The charitable sector53 (i.e., organizations described in section 501(c)(3)) is a significant part of the national economy. As noted above, relative to gross domestic product, in 2001, the total revenue of charitable organizations (including private foundations but not including churches and other organizations not required to file) was 9.3 percent.54 In 2001, of all section 501(c)(3) organizations filing returns (e.g., excluding churches but including private
foundations), the total asset value was $2.045 trillion, with total revenues of about $942 billion.55 In 2004, the number of section 501(c)(3) organizations was 1,010,365.56 With respect to the charitable contribution deduction, it is estimated to benefit taxpayers through tax savings of $228 billion over fiscal years 2005-2009.57 In 2002, the total amount claimed as a charitable
deduction was about $145 billion.58
In general, the requirements for exempt status of an organization under section 501(c)(3) of the Code are that (1) the organization must be organized and operated exclusively for certain purposes; (2) there must not be private inurement to organization insiders; (3) there must be no more than an incidental private benefit to private persons who are not organization insiders; (4) no substantial part of the organization’s activities may be lobbying; and (5) the organization may not participate or intervene in political activities. Permitted purposes are religious, charitable, scientific, testing for public safety, literary, educational, the fostering of national or international amateur sports competition, or the prevention of cruelty to children or animals. Failure to satisfy any of these requirements should result in an organization not qualifying for exempt status under section 501(c)(3), or should result in a loss of such status once a violation is detected by the IRS. Most of the Federal law of charitable organizations is designed around ensuring that each of the requirements is satisfied by an organization initially and on an ongoing basis. Each of the requirements is simple to state, but none are simple, as each carries with it a significant body of statutory, common, and administrative law.
53
The word “charitable” generally is used in this pamphlet to include any of the purposes described in section 501(c)(3), e.g., religious, educational, scientific, and other.
54
Joint Committee staff calculation based on information in Table 6, and Gross Domestic Product data from Economic Report of the President, February 2005, U.S. GPO, Table B-1.
55
Joint Committee staff calculations from Tables 5 and 6, Part IV.
56
Table 7, Part IV.
57
See Joint Committee on Taxation, Estimates of Federal Tax Expenditures for Fiscal Years 2005-2009 (JCS-1-05), January 12, 2005.
58
If an organization satisfies each of the requirements, there is a further question of what type of charitable organization it is. A section 501(c)(3) organization is either a public charity or a private foundation. In general, the basis for distinguishing between public charities and private foundations is the level of public support an organization receives over time. Organizations with widespread public support tend to qualify as public charities; organizations funded by just a few donors tend to be classified as private foundations. There is a substantial body of law detailing how to determine whether an organization is publicly supported.59 Certain organizations also may qualify as public charities as a matter of law (e.g., churches, hospitals). The classification matters because private foundations generally are subject to more restrictions on their activities than are public charities, are subject to tax on their net investment income, and contributions to private foundations generally do not receive as favorable treatment as do contributions to public charities for purposes of the charitable contribution deduction.
Satisfaction of the requirements for exemption, classification of an organization as a public charity or private foundation, plus the resulting benefit that contributions to charitable organizations generally are tax deductible provides the simplest snapshot of the law of charitable organizations.
The statutory law regarding the threshold requirements for the income tax exemption of charitable organizations is longstanding and has developed as follows:
• 1894 – The Tariff Act of 1894 provided the first statutory Federal income tax exemption for charitable organizations: “nothing herein contained shall apply to … corporations, companies, or associations organized and conducted solely for charitable, religious, or educational purposes.”
• 1909 – The Payne Aldrich Tariff Act of 1909 exempted from a general corporate
excise tax “any corporation or association organized and operated exclusively for religious, charitable, or educational purposes, no part of the net income of which inures to the benefit of any private stockholder or individual.”
• 1913 – The Tariff Act of 1913 exempted from Federal income tax “any corporation or association organized and operated exclusively for religious, charitable, scientific, or educational purposes, no part of the net income of which inures to the benefit of any private shareholder or individual.” Compared to the 1909 excise tax exemption, this income tax exemption included corporations organized for scientific purposes.
59
As explained in greater detail in Part II.D, an organization may qualify as publicly supported under either of two sections of the Code: section 509(a)(1) or section 509(a)(2). An organization generally will satisfy the requirements of section 509(a)(1) if it receives at least one-third of its support from governmental units and the general public, or, failing this mechanical test, if it satisfies a “facts and circumstances” test. Treas. Reg. sec. 1.170A-9(e)(2) and (3). Section 509(a)(2) generally extends public charity status to organizations that receive extensive public support through the operation of trades of businesses that are related to such organizations’ exempt purposes, as well as from contributions, grants and the like. Certain other organizations qualify for public charity status regardless of whether they meet one of the above-described public support tests. See secs. 509(a)(1) and 170(b)(1)(a)(i) through (v); sec. 509(a)(3); sec. 509(a)(4).
• 1918 – The Revenue Act of 1918 expanded the list of charitable purposes to include the prevention of cruelty to children or animals.
• 1921 – The Revenue Act of 1921 expanded the type of organizations eligible for
exemption to include any community chest, fund, or foundation, and added literary purposes to the list of exempt purposes.
• 1934 – The Revenue Act of 1934 added the requirement that no substantial part of an
organization’s activities may be lobbying (i.e., the carrying on of “propaganda” or “attempting to influence legislation”).
• 1954 – The Revenue Code of 1954 added the requirement that charitable
organizations may not participate or intervene in political activity. The Act also added testing for public safety as an exempt purpose.
• 1969 – The Tax Reform Act of 1969 codified the distinction between public charities
and private foundations and imposed a series of excise taxes on private foundations.
• 1976 – The Tax Reform Act of 1976 established an elective standard for determining
whether a public charity’s lobbying activities were permitted and imposed excise taxes on excess lobbying activities. The Act also added the fostering of national or international amateur sports competition as an exempt purpose.
• 1987 – The Revenue Act of 1987 imposed excise taxes on the lobbying activities of
public charities and clarified that political campaign activities may not be conducted “in opposition to” a candidate.
• 1996 – The Taxpayer Bill of Rights 2 of 1996 imposed excise taxes on “excess
benefit transactions” between a charitable organization and an insider of the organization.
To summarize the major provisions: the initial statutory income tax exemption of 1913 included religious, charitable, scientific, and educational purposes, and also contained the prohibition on private inurement. The lobbying restriction originated in 1934, and the ban on political activity was introduced in 1954, each of which was supplemented with an excise tax regime in 1976 and 1987 respectively. The present law classification of public charities and private foundations and the stricter regulation of private foundations occurred in 1969,60 and taxes on insider transactions involving public charities were enacted in 1996. There are numerous other Code sections that affect charitable organizations that are not detailed above. The most significant are the charitable contribution deduction, which first appeared in 1917 for contributions to organizations and associations organized and operated exclusively for religious, charitable, scientific, or educational purposes, or to societies for the prevention of cruelty to children or animals; and the rules imposing taxation on the unrelated business income of exempt organizations (including charitable organizations), which were introduced in 1950.
60
As discussed in Part II.D, prior to 1969 foundations were distinguished from other charities, but it was the 1969 Act that codified the distinction.
B. Summary of Threshold Requirements of Charitable Status