Starting and Managing a Nonprofit Organization: A Legal Guide

By Bruce R. Hopkins | Go to book overview

CHAPTER FIVE
Nonprofits and Private Benefit

One of the fundamental requirements for qualification as a nonprofit organization is also one of the most misunderstood. There is enormous misperception of the term nonprofit. An entity must be nonprofit before it can be tax-exempt, so it is important to understand what the ramifications of nonprofit are. The meaning of the term is found in another confusing term: private inurement. Most nonprofit organizations are subject to the private inurement doctrine, which deals with the unique difference between nonprofit and for-profit organizations (see Chapter 1).

The private inurement doctrine is applicable to nearly all types of tax-exempt organizations. It is most significant, however, for charitable organizations. By contrast, for a few types of nonprofit organizations—for example, employee benefit trusts, social clubs, and cemetery companies—private benefit is, in a sense, the exempt function.


PRIVATE INUREMENT

The federal law of tax exemption for charitable and other exempt organizations requires that each of these entities be organized and operated so that “no part of … [its] net earnings … inures to the benefit of any private shareholder or individual.” Literally, this means that the profits of a charitable organization may not be passed along to individuals in their private capacity, in the way that dividend payments are made to shareholders. In actual fact, the private inurement rule, as expanded and amplified by the IRS and the courts, today means much more.


(a) Charitable Organizations

The contemporary concept of private inurement is broad and wide-ranging. Lawyers for the IRS have advised that inurement is likely to arise where the financial benefit represents a transfer of the organization’s financial resources to an individual solely “by virtue of the individual’s relationship with the organization, and without regard to accomplishing exempt purposes.” The IRS’s lawyers thereafter more bluntly have stated that the inurement prohibition “serves to prevent anyone in a position to do so from siphoning off any of a charity’s income or assets for personal use.” These descriptions are correct for today’s private inurement doctrine, but it is a substantial embellishment of the original statutory rule.

The contemporary meaning of the thoroughly antiquated statutory private inurement language is scarcely reflected in its literal form and transcends the century-old formulation; what the doctrine means today is that none of the income or assets of a tax-exempt organization subject to the inurement doctrine may be permitted to

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