Third-Party Profit-Taking in Tax Exemption Jurisprudence

I. INTRODUCTION Nothing is free, not even charity. In almost every case, a taxexempt nonprofit organization1 must transact with profit-seekers to achieve the charitable goal for which the organization has been granted tax exemption. The organization will have to fund somebody's accession to wealth. It may be, for example, that a particular nonprofit organization need only hire one or two employees to deliver meals to elderly beneficiaries. Even in that circumstance, an organization must normally pay market rates for the labor necessary to achieve its charitable goal.2 Employees will profit; the law presumes as much,3 and we would be hard pressed to articulate an objection. In their daily pursuit of the public good, nonprofits nevertheless exist and must participate in the amoral, for-profit market just as any other consumer. They rent space, pay for transportation, and purchase labor and supplies, in most cases paying whatever the market demands and thereby conveying profit on a third party.4 The conveyance of profit on a third party for routine goods and services is an implicit condition precedent to the accomplishment of any charitable goal. Thus, nonprofits are not immune from market forces merely because their fiduciaries must personally disdain the profit motive.5 The point is so clearly axiomatic that it is almost unremarkable. It is more than remarkable, though, that tax exemption jurisprudence reacts with clearly palpable suspicion when noncharitable beneficiaries actually profit conspicuously from the accomplishment of a charitable goal. This Article argues that the manifestation of that suspicion via legal barriers and tax penalties designed to punish third-party profit-taking is as counterproductive to charitable goals as the market forces that perpetuate the charitable classes with which tax exemption law is concerned. In 2006, for example, the Internal Revenue Service ("the Service") announced a summer offensive, of sorts, against charitable housing down payment assistance organizations which assist needy first-time home buyers in prohibitive markets.6 Down payment assistance organizations sometimes solicit funds from housing market stakeholders, such as builders and developers, who might later profit from a charitable beneficiary's receipt of a down payment grant.7 The funds are then used to make grants to enable low and moderate income families to make a down payment towards the purchase of a home.8 The goal seems noble, at least enough to warrant tax exemption. In a surprising series of rulings, though, the Service has stated that if a grant-maker also happens to be the builder or developer from whom the charitable beneficiary subsequently purchases a long-sought-after home, the organization conveys an improper private benefit on a third party.9 Such a private benefit would cause revocation of the nonprofit's tax-exempt status.10 So far, the Service has given little heed to the objection that the ruling would prevent "hundreds of thousands" of low- or moderate-income citizens from becoming homeowners.11 Tax exemption jurisprudence is premised on the assumption that nonprofit organizations will enrich particular charitable beneficiaries for the public good. Nonprofit organizations are necessarily dependent, however, on noncharitable third parties-for example, vendors,-for the accomplishment of charitable goals.12 It is therefore ironic that tax exemption jurisprudence is characterized by suspicion and hostility whenever the possibility arises that a third party, even a vendor of absolutely indispensable goods and services, might explicitly profit from a formal or informal partnership with a nonprofit organization.13 Nonprofits must pay market price for goods and services, but when they do so via certain types of market-dictated transactions-formal or informal partnerships or economically similar franchises that convey conspicuous profit on third-party vendors14-tax exemption jurisprudence reacts with hostility. …