A charity’s tax-exempt status under §501(c)(3) of the Internal Revenue Code may be revoked for many reasons. However, the most common is if the charity stops operating exclusively for charitable purposes.  The United States Court of Appeals for the Third Circuit has developed and applied a 2-prong test “drawn directly from the wording of §501(c)(3) and the legislative history of its enactment. The statute explicitly cites as qualifying for tax exemption those entities ‘organized exclusively for religious, charitable . . . or educational purposes.’”  Presbyterian & Reformed Publishing Co. v. Comm’r of Internal Revenue, 743 F.2d 148, 152 (3d Cir. 1984).  That inquiry requires courts to determine: (1) the purpose of the organization claiming tax-exempt status and (2) to whose benefit the organization’s activities inure.

In Presbyterian & Reformed Publishing Co., the lower Tax Court affirmed revocation of tax-exempt status for Presbyterian & Reformed Publishing Co. (“P&R”).  The Tax Court reasoned that P&R, a religiously-oriented publishing house that was tax-exempt since 1939, had become a profitable venture as of 1980. By that point it had only a distant relationship to a church. P&R was engaged in the publication of religiously-oriented books that had become similar to a commercial enterprise.

In reaching its decision, The Tax Court considered the following factors: (a) that P&R’s net and gross profits between 1969 and 1979 increased dramatically; (b) that the prices set for its books generated consistent and comfortable profit margins; and (c) that it was in competition with commercial publishers as a result of its purchase and sale of books with a commercial publishing house. After weighing these factors, the Tax Court determined that P&R was not operating exclusively for charitable purposes and revoked its tax-exempt status.

However, that decision was reversed on appeal. The Third Circuit disagreed with the Tax Court and held that P&R would not lose its 501(c)(3) status.  The Third Circuit cited the 2-prong inquiry referred to above, which was drawn from the plain language of the statute and its legislative history.  That legislative history included a statement by the sponsor of the statute, Senator Bacon, who made the following comments:

[T]he corporation which I had particularly in mind as an illustration at the time I drew this amendment is the Methodist Book Concern, which has its headquarters in Nashville, which is a very large printing establishment, and in which there must necessarily be profit made, and there is a profit made exclusively for religious, benevolent, charitable, and educational purposes, in which no man receives a scintilla of individual profit.  Of course if that were the only one, it might not be a matter that you would say we would be justified in changing these provisions of law to meet a particular case, but there are in greater or lesser degree such institutions scattered all over this country.  If Senators will mark the words, the amendment is very carefully guarded, so as not to include any institution where there is any individual profit, and further than that, where any of the funds are devoted to any purpose other than those which are religious, benevolent, charitable, and educational. (emphasis added)  Presbyterian & Reformed Publishing Co. at 153.

In its analysis, the Third Circuit first determined to whose benefit the organization’s activities inured.  The Court determined there was no factual basis for concluding that P&R’s increased commercial activity inured to the personal benefit of any individual.  There was no evidence of personal enrichment of any individual at P&R.  In fact, the highest salaried employee of P&R in 1979 received $15,350; none of the seven other paid employees received annual salaries over $12,500 and five were paid under $6,250.  The Court was satisfied that the benefits of the organization’s activities did not inure to any individual.  For comparison purposes, see Church of Scientology of California v. Comm’r of Internal Revenue, 412 F.2d 1197 (Ct. Claims 1969) (since church allowed leader of Scientology, L. Ron Hubbard, to receive ten percent of church’s gross income instead of a salary, the earnings of the church directly inured to the private benefit of Mr. Hubbard and tax-exempt status was denied to the Church of Scientology).

Second, the Third Circuit determined P&R’s purpose.  It held that its purpose was religious, despite the fact that it was not formally affiliated with or under the control of any particular church.

Third, the Third Circuit considered the Tax Court’s concern that P&R was accumulating “profits.”  As early as March, 1974, P&R notified the IRS that it was accumulating surplus cash as a “building fund” and actually used this fund to purchase land in Harmony, New Jersey.  In 1978, P&R built a combined warehouse/office building on that site using the fund and in 1979 purchased equipment using the fund.  P&R’s notice to the IRS and the IRS’ recognition of P&R’s expansion led the Third Circuit to conclude that this accumulation of cash did not amount to “profits” such that P&R’s tax-exempt status was in jeopardy.  The Third Circuit was satisfied that P&R had not deviated from its claimed tax-exempt purpose, despite the accumulation of a cash surplus.

On this basis, the Third Circuit reversed the decision of the Tax Court and permitted P&R to maintain its tax-exempt status.

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