13 June 2017 Organization providing services-for-fee to community news co-ops fails to qualify for tax exemption, IRS rules In PLR 201720010, the IRS ruled that an organization with a substantial portion of its activities dedicated to providing services for a fee to co-op news organizations failed to qualify for tax exemption under Section 501(c)(3) because it was not operating exclusively for one or more exempt purposes. The organization's (ORG's) articles of incorporation stated that its purpose was to provide educational and administrative support to independent community journalism initiatives across the country. In so doing, it aimed to help educate local citizens on current events and enhance engagement in civic life. ORG planned to focus on communities that are underserved by local journalism and on news groups serving "less-than-affluent" readership. To accomplish its purposes, ORG developed a co-op model for community-level internet journalism. The model could be used by community groups and could be easily replicated across different communities. For this model, ORG created educational guides to creating new co-ops, business planning templates, and plans for enrolling members. ORG would also provide ongoing staff support to assist the news co-ops. ORG planned to work with community groups that are aligned with its mission and are committed to civic learning and online news. To support such community news groups, ORG created an open-source software platform that it would make freely available. This software platform would enable news sites to integrate reader collaboration in news gathering and would provide membership tracking and bookkeeping. For an upfront fee, in a news affiliate's first year after launching, ORG would provide additional services — such as life-issue reporting items that the affiliate may publish at its option, website upgrades, and additional tools. ORG would continue to provide such services in subsequent years in return for a certain percent of the affiliate's gross revenues (up to a set maximum). ORG stated that the fees that it charges would be used to offset its costs. It added that it is able to offer these services at relatively low costs because of its foundation's funding and the fact that its founders work without compensation. Furthermore, ORG stated that similar commercial services are not available, but, even if they were, they would not be affordable to the community news affiliates that it serves. ORG was providing services to new co-ops that were not exempt organizations and was charging fees for such services. In so doing, it was competing with commercial publishing software developers and distributors, with "such competition [providing ORG's] activities with a commercial hue." The IRS stated that the activities of ORG were "best described as providing a product with product information and are analogous to a product manual." Private benefit was demonstrated in that the software ORG provided was tailored to specific users, which included community groups organized as new co-ops that ORG helped to establish. In addition, ORG provided consulting and technical services for a percentage of their gross revenue. Finally, the IRS held that the primary activity of ORG was not "an important aid to education and research." The argument of ORG that its programs would assist communities, without access to newspapers, in forming news co-ops to operate online news sites was found to be without merit. By charging fees for tailored software and failing to limit distribution of programs to particular types of organizations, commercial or otherwise, ORG's activities were observed to be neither educational nor advancing education under Section 501(c)(3). The position of the IRS in denying tax-exempt status to ORG is consistent with other private letter rulings it has issued in calendar year 2017 on similar issues in which tax-exempt status was denied. In these rulings, the IRS also found the existence of substantial private benefit, operations akin to that of a for-profit entity, and proposed educational missions that were merely incidental to a primary non-exempt purpose. PLR 201717048 (issued January 30, 2017) described an organization that was incorporated to encourage, support and advance the education of a free and open source application to professional and hobbyist software developers. The organization posited that its mission was purely scientific and educational. The IRS disagreed. The IRS held that the organization's activities conflicted with Treas. Reg. 1.501 (c)(3)-1(d)(1)(ii) insofar as they served a special interest by providing specialized information to its members rather than a public interest by developing and exchanging data among users of a specific type of computer. In addition, the organization's activities did not further a charitable purpose and were not directed toward benefitting a charitable class. Rather, the organization was simply providing a commercially available product to individuals and businesses that could afford it. According to the IRS, the organization's activities amounted to "routine product development" and were not exclusively educational. Especially problematic was that the organization could not engage in educational activities without showcasing or promoting the software application. The activities were also found to be commercial in nature because the manner of the software design, development, testing and distribution was similar to that in which a commercial software company engages to create new products or adapt its products to new uses in order to be competitive. Moreover, the organization was providing services for a fee, or commission, under certain agreements. The majority of the organization's revenue came from such commissions. PLR 201710033 (issued March 10, 2017) pertained to an organization formed to provide publishing and marketing services for authors. The published materials were to include resource materials for churches for youth and adults. Despite the acknowledgement that the organization's publishing activities consisted of creating educational materials, the IRS found that organization operated in a commercial manner because more than an insubstantial part of its operations consisted of providing goods for fees comparable to for-profit entities. The organization argued that it differed from a commercial publishing company because it sought to allow ministry-related books to be published that would otherwise not likely meet the profit-based requirements of commercial publishing firms. However, the IRS contended that the organization was still selling books to the public in a commercial manner based on fair value determination and paying royalties to authors. Moreover, the IRS held that the organization, exhibited similar factors indicative of commercial operations including regular and ongoing book sales, competition with other publishers, common retail pricing structures, marketing and advertising, and the reliance on sales and fees versus contributions. The IRS further explained that the organization was not operated exclusively for exempt purposes because it served the private interests of a for-profit company, its owner and various authors. In addition to providing publishing and marketing services, the organization also collected subvention fees from authors as a means to share in the investment of their books. The organization then paid a percentage of royalties to the authors and one half of net income derived from the sale of books to a for-profit company, which provided various services to the organization. To emphasize the degree of private benefit, IRS quoted a website article noting that the authors had the opportunity to "benefit immediately" from the sale of books and receive "a much larger cut of royalties." For these reasons, the IRS reasoned that operations of the organization were indistinguishable from ordinary commercial publishing practices. In creating a tax-exempt organization, care should be exercised to ensure the organization's proposed mission furthers an exempt purpose and is clearly delineated in the organization's governing documents. The organization's primary activities should be scrutinized to make certain they do not bestow a private benefit on an individual or a group of persons. Any ancillary activities should be minimized to the extent that they do not overshadow the primary mission of the exempt organization. In addition, websites should be monitored for evidence of commercial competition. — For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg.
Document ID: 2017-0946 | |||||||||||||||||||
