho ,ru.;'y'. i""",I"""", in «fIOin polit."I .. ti,";". 

i",ILldinllobb)i"1 and ,ampai", """",,",,y. In addition. ",her ",.cx"mpt orpniza<iom 

in",I,"" in Iobb)i", or compoi", """""""y ott .';"11 <On\pl", _11< ..... " 50 thol they.1II 

maximi ... tho ....... ,.. of!OJ< de.!""tiblo oonttiboJ'iom .. lIiI. "ill'"Pai", in Iobbj'i", "" "' ..... ioo 

"""""ocy. Ss>«ir..olly. 0 public .horil)· may"" .p • tSOI«)(~) """iol "~ f.,, ....... iutioo to 

rn_ in ...... riot<d Iobb)'in$o .00:1 .... "" .. I "'.If .... __ i,,.at;'" may SO< ... 0 O<'gI'OglIt<! 

fUf>d....sa- t127. "hich I""m. politicolorpnizotion~ 10 '"_ in .1«t1on«<inl O<1ivit .... 

Tho . mliatod Of <OtttfOliod .... itid "'ill not """It in lI>o ro.. of""bli< charity ........ long as 

,ho ""blio c"",ity """ not ...... jdi .... i,her """<tafily .. 1Iv-oog. oth<r ')'po< of~ tho 

><><iaJ "'.If .... Ofglll; .. tioo Of i" . (foIiated politicol orpniutioo (or "V'ptod 0CC0Wl'), 

"",,",in, ..... . public <harily doos not .... jdi'" "'hor "''''Pni,-",ions '"'Ioi .. ,. <OfI'oI'lioated 

""pnizo1ional >INd ..... afol t"""'_ .ffon. 

n.... arran,..,...." _ only inc ...... wnpl<.ity fur .... ,",itid i .. <>lv«!. but thoy 01"" 

i ....... compl"'ity in ,ho ",-, code, .. f"""', ..... l.otOoo. and "",,,i.ioo. If< n«< •• ory 10 ....... 

,ut ... .... jd .... ",,,!able to public ,haoit;", .... "'" ."" to sub!.jdi« loI>bying and politic.1 

<.m~i", "'tivity, Today I om i"in~ to di ...... tho c""""' .. >Iri<tiom ""blio ,,,""tid foc" ~ ith 

«pnllO _lin, and inl<fV< .. ioo in politicol compoi"", how _niutiom ... up .mli,1ed 
94 


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"'p"i"" .... '" ~ in It>< """,ibi,<d oc'i,i' .... oM .som< <>fit>< ".,.. ... " 1No, h,,,~ '"<=l"Y 

"';><11 "'i," ,I>< '1In'<fII ...... "'Y ",hem< 1Il<l'l>< inl«ao1ioo b<I"..., ~Iic <twi' .... soo;" 

"oIfan: _ni.,nions. oM "",ilow "'pni",'ion>, 

Public ...... i' ....... o<,...;".u LlI'odo, ,W'(cK)) of'l>< Cod<. !'Ioblic ..... ;, .... irdudini 

.. IiJious <><pniulion>. "'" ..... od !nil« f.vorab'y,...., "' ......... ..,""",P' <><pni .. ' .... , !'lobi" 

, .... iIin OK !he _n...,ion>!ha1 """" poop" id<n'il'jl " , .... ,""p' "'P"iat ..... They 

<d""". "'" ,hild .. ", prornooo imponam pubI" " ...... and I>< ,p .... nt<d)'_ 110< .... ......, 

"'JUI;UI ...... ,'0' ,h .. i ..... JKlflIOO<. C""i""'''' ptm'id<d ..... , "")' .... <x<mpt f""" 

1aXoI .... M .... i"""",",,"Y. """ ......... "nlik. IlII><, "',-ex""'P' <><pni,..,ion>. Coovoss .... """W". lIy ptm'id<d IhoI <1000,,,,,,, 10 public chari, ...... dodUCIib .. by "" donox. From. IU 

P«>P<""i'" ,,'. 'hink of pub'" choril'" . ,,_i.ini' <Ioublc brnofit. Thoil in<omo ;" no< 1U<d, 

oM _""" 10 .... _.;,..,;0." an: dod.."ibl<. 

Sine, (I(ho,. ...... ,<mpt orp"""'ion> "" no< Jrtci •••• "k"y .. ,he: fO<m of .... 

"""""iM, «Wlibulion>. COlI"", bQIh ""''''od .... 0<1 ,.;, ... . public c""nl)' c .. ..,_ in 

oM pu' in ploc .... 'i ......... ptm'i.m. 10 CM"", 1hoI"" ..... r," of1><'o&, pub'io choriry "'or< 

no< >hill<:d 10 Ill"'" <X<mp< orpniUlioo. , A • • condi,'" ofl«.i"in& IIIi. f. ,'Ot>b .. '*" ......... Conwns .. , limirod ,he: .."i. " ... of publ" c ..... ili<> 10.,.,.. ;, .... m. charirabl<. for .. amp", 

tSO'(cKJ) p<OhibilS public ohari,i<> from int"",mini in. campo ii" r", "" 'pi""a <and ..... 

r"" pub'ic offi«. and f""" ..,p~nl in !nil« INon .. i"",klOnti.llfTIO<jn' oflobbyi"1l' 

Con"", .... 100& _~''''' mi' I ...... """"y ",'" lob" 10 "'P"i"" ... , <ngq«i in 

Iobbfinl; and campoi", O<1i.;' ... , Whil< othe, ...... " .... p< orp";".,ion> may '"PlI< in 

Iobbyi"-ll wi,t.Ju,'imi, and >Ubstut,"1 poli'ical oc'i,ilr. «>lllIi"",ion> "'_ "'P"" .. """ .... 

no< d<d""iblc by .... donox, Similorly. in mo>I <0 ..... Conar<» .... prohibir<d buoi .... ""iIi<> 

"".; 

from 

...... 

ded""inllobbyi"l""""" 

"".,. ... , The """" is!ha1 

or 

.11 

pol;,iool 

"",i, ... "'ill1>< 

m~i", 

on 

"""ribul 

a .... , ployin, 

.... .. ordinary 

freld. OrpniUl 

and ~ 

.... 

<on .. _ in _yinl and poli'ica' cam~ii>' O<1i'ilin. "'" IIIoy<o"""" "",i,< 0 "OX oub>i<ly '" 

"" form of .i""" '*" <1«1 .. ,,, ... or "" «c<ip< of .... <I«I.."iblc «Wrib<il ..... 

L In,.",.,,, ... in Pol;,,,,,,1 Com~i"" 

Aht.Ju~ 0 publi< c ..... il)' may no< in'.,. ... '" ~Iilical cam~igns. III,y may '"PlI< '" 

vo«,-«I"' ..... <In'"" di", ... i ....... <d ...... ci,i,..,,, I<>bby "' 0 ..... 11 "'~. orwI in"il< 

candida, .. 10 Speok os Ion,", ,he in,i .. ' .... 0,. iW><d on a """.porti ........... When 

orpni,.,ions enpgo in w<h O<1'.ilies.1h<y nted 10 ... !-Ur< ,hot .... oc,i,';'''' "" no< ,i .. 10 "" 

k:"d of in""""'", irt • ~1i''' ,comp.Oii>', The IRS .... developed a focI> and ci,,"mstara< 1<" '" "''',mi ... ""' ... , on or,...i .. ,ioo's O<1"iIr is in,.,."", ... in , ~li,,,. 1 cam~i,". In 

RO\',n..- Ru" 2001"' ' ..... So .... i<. p""ides on "pl ... , ... of,,,, fOCI> oM "roumlll"''' I<>L 

and """ides .,....,pl<s or .... "I'I"ication of .... " ... 

Willi "'pn! '" d<lrnnirt .. ' .......... ' """'"lIt1i< ............ rrlorod '" is ptohibitod 

in,cr •• nt'" .. . po'"'''' campOi"" ,'" IRS ~-.nu' 
95 


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S«.;". ~OI«)(J) "''"'''''' .... "'"" , ,-ojd ... y io .... odVOQCY tholl\r.c1\om .. 

polil;':,1 <om!'.i", inl«v'nt""'. E_ if. SIIl<'mrn1 don not ... .,....1)·"11 an 

.oJ;'"", 10 ,01< for or "iii"" .""",f", 'ond ...... on "'P'Ii, ..... <lo:li"",ini I .... 

... I<menl i ... ",k o" .. latin, the polilicol c .... p.ip> inl'"~''''' prohibi'''' if 

,hcfe i. any ...... f.rorini\ or oppooini\' cand idal, .. . . All the f""lS.nd 

.il<um'laO<O< nc«IlO b< _.id<m:l1O del....,i ... if the odvo<o<r is poll.io.1 

eunplrip> inte"'m' .... (S<-< IRS FS·2006-17). 

1bc I~S h .. <>pl.i'" , .... ,n OW'>'irr, I .... fo<" and .ircum.lanceS ..... 'ho k.y 

fo<"", the IRS o-\MIi ... , oro "'''''''', the ""emon" I) Klrnlir ... candidate>: 2) •. , ........ """""oJ '" disappn>Yll r",. <0, • .1 ..... '. »0$"""" """-,,,, .."",,,,: J) i, deli"""" C"'" in 

'i ..... to the 01«:'",:.) rnol<o, .. r........,.10 "",in, "' .. ,1«:1"': I) di"in,u,"-

c.ndidal.",., pon;.:uw i ...... : 6) i, port of an ""Ioi"ll5<ries of .ommun;.: ...... by'he 

"'pnizalioo indep<ndeo' of.., ..... ion: 1) is limo<l '" ooiocick ""ilh a "",,-cleclonl .,"" 

.... hI .... hod.1ed ""'" "" 1e".I., ... by. leai'''10< " ''''' is , Iso .. ..-.lidote. In 

.pplyini ,iIe>< f..,IO<>, the IRS .... m. porticularly cono:"""'" 01>00' commun",""'" , ... , i. 

biased. parti,..,. Of .learly de<ign«110 influe"","""" in 11\ elee'"",- and a"",n <O<IIm",,"'''''''' 'h>! is."" in lim<"'" ,lee,,,,,,. 

1bc do..i"",'" l><t"-..n i ..... odvoc .. y and politio. 1 campoilll' inte!"<fIlion i. portioulatly 

imponam in the <OIIte" of .ml"I" ""Ii' .... heal ..... ,he clef,""ion of pol"icol inleo""'ion urwI<, 

1101(.)(l) ,Iso i\U .... the dctmn i",,,ion "'heth<r _ ini i. poli,,,,.1 inte,",nl"'" under both 

1101(.)(4) lOci.1 ,,',If..-. _niZllio .. and §~21 pol i'ic.1 "'1I'"""i.,.... The """""'" <lo:finiliOfl 

,. impomnl 1>« .... 1< iI i. ,he Ser>i«', "'I ul .. _ and in""",llIioos obouI pol"iaol inl"""""'" 

..,,;0, i§ SIII(.)(l).SIII(.)(4)0tI<l 127' .... _""1 here, _ tho r ..... 1 Ele<liOflC"""" ... ion· .. 

Si",. the ~ "" i""!"min, in '" ,I«,ion i, .boolute. publ" .hariti,. inl~ in 

inl"",nin. in <1«lion ... "",i. " with othe, "" ...... pI_oiZll;.,.,;, ...... re lo~'" 10 do so. 

11t;, .....,iIlion .1 .. ", the publ" charil), 10 main .. in ilf "<~'mpl "., .. and ... "" an 01111<110 

.np¥' ;n ,1«,,,,,, odv<!Cocy, 

I'Iobl" 'hlri' ... .,. . Iso . 1"",-00 '0 '"Pi< in ""Iy '" mo......",i.I.....,..,,1 ofloi>b)·i'\K. 

The Cod< p«Iv .... thol "" .. ......,. .. 1 ~ of. publ'" charily" ""iyo;", ""'Y be '\:orryinl "" 

1""!"pnd1, '" """""il< "l<mpIinJ. to influrnct 1e".I.,;.,.,," Once "iii .. !he ide. is to pol the 

iobb)''"1 ",",ilie. of IllI otpI'll.olionJ "" "1 ... 1 fOOl;", and 10 'n!Uf< , .... , ....... ",jdy pto\'i.l" 

10 publ'" cha,ilie! is not used 10 ..midi .. iobb)'inl ""ivilie •. 

I'Iobl" chari' .... "''Cf< cone"""'" tha1 the "no , """.,,, .. 1 part" tcS1 ,,'" '''iU< and left 

,hem "-onderinJ how much Iobb)'ini\ "' ... 1"",'''. C""jIf<$!!.-.sp<>o>d<d 10 'hi< ,ril1<i ... by 

r«"i"ll §SOI(h). "h"h. by refer<ne< "' §4911 .... """iroe doItot """"nlS f", Ioi>b)'ini-

.. I<ul .... "" • ,lid ina".1e 'oos«I "" on _ni,-"ion', .''''''pi pu""", <xpenoJilwn _ ",fermi 

to .. the <>penoJ""", ,<>1. The ""","'urn dollor """"'" ;, >C! ., one million. The publio.1uriIy 

",." ... le , §'OI(1'l) 01«1;"" "" 11 '" opply. "'" one. a publ" ,haril)' "",ke> the <k<lion. it .... 
96 


ccoleman on DSK8P6SHH1PROD with HEARINGInsert offset folio 68 here 80340.068

more <U\oi"'y "goodin, "'h<Ih<r ~, Iobbyinl <>p<ndilW'<$'" ponni" iblt, If,,,,, "'P'ilt'ion 

",«<I. ''''' '''-nIS '" "'" in foI91'. i, wil l be ",bjoc'" , In Of! the '>'«SO ""..,..i,lD'eS. 

TIl< §50I(h) ",."ion ~ no! •• ~iI.blt '~,h""' ..... T"..."" R'gul""", ptm'i.I< f ........ 

gui<bo«. i""'L>din,.",,mpn of _ ~im:' Of>(! gr ... .-. IobbY'in" 

If on "'P'i.uoion "'ioM' '" '.Pi< i. more ,han on in",bs .. ",i,lltTI<J<j", oflobb)ina Of 

more ...... yin' than i, .110" .. ond<r the ........... i, ......... the publi< ,lIIriIy NY'''''' on 

.""";., .. "",;"1 ",.Iflt< Ofpnizo'ion _ISOI«X4) tIW may tnpg< in lotIb)'inl" its 

primory pu..,.,... ConIrib<4ions 10 the ,,,d. I ,...If .... "'Pni,,,,ion ,,-ill "'" be do<I""ibk by "'" 

"")'Or ond ''''' pu\>lio ,harily m"" be ",,,,fol ......... "'" it doe. "'" ;",_,Iy ",t:>sidi" "'" 

,.,d.1 ".If ... "'Pni""i"", 

B. Soo;,,1 W"r.,. Oo-goni ... ions (1501('X4) Orpni ....... ) 

s.c,'" 501«)(4) "'P'izol"",'" "",;"1 "',If.,. ""iI"i .. ,ions Of "vic "' ....... S<n ... 

501 ('X4) II<fi ... ""';", "-.If .... OtP"i>~Oono" "[,[i." "'I[II<S or orpnizalion. "'" orpn;,,«l 

fOr proftt b<4 opcm<d ."I ... i •• 1y for ,he ".".....01;"" of ",,;"1 "'.if",,." AIlIIou~ 1501«)(4) 

provide> "'" an orpoi,.ioon ""'" be ....... ize<l ~'Mi",,'Y f", "......,.ion or_ ... wolf¥<." the 

Tr.aury .. 11"1 ...... """,ill< rOf '""'" H .. ibil;,y Ihao "-"""_ '" pu\Nic ,",",i<>. SpeoiflCally. 

T",&fUIY "8"''' ..... oI!ow",,;" ,,<-If ... .,....."""""., in"""'" in p<>Iilicai cam~ .. """ .. 

the otpni<llion', pri"'"'Y ""i,,,y ;,. "",>01 wcjf_ AI'~ the ." ..... <10 "'" <1<[ ... 

"pi.....,..";' i. '''''''inly .... than the.taMot)' tenn ",,,,,,, •• i ... y_" The "'r'-'ltI""" <10, _....-er. indio ... ,III, in otO<r ., qualify 0, 0 _i., ""f.,. orpni .. ,ion, lhe "'Plliwion mo" b< 

",inu,ily .n;o&<d in prornooinll the ""<ommon iOO<I ond 11<"",,1 ".Ifaro" of'''' commoni'y. 

In delormini", "'h<the, In orpniwion i, ",imatily "'go,.. in ""i. , ".If . ... . IOOIJ"" 511<'" by the orpnilt'ion Of! poli'ic.1 ,ompoii" ",I .... ",,;vil;',.,. "'" """id<r<d . ""i., 

",If ... f..."ion. (So, T ...... R" . 1.501(,X4)-1 ), (F", pu"""" of ..... '"y. I h"" "'" di"' ....... 

i50 '('X') Iabot .... ions. .od 1501('X6) bu,in<Sll ... ~ ..... Similar N"'. "",Ir" _ 

OIPI'iwionl,.od ,,'hil< '""y <In "'PII< in pni i'icol ""i"ily. i, ,IIV>IIO b< ,hoi, ",imary putpI)O<) 

l.oI>I»in&. ho~-..,. ... is """,>doted. _;'1 ".If.,. ""i.i'y. ond 0 _ ;'1 "df ... orpni ... ion 

mar " Pi' in on unlimilod """"'" of iobb)'ini'" Ion." '''' kobbyin& i. ,,11«<110 .. ""'pI purpose. TO>. eJoempl orpnizalim< tho, wish 10 d,,,,,,,, i ......... "' .. , ,ho public.lOOby. Of 

<np&< in other "",,101 "'<If ... furw:tions may orpn;'" " _;'1 ,,'.,f ... orpni"' ..... ond .... y 

then in''''''11< in on .i<c,ion f ... Of ",in" 0 , .......... " Ion, .. sociol """f.,. """In .... ., be 

lhe orpnita'''''''' vrimary funo;:,ion. 

AIIhoo.oih <I>< i_.,r. ",,;'1 "',If." organizolion ;,. In-C~<"'I"- dona'ions to . _", 

~.Ir.,. orpn izotion .,. "'" d<d""iblt by the dona-. In ododilion. ifa ",,101 ".If .... otpnl ... ion 

hos in ... '....... i_. 'M' in ........ "' i""""" is w: .. k dollar for doll .... the ." .. , "'" 

orpnin'ion hos ""n' f"""'10 io .. ", .... in , polili<ol """"",ii'" (S<c §S21(f)). F", .. ampl< .• 

00<;'1 ,,~Ifo .. <><goJ>iwion with $).Il00 in in'~I"""'" I",,,,,,, .od $2.1100 in poli'ic.1 

.. p<od~"", will food $2,000 ofi" in",,,,,,,,", i_ ",bj«l '" w:.,ion. 

A ""i., "df,,, organ i ... ion ..... y ,,,II. 0 «-pam. """golod fornoJ ond<, IS21,., 

"'goP' in poIi'ic. 1 ,amp.i.., ""i.,.i,;". If the _iol ,,-.If .... otpnL,.,ion , .. " ... """goled 

fornoJ. ''''' """go«<l fornoJ i. ,,,,,«<I " • §!21 poli'ic.1 "'pni .. 'ion. oro.I "''''''0'' ,n the 
97 


ccoleman on DSK8P6SHH1PROD with HEARINGInsert offset folio 69 here 80340.069

"i"'l'tod fund .,. ... sub.i«' '" §l21(f). 

Fi .. II)·. 111< .. i • .., """""""'1 i."", ~hc!iI<f rornnIM""" to _ill <If .... 

_ni, .. ,,,,,,, OJ< >Ubje<t to "II we. Tho Cod< ,,,, ... I~ does "'" O-'<mpt "",h OfJlI'iT ......... f_ 

&ift ,." •• ,.. IRS ~idanc. ,1o"1y ioolic.o' .. tIw ton'"""''''''' .. _ill "'.If .... _nOut ..... .,. 

.. b.i«' '''&ift '0:< . Th< IRS re«n~y i,..i<.t<d. ho~ ,,·..-.lNo it i. ~"',,·i"i""' ..... fo< 

O<Idi,,,,,,,lruid,,,,,, in thi. orca. on< tho, it " 'ill not ...... ""o,.tWO .. _ ",,"i .. , ..... on th;, '''0<" ~hile it i. ""i<~'inl ~; ~idonc<. 

Thus. • pob ti< '~i'y , .... "i>lles .. "Pi< in ,uMtanti>.llobb)·i", .. ti.i,"" ,an ,rn'. 

on .ffili>.tod _ill wolf.,. "' ... i"'''''''o."..~ in Iobbyin, on< .... 0 li",it<d """"'" of 

poli'ical campai", O(I"" .. y. Tho tot.t.y;"-II ond 'ampo.i(pl ... i.~y <>ft!>< _i., ~~If.,. 

OfJlI'ilO1ion "ill "'" i~t t!>< "'idilyof"'" publ" ,hority .. ion, .. 1iI< publi< <tIori'y does 

"'" "*"idi,,, III< poli,,,,.1 octi.it;.. oft!>< _i>.1 ,,·.If_ OfJlI'ilO1ion. If tho publ" _ily 

"Mid"". "'" Iobb)'inf; "'ti.it)' "f'lI<- _ill ",'elf ... <><gani""ion. tho .""""" <>f'1I<- _idy ,,'il l II<- ooun,od"Iobb)'inl by tho publi< clw"ity. 

s..:,,,,,, sn J'I'Ovide< '",<'<cmpl ...... fOf poli'''., _ni, .. ,ion< tIw ha,~ OS ,hei, 

primary 1"''1''''< inn....,.,,"-11.,...ion<, PoH,"., <><ganilO1ion< on: ... mpt fro", ~ on .... i, 

""<X<mpr ("""ion in<:Oll\O." "k,," .. <lefi..o .. ton,,; ... .,..., membc«hip d .... and procffll. 

from poli,,,.1 fund",i,""" They _. ""~<to .. bj<<t '" , .. "" in ........... i""""" or on_, 

in<Om< thOl i. not ...... pr f"""ion income. Contril>odion< .. poI;'''. ' orpni,"'ionI ...., oj"" 

.... ..,..;I~ .. cmpl from ,he ,ift .... 

In 2()(l(), .. part of Publi< UW 106-2.10, c..w= &In<<Wl<<l jl27 and oddod di","""'" 

...,.i.,,,, •• Il. to ISH. U.",... .he di",los ... provi'ion< in §l27. most po"''''. 1 ", ... i, .. , ..... OJ< 

no'" ...,.m ,,, d",,1oso "'" """""" of ,.,,,,,i""''''''' in •• CCS> <>fSlOO.,.. III< orpo;, .. ,;.,...· • 

•• rend;'u,." in ...... <>f$SOO. If. poIiti<oJ "'pni,OIion f.i l, .. di","" iI< <Oft"ibution< '" 

<>p<,..i'''''' .. ...... ,•• !i",1oocd omoun' ;.subjec'" ~ >!,h< hiJh<sl """i .. 1 rat •• 1,., 

di",losu", p",.i,ion. ,,= only oddod 10 Il2]. ond _t<.«mpr "'pni"'ions, indadin, _i.1 

.If.,. ...... i ... ions, Of< not ,,,,,,,mly oubj«' '" di",.,...... th_gto th< , .. <ode. (The)' m. y be 

wb.i«1to di",Ios=!'I>da- <I«,ion I.w). 

Prior to tho .m<.-.l""'"" .. il27. ,he mojo< ,,, <qulalO<)' diff<r<n<~ ""'''' .... ,h< , . .m.. tax .... mpr OfJlI'ilO1ion< t_. ,han lSOI«)(J) OfJlI' izat ..... ) ...... 'h< purp<I$< of'h< 

"',""",'ion. Tho .. "'"' "try linle 0(1 • ..,,, .... "'i", """ .... i1)" """ ...,.,." .. , '~~i<'" r", 

pol i' '''' ,,'i.it)' 00 .mity planninl or ,n'i'y monipula,ion boS<d on ... ,omidoro,"'" "'"' 

. 1""", "",,<,<i",n'. In f .. ~ prior to 2001. "' ... i'~'_ olkn pr<f<TRd .. bt poJi,kol 

orpn '~'''''' ""he, 1hon lO<ill w.lr ... on« 1>« .... no di",,,,,",,, ,, , """u iml and tho JOn ... 

<",,,,,,,ion ,,~, .~pl";' . Th< IRS', "-, ... ), .... r,i<ndly ruli"1P """"'Iy <Io:fi!>«l "''''pI function 

il'lCOm<. ,hus .,,,,,,,.,,,, or ... i,.,,,,,,, .. OfJlI'iT. "' poIi''''1 or..,.i"" ...... 

U.",... .. i"io, 1a",.I>0,,~'<l'. OfJlI'izot ..... ,hat do "'" "", .. d;"'Ios< «><>1,ibul""' . ,.. 

.. .,.oolit".... h>'~ ." i""""iv< to try to q .. lify .. onotM. ')'p< of' ..... ""'pr "....;,..ion. Thi. 

inc.-.u<s CO<npl<>i'y in "", "'0)$, Fi .... ;, «>COU!"iJ<' "'gi'''''1< "....ilO1;"" to ~if"",ol< thoi, 
98 


ccoleman on DSK8P6SHH1PROD with HEARINGInsert offset folio 70 here 80340.070

......... ______ .. I ... If ..... poI~icaI""'-_I""""'<' iSGI{<)(~J 

.......... pcpMd~)_ ........ ......,.,of ....... ;.ioy .. -"'""' .... _ .... "Ir.. ............ _ ... -.ycma. ........... _ ...... _ioiSl1 ..................... 0<IId 

.... juM .....,uaI .. pOIioiW OfJIII'I',. ........ _ oflllril ..... ~its _Id quo!'l'y .. ....... --..... __ 'n1_ 

Mort ~i<" ..... r..;, ...... 1oy ... "'nJdiol: ......... """',."""""1)- WI 1121 • 

....... 1 ... ..-p1I''''''''' ..... l>«fI ... ~'nJ '" .. oid ~127 ... , .... ond III ... ""id dii<Io<...,.1oy 

.1.1 .. 1"' .......... "", .. I .I' ... <><pII, ........ 1,.pp<at"II tho, ..,.". m,i,in"", "'*",'" ,hal 

<heif """"""'"' ...... I, "'" ......... .." .... WI. poi""",1 campo' ... bill m>ICOd , ..... od.-oc .. y. 

bi<~ !hey d .... io ....... 1 .. ~If ... I\n:,-. The problem ;, "'"' WI "'"""" lIIis W<t11on. ..... .,.........iono _10 Itc .............. , ... low ... r,..;,.,., roo- uptftI od ...... y ... hi<~ is 

..... , .. Iy AIricl """ ........... n..pn.d Ioy...,..-.. '" mfII"" _1)'1'< ., _ o(..,.ion. 

lilo_b" .. _ ........ " I ....... <fII ...... poI~iooI ....... roo-_orla>.~,..".. 

_ .. ......,"".lOcuond.ft-... ....... ...,.. ___ ......... TheIOcu ... 

e......-.... is.brI)· __ .............. _ ... r ........ __ 

_ ;,-., ... ""' ............. od_,buI ............. "' .. n_ ........... ., • ....,idoI< fur public oIT~. 

In "'""y ...... <he ....... , ........ Io'm", '" be _ .. I ... If ... <><pII"",,,,. "'" bcn« 

... ,1«1 II polo"",1 IlfiOI',LaI""", ond ~ .. Id ho,,, ,~. y IlfiOI'lmi .. poll,.,0.1 O<p"iat"" 

oboc<t< ..... di,do' .... _ioions. S"'" ..... pub!i< ...,.. ""' ho,' • ..., ... '" <he n ........ 1 t«Otd, 

0(_ ................ it io ",-,111<'" lell ir!heyreoJly ......... ddlnit ... o(.ooc .. I.,.lf .... 

...... ilOIioft. (If"" pitrtoty pwpooc of ................. io _iII .... lf .... ,.".,...... '0 _I.,,~~ Thclock",ioo(_e ......... ,r~"' __ for .... 

IllS, ........ _""I~ihood ..... -... .;",,,' ....... ilhrqanllO'" """_", _ ......... _.._ .......... _,plio_bciott...,.,..,...,· 

11ooo~. 1121 __ 10 .......................... ..,.""'_ ............. _ .. 

~'-Y tqim< ~ If 1'21 _ ........ _~ ............ 01""" coo"',W>id .... 

di ... o ..... I'fO\";,.;",.,. .i ...... loy"'" Olitta II "'l] .,......w. ...... Ioy ~. dolT .......... • 

e ................. ", _PI .... <><pII,,"'.,... .. _ .... 1)1" of orpn,aI"" "'_ by ....... , ... . 

A •• ,....~ ...... if on <><pIli .. , .... 1 ...... ~ i, . 00< .. 1 w.lf .... "'pni .. 'ion. i'i"I""'1IIII)" 

purpoM I, in",,'."' ... in. politi<ll compoi." " io ..,bj<c' 10 .... d .. <lD ..... pro.i.ions .. i121. 

O. Tho PoIitical.nI<fVftII;"" 800 """ Lobb)" R ... "";",, ... C-~ ... .",.. 

no. s..,..... c...... ......................... ,ioy", .... Io>bbriooI-.n;"".........., .. ISGI(c)(lj .. Rtt- •. T __ .. /M"."..._ofJY ......... fnt·.n -l6. US,..... 

(19aJ). Spoc,focdy ..... c... ~ .... C~coo .............. .-IIy""'S;O;" .... ....... o(tSGI«)(J)_ ... orpn;..,;.,.,· ... il ........ "'I«qMI ............ _ ..,. .... .,. pooocococd _ .... f-.... A..-- 7lfII: __ ............... ""' ....... 

ISGI«)(J) -... ...... """"" .......... ', ..... "l.nowlo<!pI "'"' • _ «II1II"""" Dfill 

", .. ·itits ,,,.1I1d «>ftSisI 0( .... mpoin, '" .. nllm« .. ,i .... """ "'" orpod ,ltcloltlt) ... '""""' ... 

• 10 .. ,«1 ii, firot Am<nd ...... riJht>, , .... C ..... ,.j«I«ITWR·.d"m .... 1Ic1d ,.,. TWR ~u 

... kitta -jll" .... riih' '" Ioloby. "'" ~ ... 1", ""~i"i' ..... idy .. ,1\0 ........ of, .. """'filS for 

• 
99 


ccoleman on DSK8P6SHH1PROD with HEARINGInsert offset folio 71 here 80340.071

",Iobbyi"ll o<,i,;'in, Tho: Court "",....:I that 1bfoth III .,om",""" and "",-deductibility .... 

f""" of ",bsOcly ,I"., i, O<ImlnillCml ,Iwoo", ,he tax <y<I<m." Th< e""" «<0",;"'" ,hat e"" ...... II><! the nJh' I(> .. fuoo I(> ...... y for Iobbyin, _ or""l>ic ...,.. .... -

In "'>chin, its doci,ion. the e",,~ _>milO nnd i, "<1)' imp>rl&n' that TWR II><! on ,It<mati .. ,,",lot 'o ... ",i .. i, Fi", ... _ ...... , ~iht., In f>c~J""io:c lJIidmun in h;' 

""""urn", "!Iinion foond an .Itcmati •• "",1<1 fot the "'I""" ... ion 10 <fIlIItg< in Iobbylni to be: 

«ScfIti.l. (So< 1WR.461 U,s. .. SS2·SS4). Sj>«.r",.lIy. the Coun .-d ,two, TWR'. oti"nal 

SIno<t= """"i"i", of,,,,, 0<pan0' orpnizat"""." public <""~'y "'at ~ ..... in)y invol"" in 

«I"" .. ional .. ,i,nic:. and • """ill "df ... O<pIIi, .. ,ion that " ... ",vol,'''' in inn ",""i", .1o<IO>ns--.,""" .... TWIt. to lobby. Unde, "'ill JWc ..... , ,he ""blic <lIIti,y "<101d .... ,i,. ",. dod"'I'." <100\0,;00. "hi .. the """iol .,<If ... otpniution W<>\IkI 0>01. 

1". <Otl>Ii''''ional "'I)~i, in llI'R 'imilotly ..,.,Iin '0 the pol i'icol u",!>'i .. bon 

""",ilIion in §5(lI«)(J)_ .... thee"""_i«<! in TWR,onotpnization """,,,,,,itle<!l0 

prcf.muia] III ............ .,.j Co<\gr< .. <on oondi'm ... <>.emp< """' und<t i5(l1«)(J) "" "" 

otpnizot""" willin ..... ., nwfl the reJIII>toty reqoi~",. of'he ... , .... Sec,ion SOl (0)(3) 

...... i. not Ofiib" Th< poIi'icol caml"i .. "'" ., _"i,",;""'1 bccau .. j." .. in TWR •• pu.'ic: 

,two,ity """ '''''''< ,_ill ,,-.If .... amli.1< tho, oon "Pi< in 1obby;'1 and the """,01 ... If ... 

orp.n;"",;.,., ,on , ... '" • s<w<p,«I ""count under flU to <npi< Ut poIi,ic.l ... i,;,y. Thu ..... 

• ,,,,,,,,,,,,,. of . rr,ho,«I otpnl .. ,ion. in ,he .. ,<''''''''' ronl<,,' may II< ~' 10 moinl.o;n ,he 

<Of\!otitutiotulity oflll< <"""" "''"lOt)' bAns "" Iobb},in,.,.j poli'ical inl<"'<t1'ion. 

In Ioildnion. ~ i. import>nt to ~;.. that i ........ .cxemp< oonl<x' th< ~ I 

ha .. d;", • ....:1 •• Iobbyi,.. ""Ii'icol caml"i .. !>on. and di"'\osun: •• ore"" """",leI< 

po-oItibi'i_ "" ,be: ",,;.i,y;" qoeotion, They .... -.M:t;.,." " 'ithi. th< "'JIIIItIOfy l<lIi .... and 

"" 0>0« .. boa,ketin, """,i<ion' fOf dilT<rmt o<'i,i' .... n-.n. ,lIItlto.1< "",i,i,i« or< pIac<>d in 

.... §SOI{<)(3).....,<I. so<ili ~~If"", .,.j Iobbyin, in the ~SOI«)(4) b-ask<1. ond ""li,,,,.1 in the 

fS27....., ... Th< ~""" th"' ".,......010 ptVIC<' ,fie ('" and "'" ""i,i,;'" to "'"., "'I<,~nt 

t.om.. Th< """,i.;"'" do not ope"'." an 01>$010'" bot to ,he ",,'i'ity. 

The: ",,,rict ..... in iSOI«)(l) on Io!!toyin,"'" poli' ic" <In\~illt' .. ,;.i,ies "" «ScfItill 

(Of mointoini~ the >p«i.1 role public <hatities ploy in our ""tionallif<. I"ublic ,harities ........ 

.. filii", . >p«ill n«d in our """i<1y: fle lpin, f«<l the hunl1)". oO"""UtI_<~ild"", 

"I"ooin, __ ,u"""" ~no~ le<!i<, ond I!<fl<'IlIy promotjn, _ .... , "'011«1"," T"" policies """ f._ '''''oo organ.,., ..... and (""he, roo"" ..... them ore i< ..... lIy ...... posi, i"" and do 

not app<at honnful to "'" d<""",,,,,ic ,)'",," of iO"<fIW1«. II .. pro.icli"1I public <lIItilies wn~ 

o ...... icly ., k>bby..,., i.' .... , ..... i. polil ical <In\po;i''' honn. both ""blic ,harities Ut """,rol 

and "'" d<""",,.,ic: pt'>CC'S_ 

Fif>~ .1Io..'in, public dwi'in '0 in'<fVO" In pol;'ical '11m".;"" .,.j to en",&< i •• 

sulnton,ill .moun' of lobbying "'iII <h""" th< elw'oo<,,," of, ..... O<pni''''iono. Th<y iII "" 

long« be ol,,,,;<oic. <two,; ... I<. and «I"".,iotul 'H" """,,iution .. 1"1Ind, they "'ill be: """' .. 

, ... ila.-IO oth« pol;,ic" O<pni,.,ion. and any i""ir" .. lon fOf f"'oml "" "",u' ~ ill dioapp<or. 
100 


ccoleman on DSK8P6SHH1PROD with HEARINGInsert offset folio 72 here 80340.072

Sooond, iii< fO<1 tha, 'hoo< orpnizaoions Of< ",!,,<I«I .... ore ofl<n <ngo.&«l in O<1i,";" 

<k>igned 10 promo!< lO<i<o.ol "'<II-11<in8 ~ .. liI<m parlic"llfl~ .If«li .. in manipo",j", tho>< 

~rod<pmd upon ,hom, Th~ i.nue..:c .... dc;><nd<n« bY""",,~ .. poli'ic. l in'.". ..... "'" 

ond ' i!!>'if"'''''' k>bbyinl by public , ... ilito parlic"iorly ina"""""",'c. 

Tho ,..."ic,ions on 1oI>I»'ina ond poli'icol int.,,',",ion ....... '" thao .... -<I<d""'ib1< 

_'ion<, ~hich OJ <II< S"pr<m< C"",,- I'«"",i«<l ....... ",Ol1o. f..,.. iii< p"bl1o r.s.:. Of< "'" 

"1«110 prornot. polilic.1 bolier., I, "'I"i ..... orpni .. 'ions thai " 'i'" 10 •• pgt' i. """",i"i Of 

po",k., ..,ti • .,,.. 10 bo 011 ,I>< >am< foxin, .. 0Ih<r <i,i""" 

I. OiI<li,ion, ~e ho,e _n • , .. m<ndooo.mount of .ml,)' ....,ipol .. ion with .. ptd 10 ... · 

"e""" ",¥""iZ01ion,' in",I ... ...." in poIiliuI <OII'IfIOi", "",ivili<>, There i, .tr.ody , i""foun' 

risk that .... dcd""ibl< -.ions 0« boina U>«l ... ...... of _in, poli'ic.1 campoi", 

.'i,;'y. Aborn" No "" ...,h .."ivi,ico. public <hori,i<. oould .. ,ily bo U>«l ... .... ",b,;diHO 

,chick fo< poIi,k.1 <''''J'I'i_ .... poblic <hori1ies oould rtploa: "",i, 1 ,,<Ir. re orpniZ01lon . .. 

iii< <oml"ign ...,hi<k of <hoi« f", """,PO"""'" _, 

A. p",,,,,,,ly di",",>«I. public <har;,i<, .... lIo",ed to .mlia'" with 0Ih<r ... ~ .. """ 

<n,i,"'. In "''''' cases. ,II< public du,rily is iii< '1<od" _"i",'ion ond in o<hcn iii< publk 

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101 


ccoleman on DSK8P6SHH1PROD with HEARINGInsert offset folio 73 here 80340.073

Otpni",,;.,... -.I .ml;"'" poli,.,.1 "'iOIIil>1ioon is 10 orpnilo" ith . p&r<fII""d.1 ... oIf.,. 

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102 

f 

Chairman BOUSTANY. I want to thank all of you for really excellent testimony, both written and oral. We really appreciate what 

you have brought to the committee. 

Right now I want to start by looking at these complex interactions between UBIT rules, complex organizational structures, 

and reporting requirements. It is my understanding that passive 

income, such as royalties and interest, is exempted from UBIT. 

So I would like to ask Ms. Borenstein, Mr. Hyatt, Professor 

Colombo several questions about what appears to be a relatively 

simple issue, but clearly is not. 


ccoleman on DSK8P6SHH1PROD with HEARINGInsert offset folio 74 here 80340.074
103 

First, Mr. Hyatt, this Committee has been told that often such 

income is generated in subsidiary organizations instead of the parent organization to protect the exempt status of the parent. Oftentimes, joint ventures are formed. So explain how this type of income can arise for a public charity. 

Mr. HYATT. Certainly, Mr. Chairman. Obviously, the fundamental purpose of a charitable organization is tax exempt. That 

doesn’t mean that it can’t entertain or carry on some level of commercial activity. When it does so, the unrelated business income 

rules apply. And back in the fifties when Congress first looked at 

this the idea was to have a level playing field. So if you have some 

level of unrelated activity, perhaps you run a hotel to help families 

that are visiting your hospital or your campus, for example, there 

may be a legitimate reason to run that business enterprise as a 

part of your charity. But if you are starting to operate it in a commercial fashion and one that looks to the layman like something 

a for-profit concern would operate, you can do that as long as you 

pay taxes on that income. 

At some point, however, there is a line that you cross. It is, as 

has been discussed by the panel, a facts and circumstances line. It 

is not a bright line test. But at some point that line is crossed 

where it becomes too commercial in nature. And if you were to continue it and if it represents what the law calls a substantial nonexempt purpose, you could lose your tax exempt status. That would 

then cause the organization to say the best way to protect our exemption and continue to carry on this activity is to spin it off into 

a separate corporation, a taxable subsidiary, for example, that we 

would control, and that taxable subsidiary might generate interest, 

royalties, annuities, et cetera, up to the parent as passive income. 

Chairman BOUSTANY. Thank you. 

Mr. Colombo, you went at great length in your written testimony, 

which I read, about these regulations and some of the conflicts, the 

definitional issues that have come up. Clearly, I think we are going 

to have to work to provide more clarity there. I know passive income is generally exempt from taxation under UBIT rules. Just 

briefly, why does this exception for passive income exist? 

Mr. COLOMBO. Well, I think that the answer to that has always 

been that passive income was consistent with the notion of charitable expenditures and funding charities. You would get money in, 

if you needed it you would spend it. If you didn’t need it, you would 

invest it in a diversified portfolio and put it in the bank and then 

you would use your earnings off of that. Endowments have always 

been a feature of the charitable sector. And I think we have always 

viewed the notion of passive investing as being particularly consistent with charitable expenditures and charitable operations in a 

way that we have not viewed the direct operation of a commercial 

enterprise as being necessarily consistent. 

Chairman BOUSTANY. Thank you. 

Ms. Borenstein, if a public charity does have passive income and 

it is generated through a subsidiary or involves a related party 

transaction, how is that income reported on the new Form 990? 

Ms. BORENSTEIN. Well, one of the points to make is that excess capacity is what generates passive income. We have excess 

cash or extra office space, our budget is under stress a little bit and 


ccoleman on DSK8P6SHH1PROD with HEARING
104 

now we want to rent out some offices at the end of the hallway to 

other entities. If we turn our building for liability purposes over to 

a for-profit corporation or another nonprofit corporation, that we 

have control over it, we are going to report that other entity as a 

related organization. And because of the 512(b)(13) rules—which I 

am sure everyone loves the complexity of that number even having 

to be cited—it is a loophole closer in the Code that requires payments of these types of passive, otherwise not subject to UBIT 

streams to be reached by UBIT, and thus so rents from real property paid by a controlled organization have to be reported on the 

990. This was an addition from the Pension Protection Act of 2006 

requiring such receipts to be reported on the 990. And so now the 

Schedule R not only gives detail of who are my related organizations but requires me to denote dollar amounts of all transactions 

that have passive streams from my related organizations that I 

control, as well as denote any other transactions, once they are 

large enough, by type and potentially amount. 

Chairman BOUSTANY. Thank you. Professor Colombo, in your 

written testimony as well as oral testimony you discuss 

commerciality, the commerciality doctrine. Commercial activities of 

public charities and tax exempt organizations in general have been 

an issue raised by Members of this Committee several times over 

the past year-and-a-half. And as you note, the policy question is 

how much if any commercial activity may a charity undertake 

without impairing its exempt status. 

Could you elaborate? The regulation seems very, very confusing. 

We need more guidance on this. 

Mr. COLOMBO. Well, it is very confusing and I think that is 

why we need to have a policy discussion about where we want 

charities to go with respect to commercial activities. I am actually 

not opposed to charities being involved in commercial activities. I 

would probably do so in a manner that, first of all, I would tax all 

commercial activities. I would probably get rid of the related versus 

unrelated distinction. 

And second, I think maybe the more important piece would be 

that I would make sure that charities have to demonstrate to us 

that the commercial activity is enhancing their charitable outputs; 

that that is better for them in some way than simply investing in 

a diversified portfolio. If it is not, if they can’t show that, then my 

response to them would be: Well, then why are you doing this? Go 

invest your money in a diversified portfolio and use the earnings 

to do your charitable activities. 

So I do believe the law is very, very difficult in this particular 

area and that I think there is an underlying policy question that 

I think Congress should engage. 

Chairman BOUSTANY. Well, I think Ms. Borenstein raised this 

issue of excess capacity and more efficient use of resources. I think 

in your testimony you talked about empire building, on the opposite side of the scale. If all commercial activity were taxed and we 

got rid of this distinction, would that ease the compliance burden 

for the IRS? 

Mr. COLOMBO. Well, I think it would ease the burden in the 

sense that they would not be required to deal with this very difficult, as Mr. Miller pointed out, very difficult test of related versus 


ccoleman on DSK8P6SHH1PROD with HEARING
105 

unrelated. Now pieces of the compliance, however, are not going to 

go away. The issue of how you allocate expenditures, particularly 

how you allocate overhead and that kind of thing, are always going 

to be with us, no matter what, when you have a differentiation between charitable activities on one side and taxable activities on the 

other. But it certainly would get us out of the business of scratching our heads and figuring out whether selling rock CDs is related 

or unrelated. 

Chairman BOUSTANY. I see. Of course, you went at great 

length in analyzing commercial activities by charities and showing 

it is not a really easy task. And to make sense out of the area, in 

your written testimony you talked about five categories. And the 

first categories were commercial activity by a charity is also a primary exempt activity. A prime example of this type of charity is 

a nonprofit hospital, for instance. 

Explain in more detail this particular category of commercial activity and how it applies to nonprofit hospitals. 

Mr. COLOMBO. Well, the question in my category 1, there are 

certain charities which I would say do nothing except conduct a 

commercial activity. I think the publishing cases are another example, where you have a religious publisher for example. The question 

right now is: Does that commercial activity further a charitable 

purpose? Well, in some cases, we have said so, right? So in the case 

of nonprofit hospitals, they sell services for a fee. There is not any 

question that that is what they do. But we have said that under 

certain ancillary rules and circumstances that that in effect will be 

a charitable activity. 

We have had a lot of litigation over religious publishers. And so 

my sense of that one is we need to figure out what that policy rule 

is and apply it consistently across all sectors of our charitable operation. I am not sure why you wouldn’t say publishing religious text 

is as much furthering a religious purpose as selling hospital services is furthering a health care purpose. 

Chairman BOUSTANY. Thank you. 

Finally, Mr. Hyatt, the last thing I would like you to do for us 

is if you would be so kind as to come up and use this white board 

we have set up to draw what I will call a simple complex structure 

for public charity and briefly explain the different elements. 

Mr. HYATT. I would be happy to, Mr. Chairman, if the committee will indulge me in any lack of artistic ability I might have 

in doing so. 

Chairman BOUSTANY. We won’t criticize your artistic ability. 

Mr. HYATT. Simple. A hospital, a college or university. Not unusual still today to find a single hospital operating corporation running the full enterprises of a hospital or university. However, I expect if you were to look at the internal organizational chart of that 

organization, you would see the Rube Goldberg scheme. There are 

a lot of far-flung enterprises, services being provided, primarily 

charitable, some taxable, that they pay unrelated business income 

tax on, but it is certainly possible to run it through a single operating corporation. 

If you wanted to have a multi-corporate system for some of the 

reasons I mentioned in my statement to deal with competing reimbursement and regulatory schemes, to improve the governance by 


ccoleman on DSK8P6SHH1PROD with HEARING
106 

division of labor, by helping others get into the mix, to really focus 

on the knitting of particular activities, or perhaps to put out, as I 

mentioned a moment ago, a commercial activity that might threaten your exemption if it really took off, you might very well look at 

this type of corporation structure. 

Externally, this is a pretty common structure for large institutional public charities today. So what would this box become then 

in that complex structure? This would now be what is commonly 

called a parent holding corporation or a parent entity. You would 

see this primarily in health care systems, less so in private universities. You would see it in public universities, where there is a flagship overseer and then the individual colleges and campuses. But 

commonly a parent corporation has its own board of trustees, it is 

a 501(c)(3) public charity as well, and its job is to do the strategic 

thinking here. If each of these boards focuses on their own activities, someone has got to see what do we do in concert. Are we all 

pulling in one direction. That is what this board would commonly 

do. 

So, again, this is a public charity, the parent corporation. This 

public charity here might be the primary organization in the system. It is a hospital, it is a college campus, it is school of medicine 

or a school of law. It is a separately contained organization that 

carries on that primary activity. You might have a separate or distinct activity here that is also a public charity focusing on a distinct activity. If you are a hospital system, this might be a home 

health agency or a cancer treatment center or laboratory. If you are 

a college or university, this might be an alumni association. It 

might be an investment management company to manage your endowment to grow revenues and funds for decreasing the cost of tuition and improving faculty, et cetera. 

This might be yet another public charity or it might be a taxable 

corporation. It might be a credit union for your employees, for example. Or, it may be some new technology that you are developing 

that you want to be able to license and use the revenues to support 

your mission. It may or may not be a public charity or a taxable 

enterprise. 

If you are a hospital system over here, this, again, would typically still be a public charity. It could be a physician group that you 

now employ. It has now become quite common. The pendulum has 

come all the way back for hospital systems to employ doctors directly to provide services. So now increasingly the IRS is seeing, 

again, applications for tax exempt status by physician groups, 

whereas they used to be solo practitioners and private practitioners 

in that area. 

Then you might also see joint ventures between for-profit entities, public charities through a joint venture entity. The limited liability corporation, or LLC, is probably the most common vehicle 

for joint ventures today. It could still be a taxable corporation. It 

could even be another tax exempt organization. But commonly you 

are doing that for one of three reasons. You are trying to get access 

to capital that you wouldn’t otherwise be able to obtain. You are 

trying to get access to expertise. That for-profit enterprise knows 

a lot about this business. You need to get them to help you manage 

that so you can do it more effectively. Or, you are trying to get acVerDate Mar 15 2010 23:57 May 10, 2013 Jkt 080340 PO 00000 Frm 00110 Fmt 6633 Sfmt 6602 I:\WAYS\OUT\80340.XXX GPO1 PsN: 80340

ccoleman on DSK8P6SHH1PROD with HEARING
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cess to a neighborhood, an area market where it is difficult because 

of barriers to entry economically to get in, logistically to get in, so 

you get the help of others to run that joint venture. 

So as you can imagine, this is the basic form of complex. There 

can certainly be a lot more boxes under it. The key there—and I 

think this is where the Service has done a good job and can continue to do a good job—is transparency. And keep in mind that the 

Form 990 is a public record document. And the IRS, while it is the 

regulator, is but one constituency for that document. Because it is 

public record, you can see it online on guidestar.org, look at these 

990s of organizations. You want to make sure that regulators, donors, funders, staffs, patients, Members of Congress understand 

what each of these boxes are and it is very clearly reported and 

transparent. And I think that is where we can continue to see 

progress in that direction. 

Chairman BOUSTANY. Thank you very much, Mr. Hyatt. That 

is a very helpful description to get the committee focused on some 

of the complexities of these organizations. 

With that, I am happy to yield to the ranking member, Mr. 

Lewis. 

Mr. LEWIS. Thank you very much, Mr. Chairman. 

I want to thank each of you for being here, for your testimony. 

Thank you so much. 

Professor Tobin, since you have been so quiet and you haven’t 

had an opportunity to respond, is there anything that you want to 

say, to just get it off your chest? You have been waiting so patiently. 

Mr. TOBIN. I think on UBIT and associated entities my colleagues have done quite well. So I am happy to answer your questions regarding the tax exempt entities and the way that they affiliate. 

Mr. LEWIS. Professor Tobin, Schedule R of the new Form 990 

asks for information about organizations related to a public charity. 

This includes for-profit subsidiaries and affiliated tax exempt organizations. Why is this information so important and so necessary 

for the IRS and the public to know? 

Mr. TOBIN. So in the tax exempt situation it is very, very important, and that is because the public charities get a significant subsidy from the public. Donations to public charities are deductible 

by donors. And we see these organizations as special, as ones that 

serve some type of government function. When they affiliate with 

other organizations there is a serious risk that that subsidy that 

we provide to them gets pushed off to those other affiliates. And 

what we really want to make sure of is that public charities are 

doing public charity work and that these other organizations are 

doing what they are designed to do. So if they are lobbying, if they 

are engaged in political campaigns, we want to make sure that is 

not being done by the public charity. It is separated off. And the 

Form 990, without it, it is very hard to figure out who the different 

affiliated organizations are and what role they are playing. 

So the Form 990, Schedule R serves a very important public 

function of letting us know who those organizations are and what 

they are doing. 


ccoleman on DSK8P6SHH1PROD with HEARING
108 

Mr. LEWIS. Could you really elaborate and make it simple and 

plain to this Member? Are there activities that an affiliated tax-exempt organization may engage in that a public charity may not? 

Mr. TOBIN. Sure. So public charities are only allowed to engage 

in an insubstantial amount of lobbying. And there is section 501(h), 

which helps determine how much that is. So a (c)(3), a public charity, can engage in some little amount of lobbying, but not a lot. And 

the idea here is they are doing their normal functions and they 

may doing some little thing that may be considered lobbying, and 

we want to let them do that. But if they are going to be a lobbying 

organization, they are supposed to be a 501(c)(4) organization, a social welfare organization. Because lobbying is considered a social 

welfare function. 

So it is perfectly fine for a 501(c)(4) to be a lobbying organization, 

and a (c)(3) can form a 501(c)(4). And it happens all the time. 

Now a charity, a public charity, is not allowed to engage in a political campaign for or against a candidate for public office, 

501(c)(3) makes that very clear. We do not want the subsidy that 

goes to public charities to be going into campaign organizations. So 

a 501(c)(3) is prohibited from engaging in political activity. They 

should do that through an affiliated (c)(4). Actually, they are not 

allowed to create an affiliated 527, but they are allowed to create 

an affiliated (c)(4), which is allowed to create an affiliated 527. So 

that is how they get that done. 

Mr. LEWIS. In your testimony, you noted that there are serious 

enforcement problems. Some big issues. I know the chairman and 

others do not want us to move into this political climate that we 

are in right now, but it seems like each time we pick up the newspaper, hear something on television or the radio, that there are 

real problems out there. 

Do you think the IRS is having a major problem in enforcment 

with limited resources, limited staff? Who is watching? Who is policing? 

Mr. TOBIN. This interrelated affiliation is a mess. And it is a 

mess for a lot of reasons that are the faults of a lot of us and a 

lot of reasons that are not anyone’s fault. The IRS is not set up to 

be a campaign watchdog. They are not good at it and it doesn’t 

serve their primary purpose. And so when they are placed in the 

position of having to get involved in these kind of political debates, 

it is very difficult for them to make these kind of determinations. 

But in addition, we have seen really, really aggressive pushing by 

organizations and what they claim their activities are. So the more 

aggressive organizations push, the more it creates problems for the 

IRS in enforcement. If we talk about a public charity not being allowed to intervene in a political campaign, and the public charity 

starts doing it but claims they are not from some weird definition, 

it creates this enforcement burden on the IRS; have the engaged, 

have they not. 

We have seen in the social welfare context where the definition 

that organizations seem to be using appears to be the election law 

definition, not the Tax Code definition. So you have a whole set of 

(c)(4) social welfare organizations who in my view are absolutely 

527s. Now who is supposed to police that, right? If a social welfare 

organization says this political campaign activity is social welfare, 


ccoleman on DSK8P6SHH1PROD with HEARING
109 

who comes in and checks that? And the answer is it has got to be 

the IRS. And it is just very difficult for them to do that. 

Mr. LEWIS. Thank you. I notice my time has expired. And the 

chairman has been so liberal here. Thank you very much. Thank 

you, Mr. Chairman. 

Chairman BOUSTANY. Thank you. 

Ms. Jenkins, you are recognized. 

Ms. JENKINS. Thank you, Mr. Chairman. Thank you all for 

being here. 

Ms. Borenstein, in your testimony you discuss the extensive 

changes to the Form 990 and note that some problems still exist. 

Can you talk more about what challenges still exist for tax exempt 

organizations, preparers, and the IRS, and also maybe what recommendations might solve them? 

Ms. BORENSTEIN. Yes. At basic ground level the difficulty with 

the form vests in a couple of places that have been vexing to preparers. Again, I stress that there is many people who are doing a 

good job preparing their own form, especially when filing organizations do them on their own. 

My first suggestion is that the IRS should do more educational 

efforts to explain that some of the terminology used is not inherently value-laden as we are finding a fear in the exempt sector: 

‘‘That I should not have a board member whose company is providing us a good deal because then I have one less independent director and there is something inherently wrong with that director’s 

capacity to serve,’’—which is certainly not the case. Folks like myself can say that as much as we want. Hearing it directly from the 

IRS would be helpful. So I am asking for more educational outreach on the part of the Service to express that they are just asking 

the question, rather than saying there is anything inherently bad 

about disclosure of favorable transactions with insiders. 

The Schedule L, colloquially we refer to it as ‘‘lose your mind.’’ 

The Schedule L has four separate parts. One deals with a statutory 

regime regarding excess benefit transactions that there is to ensure 

public charities cannot be taken advantage of unfairly by people 

who have been in substantial influence at any point in the last 5 

years. You turn someone in if that has been the case. So one part 

of the Schedule L filers have a definition of and disclosure asking 

‘‘has that happened with a certain group of people?’’ Another part 

asks, ‘‘are there loans outstanding at year end with a different 

group of certain people?’’ A third part asks, ‘‘have there been grants 

or assistance provided to yet another group of certain people?’’ And 

then finally, one last part asks, ‘‘are there business transactions 

with certain people?’’ 

I have strongly recommended that the IRS create some sort of 

educational materials or flow chart in the instructions to the end 

of simplifying the definitions, trying to make them easier to handle. 

Standalone they all make sense as bright lines in the sand, but 

paired together their combined weight creates a very daunting task 

for the sector. 

Past there: The Schedule F. I think there is much concern about 

the utility of the information being provided to the IRS about activities outside the borders of the United and widespread evidence 

that the info asks are burdensome (and potentially of questionable 


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value). So I am recommending that that schedule be either extremely streamlined or eliminated. 

And then there was a vestigial part of the old 990 that I think 

there was huge agreement had very value to the IRS. It is there 

at the behest of States and requires groups to functionalize their 

expenses between program and fundraising and management. 

There was an old-school belief that I would give a dollar to a charity first who was going to spend 90 cents of that dollar on program, 

but I know that I might want to give a group a dollar who is going 

to spend only 60 cents on program because that is where they are 

in their lifecycle and they need to build up management or need 

to put some efforts into fundraising, et cetera. That part/statement 

that has groups functionalize expenses should not be on the form. 

It is subjective. It doesn’t work, and it continues longstanding mythology in favor of giving money to groups who say more dollars 

are going to program. 

And then finally, it is clear that in spite of my saying groups can 

do their own Form 990, that small organizations can’t. They are 

being very burdened. We had a transition period in which small organizations did not have to file the full redesigned 990 for a period 

of years. That finally ratcheted down to gross receipts of $200,000 

as the level at which one must fill out the Form 990, or gross receipts at any level but owning assets of more than a half million 

dollars (requires the whole 990). I am suggesting that those thresholds rise back to the first transition year of a million dollars of 

gross receipts or perhaps on average a million dollars of gross revenues a year or having assets of $3 million. We have amateur athletic associations who have built a hockey and sports facility arena. 

They own $3 million worth of real estate. Well, $3 million might 

be the point at which they are filling out the full 990. But if they 

own a million dollars or $2 million worth of real estate, I and many 

others think they are still a small organization if their budget is 

less than a million dollars a year. On top of those increased thresholds by which groups could still fill out the Form 990–EZ, I am suggesting that the IRS come up with a third way to find ways in 

which that Form can be bettered in order to let more small organizations fill out a less comprehensive form. In sum total, that was 

my last recommendation. 

Ms. JENKINS. Thank you. 

Mr. Chairman, I yield back. 

Chairman BOUSTANY. Thank you. 

Mr. Becerra. 

Mr. BECERRA. Mr. Chairman, thank you. Thank you all for 

your testimony. Each of you has to some degree focused some of 

your testimony on the growing complexity in this area and also the 

need for more transparency, a greater degree of disclosure, and so 

forth. I know that Mr. Miller put the best light or best face he 

could on the capacities of the IRS to try to oversee the numerous 

organizations that are now popping up under the tax-exempt structure, but it seems like what we are doing is losing ground every 

day on the ability to seek transparency and reduce the complexity. 

And so we thank you for your guidance and some of your ideas of 

how to try to make that better. 


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I think, Mr. Tobin, you have also suggested some ways to try to 

enhance the ability for us to pursue the bad apples, those who 

make the rest of the nonprofit world look bad because they have 

done things that don’t conform with what we consider to be good 

mode of procedure for a nonprofit, the kind of things that we think 

of when we think of that charitable hospital or the cancer society 

or those organizations that are out there to do good for a lot of 

Americans. 

Can you tell us a little bit with more detail from what you say 

in your written testimony about how we can go about enforcing 

some compliance in the tax-exempt area where, for example, we 

deal with lobbying, political campaigning, and other activities that 

seem to go beyond what we typically think of the work of a charitable or a not-for-profit entity? 

Mr. TOBIN. So one of the problems in this area is that we have 

put the IRS in charge of policing and we haven’t really given them 

the tools that we would normally give an agency that is required 

to police in this way. For example, the Federal Election Commission, you can make a complaint to the Federal Election Commission. But the IRS, it runs, it does its audits. You don’t complain 

that your neighbor has not been audited and have them all of a 

sudden audit your neighbor. There are whistleblower statutes. But 

for the most part the IRS does their audit and then they keep it 

all secret, because that is what they are supposed to do. They are 

not supposed to disclose my tax return to anyone else, and we expect that kind of privacy. 

Well, that is happening in the tax exempt area, and I think there 

is a real question whether we need it to happen in the tax exempt 

area. Tax exempt organizations are public charities. They are public organizations. They are receiving this public subsidy. So I think 

that there are ways in which we can have a public complaint process, where the public are looking at what is going on, they find that 

there is a problem. Right now they can send a letter to the IRS, 

but they don’t have any idea what is going to happen. There is no 

requirement the IRS look at it. There is certainly no requirement 

that the IRS tell you what happened in that process. And they 

can’t, in most cases. 

And so I advocate that you have a public complaint process that 

you set up and that we have some transparency in that process because I think both sides of the aisle—in my history, I have been 

a professor for 11 years, and before that have at DOJ for 4 years, 

and then I was a judge, and I was on the Hill for 7 years, so there 

is a good 20 years of this stuff—and both sides of the aisle, when 

these things happen, you want to have some certainty that it is not 

political and that it very objective. My experience is the IRS handles this in an objective way. And the more we can be transparent 

in that, the better. 

Mr. BECERRA. Are there any existing complaint processes that 

we could use to guide us in how you would form such a complaint 

process? 

Mr. TOBIN. It is nice when you are a professor and somebody 

asks you about something you wrote, you just have to remember 

what you said. But I did an article on that in Georgetown’s Law 

Review on the process. And I think having a panel of nonpartisan, 


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of career service employees that could rotate through so that you 

weren’t doing something like the FEC, where you had three and 

three, which creates a possibility for deadlock, where you had 

transparency in the decisionmaking process so that you could have 

some sense of what was actually happening, is the best way to go 

forward. 

Mr. BECERRA. Thank you. Thank you all for your testimony. 

Yield back, Mr. Chairman. 

Chairman BOUSTANY. I thank the gentleman. 

Mr. Marchant. 

Mr. MARCHANT. Professor Colombo, it is easy to imagine an instance where a tax exempt organization would participate in a soup 

kitchen kind of scenario and then everybody liked the soup and so 

started canning the soup and then selling it and made that. But 

can you describe in better detail how one analyzes a for-profit activity and at what point the activity jeopardizes their tax exempt 

status? 

Mr. COLOMBO. Well, I think in my world a commercial activity 

is one that competes in the private market with products and services available widely in the private market. So I will use my example of selling soup. I don’t know whether selling soup is related or 

unrelated to operating a soup kitchen, but I am quite certain that 

it is a commercial activity. It competes in the private market with 

other soup makers. 

How about tuition charged by a private school? Well, that one I 

would say is not a commercial activity because we have not yet 

reached the point where educational services are widely available 

in the private market. There are a couple. There is the University 

of Phoenix. But we are not there yet. So my view about that one 

is that tuition charged is not. 

So I would look to the private market and I would say that if 

what the charity is doing is selling a good or service that is widely 

available in the private market, that is a commercial activity. 

Where would I draw the line? I actually wouldn’t draw the line. 

I would say to charities, You can engage in as much commercial 

activity as you want, provided that all of it is taxed and that you 

show us that that commercial activity is generating revenue that 

is expanding your charitable outputs. If it is not doing that, then 

why are you doing it? Do something else. Go sell your business and 

invest it in a diversified portfolio and use the money from the portfolio to operate the soup kitchen rather than selling soup. You may 

not be good at selling soup. 

Mr. MARCHANT. So in my State and many States are now experiencing expiration leasing income on the land that they own. So 

that someone comes to a local university, simple, that first box up 

there. They have never really even thought about getting out of 

that box. And all of a sudden they discovered oil and gas on their 

campus or a piece of land that they have always considered to be 

their campus. That income, is it clearly not taxable? 

Mr. COLOMBO. I think under current law it is pretty clearly a 

royalty, if that is the way that it is structured. I come from southern Illinois. We have oil and gas in southern Illinois, too, but I forget how the oil and gas leasing is done in that situation. But I 


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think it is pretty clear that it would be passive income either as 

rental income from real estate or as a royalty arrangement. 

Mr. MARCHANT. If they chose not to lease the royalty out and 

chose to drill, actually hire a rig and start drilling and producing 

their gas and oil, is that—— 

Mr. COLOMBO. In my world, that is a commercial activity. Now 

you are Shell Oil. 

Mr. MARCHANT. And then, in your opinion, you would have an 

unrelated—— 

Mr. COLOMBO. Yes. 

Mr. MARCHANT. Ms. Borenstein. 

Ms. BORENSTEIN. If it were a school and you were teaching 

your students how to do that drilling and operate a business, you 

would be able to, under the current UBIT regime, talk about a substantial relationship to the conduct or accomplishment of your exempt purpose. 

Mr. MARCHANT. Mr. Tobin, would you feel like that that fell 

outside the actual participation in the drilling and becoming the 

consumer, not just the royalty owner? 

Mr. TOBIN. I agree with both examples. In the first example I 

think if you actually engaged in the commercial activity and you 

became the driller, it would be much more problematic. If you were 

able to make it part of your teaching process, then it would be less. 

We are talking about a hypothetical here, but it would be less problematic. 

Mr. MARCHANT. Thank you, Mr. Chairman. 

Chairman BOUSTANY. Thank you, Mr. Marchant. 

Mr. Paulsen. 

Mr. PAULSEN. Thank you, Mr. Chairman. As you know, one of 

the issues that has come up at prior hearings actually deals with 

our learning about tax exempts and the ability of exempt entities 

to enter into partnerships, whether it is with another exempt entity or with a for-profit entity. Can you just explain maybe, Mr. 

Hyatt, in a little bit greater detail how a public charity would actually enter into a partnership or a joint venture with another organization and what are the specific issues in particular that have to 

be dealt with to ensure that an exempt organization actually remains exempt? 

Mr. HYATT. Certainly. Thank you, Mr. Paulsen. Joint ventures 

are really one of the areas of substantial corporate growth certainly 

in the last 20 years, since about the late seventies or early eighties, 

for the reasons I described. Typically, what would happen is the exempt organization would look to this outside for-profit party, look 

for a way of sharing mutual abilities and enter into a joint venture 

through a limited or general partnership. A limited liability company, as I say, is the most common model these days. 

If you look back historically prior to about 1980, the IRS took the 

position that you couldn’t as a public charity engage in limited 

partnership joint ventures, for example, that it was too much of 

sharing of your activities with the for-profit side and that was inconsistent with the tax exempt status. The Tax Court overruled 

that position. The IRS subsequently pulled back from that line and 

over the years has come up with a series of guidance that approved 

certain structures for entering into joint ventures. 


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The essence of it is no matter how you do it, no matter how you 

structure that joint venture, your participation in it has to further 

a charitable purpose and you have to ensure that you haven’t unduly ceded control over the organization to for-profit parties. 

So if you look back into the 1980s, for example, we were starting 

to see hospitals cede the entire operation of the hospital to a joint 

venture with a for-profit party, what is sometimes called a whole 

hospital joint venture. The IRS took a look at that and used a fact 

pattern that is not uncommon in these sorts of situations in a revenue ruling, the good situation and the bad situation. And in essence, they said as long as you ensure that you haven’t unduly conceded control to the for-profit parties, as long as you are doing this 

for a legitimate charitable purpose, perhaps you are, as many hospitals are, particularly academic medical centers, struggling to 

make ends meet, this is the way to remain as a charitable entity, 

you got a legitimate reason for doing that, and as long as you are 

not improperly benefiting private parties under IRS rules, that is 

an acceptable way to go. But if you ceded so much control to the 

for-profit party that they in effect are really operating the charity 

now, it no longer continues to qualify as a charity and the IRS has 

indicated we would take that away. 

Another version of that is what is sometimes called an ancillary 

joint venture. The example in the most recent revenue ruling by 

the IRS in this circumstance was a college or university that wanted to do distance learning. They wanted to ensure that teachers in 

the summertime could come and take courses without actually having to be on campus. They said there are for-profit companies out 

there who can do a better job at figuring out what cameras to 

choose, how to get the mikes set up, what halls should we rent, 

how do we go about doing that. What we do very well is figuring 

out what our curriculum is, who our best teachers are, what the 

standards are for passing that test. 

So we will approve that kind of ancillary joint venture as long 

as you haven’t ceded control over to this for-profit party and the 

for-profit party is dealing with the business aspects, the charity 

continues to deal with the charity aspects of it. If you break it up 

in that fashion, otherwise share risks and rewards, have shared 

governance of that organization, in the IRS’s view back in 2004, 

that is a legitimate way to do an ancillary joint venture as well for 

a public charity. 

Mr. PAULSEN. That is helpful. Thank you. Let me just dovetail 

into something real quick, Ms. Borenstein, if I can ask you a question. Because in your testimony you noted that the changes have 

occurred for the Form 990 and entirely new information now is required and existing requirements have changed substantially. 

What were the deficiencies of the old Form 990 and what particular concerns actually prompted all these substantial changes 

with 990 

Ms. BORENSTEIN. Well, where should we start? I mean, the director of the exempt organization division referred to the prior 

iteration of the Form 990 as a disaster, and it was perhaps the one 

time that the entire exempt organization community completely 

agreed with the IRS. 


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The old form was built out very, very poorly. Questions were 

asked as the topic du jour rose through hearings in this august 

body and through law changes. There was no rhyme or reason to 

how it was structured. And as I earlier stated, it was perceived as 

a financial statement because you largely saw numbers, but there 

were questions all over the place that said attach a schedule, and 

you had to read the instructions to know what to attach in the 

schedule. The software providers for 990 preparation all had a different inclination as to what the schedules should provide. You 

couldn’t find the data. You would go to Guide Star and find a 300- 

page return, and be endlessly searching for the list of directors, officers and key employees, or other common attachments without so 

much as a clue where that information was going to be. 

It was widely understood that it was time to start over, which 

is why the IRS, starting in 2005 and 2006, went through what I 

thought was a very thoughtful process of engaging the entire sector 

to say if we have to ask questions about who you are and what you 

are doing and why you continue to be an exempt entity in terms 

of qualifying, ‘‘what would you want to see us put on the form?’’ 

And there was a fair amount of back and forth. The IRS proposals 

I am sure included items that they were ready to negotiate on, and 

they did jettison some completely. They took a lot of suggestions. 

The architecture of the form was agreed to for the most part by the 

sector. The instructions are relatively plain English. They worked 

very, very hard on that. They continue to make corrections each 

year, resulting in improvements to the form. But again, the notion 

is that we want an environment of transparency and accountability, particularly for public charities. And so to annually report 

on the sum total of who they are, under whose watch are things 

being performed, what compensation is being paid particularly to 

those in charge—a full view—is what the new 990 affords. The old 

990 attempted to ask a lot of that information but only someone 

like myself understood those questions. 

Mr. PAULSEN. Thank you, Mr. Chairman. 

Chairman BOUSTANY. Thank you. 

And Ms. Borenstein, just in follow up on what Mr. Paulsen 

asked, in your testimony, you had discussion of eight completely 

new areas on the revised Form 990. For example, any information 

required on authority and management practices, related parties 

on Schedule R is one example. Explain what specific information 

is now required there. How the IRS or other interested parties may 

use that information to examine the organization. And how have 

these requirements prompted public charities to make changes for 

compliance purposes? 

Ms. BORENSTEIN. Well, I am sorry, Mr. Chairman, are you 

asking about the Schedule R? 

Chairman BOUSTANY. Yes. 

Ms. BORENSTEIN. I think the chief imperative behind the 

Schedule R was to afford a view into the linkages between the filing organization and organizations over which control existed in 

one direction or the other. Also, in addition to noting where the 

linkages are, it gives the opportunity for the IRS and the public— 

the court of public opinion in my eyes is the third regulatory body 

to the States and the IRS—to see answers to the IRS’ asking the 


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right questions, depending on whether the related organization is 

for profit and taxable versus exempt or a partnership—in each of 

those instances, there is different contextual information asked of. 

So you and I as readers of the return see who those entities are 

with much more detail than that afforded by the prior 990. 

One of the things I don’t note in my testimony that is important 

to understand that the Schedule R serves to inform the compensation picture, too. The very important people, the in-charge people 

for the filer, for these individuals the Schedule R triggers visibility 

for what compensation they are paid by, and what hours they are 

providing to, the filer’s ‘‘related organizations.’’ In the good old 

days, before the current 990, if I had a complex organization that 

was comprised of a (c)(3) with a related (c)(4), I would not know 

from reading the 990 of either if an important person for the (c)(3) 

was also being compensated by or providing services to the (c)(4) 

or vice versa. I would have had to read both returns together but 

now it is in one place on each organization’s return. 

Chairman BOUSTANY. Okay. Thank you. That was very helpful. 

And finally, Professor Colombo, in your testimony, after discussing the many problems with the commerciality doctrine compliance IRS enforcement, you provide several suggestions for reform. 

And I want to just focus on two of those options you had laid out. 

First is to return to the commensurate in scope doctrine. Explain 

to me in more detail what that proposal is and how it would actually work. 

Mr. COLOMBO. Well, this is actually part of this question of 

how much commercial activity should a charity engage in. In 1964, 

actually, the Internal Revenue Service took a look at this problem 

and wrote a ruling and basically said that you could engage in— 

there was no limit on the amount of commercial activity you could 

engage in as long as your charitable activities were commensurate 

in scope with your investment in commercial activity. 

So this was the IRS’s check on making sure that the commercial 

activity was providing resources to the charitable side as opposed 

to just becoming, as I point out, empire building. 

I would resurrect that test. I probably would resurrect it. The 

IRS has sort of let it lie, and then they resurrected it in other 

areas, and now I am not exactly sure anymore what—— 

Chairman BOUSTANY. It is inconsistent. 

Mr. COLOMBO. Yeah. I don’t know what it means anymore. I 

am not sure they know what it means anymore, frankly. So I would 

resurrect it for its original purpose. 

I might even add some kind of safe harbor rule, that if you earn 

a rate of return that is equal to the current Federal rate, mediumterm Federal rate or something like that, that you then redeploy 

on the charitable side, you are okay, it is fine, you go and you can 

engage in as much commercial activity as you want. So that is the 

piece of it that I refer to as resurrecting the commensurate in scope 

doctrine. 

Chairman BOUSTANY. Okay. 

And finally, second is to no longer use the relatedness test for 

UBIT and impose tax on all commercial activities by charities. You 

kind of talked a little bit about that in our previous back and forth. 


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How would that work? Would it make oversight easier? And what 

kind of impact would this have on the tax-exempt sector overall? 

Mr. COLOMBO. Well, I think, first of all, if you just tell charities 

that all of your commercial activities are taxable—you could actually I think do it either way, tell them they are all taxable or tell 

them they are all not taxable; I think that it happens to be not a 

good idea to tell them that they are all not taxable—hen again, you 

eliminate this, as Mr. Miller pointed out, very difficult to enforce 

line between what is related and unrelated. 

Now, there is still a definitional question, no doubt about that, 

there is a definitional question about what is commercial. But my 

own view about that one is that is a pretty easy definitional line 

to meet, certainly much easier in my view than related or unrelated. I am not sure at the end of the day that that will have much 

effect on charities other than giving them clarity that they can engage in commercial activities. It will not cause them to lose their 

tax exemption. They can then set up the corporate structure or the 

business structure that makes sense from a business perspective as 

opposed to worrying about, well, do I have to drop this thing into 

a corporate container because if I don’t, then someone from the IRS 

might come along and say, well, that affects your tax exemption. 

No. You know, let them make those decisions based upon issues 

that are not tax issues, that are issues of business issues. So my 

own view is that that would in fact simplify oversight. How much? 

I don’t know. But I think the system we have got, sort of anywhere 

is up. 

Chairman BOUSTANY. Thank you. 

Mr. Lewis, do you have any follow up. 

Mr. LEWIS. No, Mr. Chairman. 

Chairman BOUSTANY. Mr. Paulsen is gone. 

Well, that concludes our hearing. Thank you very much. Your 

testimony was very, very helpful to us. Keep in mind that members 

may have some additional questions that may come up, and they 

would submit those to you directly for answers. Both questions and 

answers will be made part of the official record. And with that, I 

will now conclude the hearing. 

[Whereupon, at 11:38 a.m., the Subcommittee was adjourned.] 


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[Submissions for the Record follow:] 

American Bankers Association 


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Jul)' 25. :::0"12 

Statement for the Record 

On helJa(l(~(the 

American Bankers Association 

before the 

Oversight Subcommittee 

C?lthe 

Committee on \Vays and Means 

United States House of Representatives 

July 25,2012 

Chairman BOllstany. Ranking Member Lev-/is and members of the Subcommittee. the American 

Bankers Association (ABA) appreciates the opportunity to submit a statement for the record for this 

hearing on tax-exempt organizations' compliance ,vith unrelated business income ta:\ (UBIT). ABA 

represents banks of all sizes and charters and is the voice for the nation's S 14 tril lion banking 

industry and its t\vO million cmployc~s. 

Over the last t",o decades, tax excmpt organizations of all types havc grO\vn increasingly morc 

complex in their organizational structures and operations. Contributing to this complexity is the 

prcvalence of profit-generating anns within the tax-exempt organizational structurc. We commend 

the Subcommittee for holding this oversight hearing \vith regard to tax-exempt organizations' 

compliance with Federal tax law, including rules that subject business income from for-prollt 

activities to UBIT and the disclosure of information about sources of income and expenditure on the 

Form 990. 

Jusllike other tax exempt institutions, all credit unions should be subject to UBIT on income 

earned from activities outside of the scope of their tax-exempt purpose. CUlTently, only stale credit 

unions are subject to UBIT; federal credit unions should also be required to comply. Similarly, state 

credit unions are required to disclose infonnation about income and expenditures, such as executive 

compensation and charitable donations, on IRS Form 990. Federal credit unions should also be 

required to comply. 

Credit unions 'vere originally created for the purpose of promoting thrift and providing credit to 

members of the credit union and 'vere granted their tax exemption to serve people of mod cst mean~. 
120 


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Jul)' 25. :::0"12 

However. many of these credit unions have 110\\' morphed from serving "people of small means" to 

become full sefyice, financially sophisticated institutions that compete head-to-head \"lith local 

taxpaying banks. In many cases, these morphed credit unions offer products and service~ that are 

outside of their tax-exempt purpose and should he subject to UBIT, just like what is applied to other 

tax-exempt entities. 

Our statement v,ill make several points: 

r Credit unions are becoming increasingly complex organizations, virtually 

indistinguishable from taxpaying banks. 

~ Federal Crcdit Unions Should Disclose Activitics on Form 990 

j.. Activities outside oCthe scope of the credit wlion tax-exempt purpose should be 

subject to UBIT. 

}- Federal credit unions should be subject to UBIT,just like slate chanered credit 

unions. 

We will discuss these items in detail below. 

I. Credit Unions Are Becoming Increasingly Complex 

Many ortoday's credit unions arc a far cry from the small, traditional credit unions that served 

distinct groups of '''people ofsmallmcans," which Congress sought to as~ist \vhen it provided tax 

subsidies to credit unions in the 1930~. Today, the credit union industry has surpassed the $1 trillion 

asset threshold and will soon hold more assets than the savings association industry. 

rhere are now 194 credit unions that have more than $1 billion in assets each; these credit 

unions hold 50.3 percent of all credit union assets but represent only 2.8 percent of the total number 

of credit unions. These 194 large credit unions are larger than 9! percent of all banks. For 

consumers, credit unions arc indistinguishable from taxpaying community banks. [ndeed, these 

credit uniolb compete for the same loans as their community bank counterparts, but pay no taxes. 

Credit unions \\ ere not intended to be simply tax exempt banks. 

Moreover, many credit unions are exhibiting increased organizational complexity, including 

operating for-profit affiliate~ known as credit union service organizations (CUSOs). According to 
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Jul)' 25. :::0"12 

the National Credit Union Administration, approximately 33 percent of all credit unions reported 

using CUSO services in 2010. 

These for-profit aftiliates can be wholly orjoinlly 0\-\11ed. Many are organized as limited 

liability companies. Limited liability companies are pass-through entities, where the shareholders 

pay the taxes on the profits of the company. HO\vever, since credit unions are tax exempt. the 

earnings ofCUSOs structured as LLCs!{o untaxed. Additionally, CUSOs have the authority to 

offer products and services that credit unions cannot offer and CUSO's can serve nonmembers. 

National Credit Union Administration regulations only require lhat the majority of a CUSOs 

business must come from credit wlions or credit union mcmbers. 

Alaska USA Federal Credit Union in Anchorage, Alaska is illustrative of this growing 

complexity. The credit union owns a mortgage company, insmance agency, trust company, and title 

agency and pays no U BIT OIl income earnell from the:'ie activities. 

II. Federal Credit Unions Should Disclose Activities on Form 990 

As credit unions become more complex, it is important to increase credit union transparency. 

Credit unions should be required to reveal ;nf01111at;on about sources of income and expenditures, 

such as executive compensation and charitable donations. Mo~t tax-exempt organizations, including 

universities and hospitals, mu~t disclose the compensation of senior officials to the Intc111al 

Revcnue Service on the Fonn 990-a form that has become an important tool for dctennining the 

transparency and accountability oftax-excmpl organizations. By publicly disclosing this 

information, the Form 990 fosters good corporate governance as it attempts to ensurc that the tax 

expcnditure is being appropriately employed. 

State-chartered credit unions are already required to tile a Form 990, bLlt federal credit unions 

are not. Since federal credit unions arc cooperatives, thc mcmbCT-O\vncrs have a right to know the 

total compensation paid to senior officials. For example, ifPuhlic Service Credit Union of Denver 

had been a federal credit union (rather than statc-chmtcred), information regarding the $9.8 million 

base compensation of its CEO and President would not have been disclosed. His 20 I 0 pay package 

\\'a~ almost 20 times the average for comparable sized credit unions according to press reports. 

Federal credit unions should be required to file Forrn 990 infonnationjust like state-chartered 

credit unions and most other tax-exempt institlltions. Expanding the public's opportLlnities to review 

executive salaries \vould promote improved corporate governance and greater credit union 
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accountability. It would infonn Congress, taxpayers, and credit union members about whether this 

valuable tax subsidy is going tmvards the credit union mission or is subsidiLing credit union 

management. 

III. Numerous Credit Union Products and Services Should Qualify for UBIT 

ABA believes that income derived from non-members and from activities unrelated to the 

credit union '$ tax-exempt purpose should be subjt:ct to taxation. In general, a tax exempt 

organization is subject to UBIT if income is derived from an activity that is (!) a trade or business, 

(2) regularly carried on, and (3) not substantially related to the exempt purposes of the organization. 

An activity is related to the exempt purpose only vvhere the conduct of the activity has a causal 

relationship to the achicvement of the exempt purpose. 

Today, credit ulliom; and their subsidiaries offer Ilumerollsfinallcial pr()(/ucts and serl'ice.~ 

that are Itot substantially re/atell to their tax-exempt purpose ami ~JlOuld be .subject to U BIT. 

Consider the following examples: 

;... La Capitol FCU in 2004 built a nc\v six-story building in downtown Baton Rouge. The 

credit union occupied 30,000 feet of the 80,000 square-foot development and leased out the 

rcst. The income from the 50,000 square feet of leased out ot1kc space -should be taxel/. 

..,. Another credit union, First FAA FeU located in Los Angeles, leased its unused p0l1ion of 

its offic~ at above-market rates to th~ "CSI: Miami" production company. Space on the 

main noor of the building is set up to look like a police interrogation room. The income 

from the "CSt Miami" set should be taxed. 

,. Forum Credit Union in lndianapolis operates a 

conference and events ccnter. It can bc used for 

special occasions like weddings or corporate 

events. ffyou want to rent the entire facility during 

the weekend for a corporate event, the price v.rould 

be $1,700 plus $4 per person. The income tram the 

convention center rentals -should be tILted. 

)r Lake Michigan Credit Union in Grand Rapids, 

Michigan operates an auto dealership, called Lake 

Michigan Auto Center. The credit union also operates a car wash. It is hard to fathom \\/h3l 

a car dealer~hip and a car wash has to do with a credit union's tax-exempt purpose. The 

income from the Lake Michigan Auto Center SllOUltl be taxed. 
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;... Many credit unions are surcharging nonmembers for using their automatic teller machines. 

The income !loom the nonmember lee!) should be taxed. 

';r A number of the largest credit unions arc now offering real estate brokerage services. 

Digital Credit Union of Marlborough, Massachusetts ofTers real estate brokerage services 

through its DCU Realty affiliate. The income from the real estate brokerage should he 

taxed. 

FUlihermore, UBIT should also be applied to a credit union when it purchases or participates in 

a business loan to nonmembers. Since the first quarter of2004, the NCUA has collected infomlation 

on the number and the dollar volume of nonmember business loan purchases and participations. 

According to NCUA, 820 credit unions held $6.4 billion in nonmember business loan purchases anti 

participations at the end of the first quaner 01'2012, ABA believes thi~ activity is outside the scope 

of a credit union's tax-exempt purpose and : .. 1multl he taxed. 

IV. UBIT Should Be Extended to Federal Credit Unions 

Currently, state-ChJl1ered credit unions must pay USlT. However, federa!ly-chart~red credit 

wlions are statutorily exempted from paying UBIT In fact, the tax exemption for federal credit 

unions is so broad that these organi7.ations arc excluded from all forms of federal and state taxation. 

other than state property taxes.] This statutory exemption from U HIT is no longer \varranted. The 

only significant difference bet ... veen state and federal credit unions is that federal credit unions are 

chartered by a federal agency, the National Credit Union Administration, while state-chartered 

credit unions arc chartered by state regulators. 

Tax policy should not differ between federal and state credit unions that offer virtually the 

same business services and compete for the same customers, The same competitive pressures 

between taxahle businesse~ and tax-exempt organizations that motivated Congress to enact the 

unrehlted business income tax also exists between federal credit unions and the nation's community 

banks. Disparity in the application of UBIT between state and federal credit unions also creates the 

potential for tax arbitrage and creates an incentive for credit unions to obtain federal chartcr~. 

; "The 1ederal credit unions organiz.ed hereunder, their property. thcir fl'anehi"es, capital. rcscrves, surpluses, and other 

fund"" and their income ",ha!! be exempt rrom aU taxatIOn mw,' or hereafter im]K!sed hy the United Slates or hy any ~l<lte, 

territorial. or exccpt that any rcal property and dny tangihle rer~omll property or ~uch federal 

state. territorial, and local taxation to the S<lIllC extcnt as othcr "imi!<Jr propert)' 
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Center for Fiscal Equity 


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Comments for the Record 

House Ways and Means Committee 

Snbcommittee on Oversight 

Hearing on Public Charity Organizational Issues, Unrelated Business Income Tax, 

and the Revised Form 990 

July 25,2012,9:30 AM 

1100 Longworth House OtTice Building 

By Michael G. Bindner 

Center for Fiscal Equity 

Chairnmn Boustany and Ranking Member Lewis, thank you for the opportunity to submit 

comments for the reeord on these issues. We will leave it to others to examine how the current 

system 18 working and contine our comments to how our tax rcfoTIn program would impact these 

questions. As you know, the Center l'or Fiscal Equity has a leur pan proposal l'or long term tax 

and health care ret'onn. The key elements are 

A Value Added Tax (V AT) to fund domestic military spending and domestic 

discretionary spending with a rate between 10% and 13%, which makes sure every 

American pays something. 

Personal incomt! surtaxes on joint and widowed filers 'With net annual incomes of 

$100,000 and single tilers earning $50,000 per year to lund net inLerest payments, debt 

retirement and overseas and strategic military spending and other international spending, 

with graduated rates between 50/0 and 25% in either 5% or 10% increments. Heirs would 

also pay taxes on distributions from estates, but not the assets themselves, with 

distributions trom sales to a qualified ESOP continuing to be exempt. 

Employee contributions to Old Age and Survivors Insurance (OAS I) with a lower income 

cap, which allows lor lower payment levels to wealthier retirees without making bend 

points more progressive. 

A VAT-like Net Business Receipts Tax (NBRT), which is essentially a subtraction VAT 

with additional tax expenditures t'or tamily support, health care and the private delivery 

of governmental services, to fund entitlement spending and replace income tax tiling for 

most people (including people who file without paying), the corporate income tax, 

business ta.x filing through individual income taxes and the employer contribution to 

OASI, all payroll taxes 1'01' hospital insurance, disability insurance, unemployment 

insurance and survivors under age 60. 

We agree that charity has hecome big business and needs to be taxed accordingly where 

appropriate. We also agree that charitable organizations deserve special treatment in any tax 

reform. 
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Charities that havc commercial operations will be subject to a VAT, like any other commcrcial 

company, at least to the extent of such commercial operations. This is essential to provide 

visibility to their customers as to taxcs imposcd by the entire supply chain, unless sales to 

charities are also made VAT exempt. As this would tum every business into some fonn of 

charitable organization overnight. this would not be advisable. Fiscal conservatism should not 

be synonymous \vith empO\\'cring tax evasion scheme~L The degree to \\'hich this needs mention 

sbows the extent to which it has become so. 

Whether non-commercial operations are subject to a VAT depends on the extent they are used to 

fund entitlement spending and payrolilaxes versus discretionary government spending. For 

example, if Social Security or Medicare were to become VAT [tmded, replacing the payroll tax, 

than charitable organizations must continue to fund these operations, as they will bene!it the 

employees of these organizations. Jf, howev!:r, entitlement services arc funded through our 

proposed VAT-like NBRT, tben there is an argument to leave the non-commercial activities of 

these entities V AT-exempt and we would urge you to do so. 

Political organizations and committees would pay V A T on their payroll and their purchases 

would not be V AT exempt. 

Transferring tax exemption to the V AT will also soften the blow should the charitable 

contribution bc eliminated [i'om nattcr individual incomc surtax rates. The rationalc for 

cancelling such an exemption is that if everyone uses the exemption, it will simply require that 

the tax rates be sct higher to yield the same income. The Center is agnostic as to which option is 

best, as this depends on how entitlements arc funded, although contributions to political 

organizations should certainly not be tax exempt after reform. 

Charitable organization employees will continue to pay the employee contribution to Old Age 

and Survivors Insurance, assuming it is not subsumed into the NBRT. 

Charitable organizations will pay Ihe NBRT because their employees will benefil from the 

programs limded by this levy or [l-c))n offsets to it. For example, Catholic Charities employees 

might designate tbe Catbolic school system as an altemative provider to public schools, which 

would allow Catholic Charities agencies to lake a credit on this levy, which would otherwise be 

paid against their lotal value added. Likewise, employees would be paid the same child tax 

credit as commercial employees - again as an offset to NBRT levies. Health and higher 

education credits proposed for other enterprises would also be available to cbaritable 

organizations, as well as any other applicable credits. Note that because certain payroll and 

personal income taxcs will be eliminated, the gross pay of charitable employees will decline in 

like manner to those of their commercial counterparts. 

On the issue of disclosure, paymcnts oC various taxes mayor may not be listed on the Revised 

Form 990, although doing so would serve the function to donors of offering receipt visibility for 

Ihe VAT. The lolal amounl ofNBRT paid mayor may nol be included, as well as the total 

amount of credits taken. We are agnostic as to whether the credits taken should be itemized, as 

privacy concell1S should be dealt with in deciding whether to do so on a public form. 
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Finally. this schema is as applicable to governmental organizations as it is to charitable 

organizations, with modifications. Stale governments would be the federal NBRT, while federal 

organizations would pay the statc NBRT, both on the same basis relating to value added through 

payroll. These organizations would not pay NBRT to themselves, however their personnel 

systems should contain a similar range of benefits. This schema provides a better explanation of 

how a FairTax might work on these levels, while also providing a rationale t()r adjusting 

government employee salaries and providing for non-governmental performance of services 

through the same lype or alternative NBRT programs. 

Thank you again for the opportunity to present our comments. We are ahvuys available to 

discuss them further with members. staff and the general public. 
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Economic Research Institute 


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Testimony for 

Subcommittee on Oversight of the Committee on Ways and Means 

Hearing on Public Charity Organizational Issues, 

Unrelated Business Income Tax, and the Revised Form 990 

July 25, 2012 

Whither Form 990 E-filing -- or Is It Wither? 

Submitted by Linda M. Lampkin, Research Director 

ERI Economic Research Institute (www.erieri.com) 

Congress can take a simple action that would: 

Improve the efficiency of IRS form processing; 

Help target IRS compliance resources; 

Promote high quality data on the nonprofit sector; and 

Increase the transparency of nonprofit data for all users. 

Minimal funding is required and the Exempt Organization division of the IRS could refocus its 

resources from processing paper and creating databases to research, education, and 

compliance. 

The action is to enable universal electronic filing of Form 990. All that is required is simple 

legislation that amends the Internal Revenue Code to permit lowering the number of returns 

that trigger the requirement to file electronically from 250 to five filed per year. 

Background 

The Form 990 now serves as the major public source of information about an organization's 

finances, governance, operations, and programs for federal and state regulators, the public, the 

media and nonprofit watchdog groups, foundations and donors, and even nonprofit clients and 
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customers. Supported by nonprofit sector groups such as Independent Sector' , e-filing actually 

promotes accurate Forms 990 as the preparation software detects incomplete and potentially 

inaccurate information before returns are filed. It also allows the IRS to provide immediate 

feedback to organizations about incomplete returns and those with obvious inaccuracies. 

The IRS currently requires larger organizations --with assets of more than $10 million -- to e-file 

if they filed more than 250 returns (including W-2s and other returns). Private foundations that 

file at least 250 returns are also required to e-file Form 990-PF, regardless of total assets. And 

of course, the 5-question Form 990-N postcard is available only electronically, and must be efiled by the very smallest organizations in the sector. The vast majority of the non profits are 

not required to e-file - software is used to prepare their returns, then they are printed and 

mailed to the IRS, where they are scanned and turned into images for distribution, a time 

consuming and expensive process that does not result in data usable for research. 

When the IRS attempted to meet the demand for clearer and more accurate information about 

nonprofit organizations by redesigning the annual information return they file, a basic 

assumption was that all or most returns would be filed electronically in the future. And in fact, 

the public, nonprofit organizations and the government will not fully benefit from the 

improvements to the Form 990 until most nonprofit organizations are required to file their 

returns electronically. 

Current Form 990 E-filing and Future Projections 

The IRS expects that about 741,000 Forms 990, 990-EZ, and 990-PF were filed for 2011. Of 

these, about 13% were filed electronically with the IRS.' Another 480,000 organizations will file 

the electronic post card, the 990-N - these are the very smallest nonprofits with less than 

$50,000 in annual revenues. 

While the IRS tries to manage its ever increasing work of processing data by encouraging (and 

requiring where possible) e-filing of returns, the expectations are discouraging for the nonprofit 

sector. The number of Forms 990, 990-EZ, and 990-PF filed in 2018 is projected to increase by 

about 14% from 2011. The percentage e-filing rises also, but only to 38% in 2018, not nearly 

the level for individual tax returns (84% in 2018), or corporation returns (55% in 2018). The 

table below, derived from the IRS Statistics of Income figures, breaks out the estimates by type 

of return. 
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T'i!!e of Return Estimated 2011 Projected 2018 

990, 990-EZs, 990-PF 741,200 842,600 

990, EZ, PF e-filed 203,100 321,500 

% of all e-filed 27% 38% 

Total Form 990 401,700 448,100 

990, e-filed 113,900 175,500 

% of 990s e-filed 28% 39% 

Total Form 990-EZ 222,500 264,500 

990-EZ, e-filed 73,600 114,200 

% of 990-EZs e-filed 33% 43% 

Total Form 990-PF 117,000 130,000 

990-PF, e-filed 15,600 31,800 

% of 990-PFs e-filed 13% 24% 

Currently, about 77% of all individual income tax returns are e-filed, projected to rise to 84% in 

2018. When e-filing reaches these levels, the processing of the data is less of a burden for the 

IRS. 

The impediment to requiring e-filing for Forms 990 is a provision in federal legislation from 30 

years ago designed to reduce filing burdens for smaller entities, not just nonprofits. However, 

with the dramatic change in how computers are used from the 1980s to the present, e-filing for 

all organizations is not a burden and is generally supported in the nonprofit sector. As shown 

above, the smaller nonprofits that can use Form 990-EZ have the highest percentage of efilings! And of course, the very small nonprofits that must file the postcard Form 990-N can only 

e-file. 

Advantages of E-Filing 

Forms 990 are often the primary document providing information about an organization's 

finances, governance, operations, and programs for federal regulators, the public, and many 

state charity officials. Many returns filed indude inaccurate or incomplete data and the Internal 
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Revenue Service currently uses a costly, labor~intensive, manual process to review the 

submitted forms. If there are errors or omissions detected, the IRS then sends a notice to the 

filing organization, usually requiring an amended return which can add considerable time 

before the complete, correct information is available to the public and regulators. 

E~filing actually prevents many of the most common problems with Forms 990 as the software 

ensures that the numbers add up and all required blanks are filled before the file can be 

transmitted. This means that incomplete and potentially inaccurate information is fixed before 

a return reaches the IRS. 

The redesign of Form 990 restructured questions and the presentation of financial and other 

information assuming that most returns will be filed in the future by electronic means. Most 

returns are now prepared using software but then printed and mailed to the IRS. So the data 

are in electronic format initially, then converted to paper, and then converted back to 

electronic data by the IRS and by all the users of the data - state regulators, foundations, 

donors, media, watchdog groups, companies and consultants providing services to the 

nonprofit sector, etc. And even the IRS is projecting only a minimal amount of e~filing in the 

future, seemingly resigned to the current situation of lack of authority to require electronic 

filing by entities filing fewer than 250 returns during the year. 

As a result, most organizations will continue to submit paper tax returns, thus depriving the IRS 

and the public of the most efficient and effective means of disclosure. Legislative action in 

needed to require organizations that file at least five tax forms to file their informational 

returns electronically. 

Role of ERI Economic Research Institute 

ERI Ecol1omic Research Institute was founded in 1987 to provide compensation, benefits, and 

human resource research for private and public organizations in the form of published reports 

and software database products. Our research database software subscriptions are available to 

management, analysts and consultants and are widely used (over 10,000 corporate and 

consulting subscribers, affecting pay practices in over 100,000 organizations). Subscribers 

include corporate compensation, relocation, human resources, and other professionals, as well 

as independent consultants and counselors, and US and Canadian public sector administrators 

(including military, law enforcement, city/county, state/provincial, and federal government pay 

administrators and regulators). 

One of ERI's primary products is the Nonprofit Comparables Assessor'- & Tax~Exempt Surveyor 

CA, a desktop program that converts the compensation data reported to the IRS on Forms 990, 

990~EZ, and 990~PF into infinite combinations of reports and analyses, based on characteristics 

chosen by the user. ERI makes a basic version of the CA available at no cost - this provides 

information that can be used by the vast majority of non profits to benchmark their executive 
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Elizabeth Boris, Thomas Pollak, Charles McLean and Jeffrey Falkenstein 


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Comments Submitted to 

The Subcommittee on Oversight of the Committee on Ways and Means 

United States House of Representatives 

I-Iearing on Public Charity Organization Issues, Unrelated Business Income Tax, 

and the Revised F ann 990 

July 25, 2012 

by 

Elizabeth 'L Boris 

Director, Center on Nonprotits & Philanthropy & Program Director 

Thomas Pollak 

Program Director, National Center for Charitable Statistics 

The Urban Institute 

Charles McLean 

Vice President 

GuideStar 

Jeffrey Falkenstein 

Vice President 

The Foundation Center 

Congress can take key steps to improve the transparency and accountahility of the nonprofit 

sector, without creating a burden on nonprofits, by requiring that the Internal Revenue Service 

immediately implement electronic tiling of all Fonn 990, 990-EZ, and 990-PF returns by Tax 

Year20l3. 

Electronic tiling has been required of smaller organizations since implementation of the Pension 

Protection Act of 2006. All in all, this has proved a major success. Approximately 300,000 dead 

organizations have been removed from the IRS rolls as a result and \\c now have a much clearer 

picture of the nonprofit sector. 

Voluntary electronic filing of Form 990s began in 2004 - yet the I RS does not provide timely 

public access to the raw data from these returns because it is obligated to treat electronically filed 

returns the same as paper returns. 

There are clear eftkiency gains for the federal government, nonprofit watchdog and transparency 

groups like GuideStar and the Foundation Center, state governments' charity monitoring 

divisions, and ordinary nonprofit organizations if electronic filing were to be required. The IRS 
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