01 March 2018 IRS rules organization developing bionic hand does not qualify for Section 501(c)(3) status In PLR 201808019, the IRS has determined that an organization that plans to develop open-source technology to create a bionic hand does not qualify for exemption under Section 501(c)(3), because it is not operated exclusively for charitable purposes. The organization at issue incorporated as a Nonprofit Public Benefit Corporation, with its Articles of Incorporation stating that it was organized for the charitable purpose of helping people with limb differences. Specifically, the organization intends to develop open-source technology to create bionic hands that will help adults and children with hand amputations to become fully abled. The open-source technology will be developed in collaboration with teams around the world, and the organization hopes to ultimately use the technology to develop other artificial and bionic limbs. The organization has started a fundraising campaign and website to collect donations toward its goal. The organization's website indicates that the organization was formed to create a bionic hand for a preselected individual. Although the redaction of information in the PLR makes it unclear, it appears that the preselected individual is a family member of an officer of the organization. The IRS concluded that the organization is not operating exclusively for exempt purposes because its funds inure to one of its officers. Although the organization intends to expand its operations to help others, it was formed to create a bionic hand for a preselected private individual. The IRS stated that the organization is similar to an organization described in Revenue Ruling 67-367, in which the IRS ruled that an organization established to operate a scholarship plan for preselected individuals did not qualify for exemption. The IRS added that the organization is not exempt because its selection of an officer's family member as a substantial beneficiary of its disbursements violates the prohibition against private inurement of exempt organization funds. The IRS acknowledged that the organization's activities further a charitable purpose in part, but stated that more than an insubstantial part of its activities benefit the private interests and family of the officer. In addition, the IRS noted that the organization had a substantial non-exempt purpose because it was developing open-source software, which is published under licenses that allow any person to use the software for any purpose — whether charitable, personal or commercial. Furthermore, the IRS noted that, although the organization provides some information about a product, this information does not serve an educational purpose under Section 501(c)(3). Similarly, the IRS concluded that the organization's activities do not qualify as promoting health exclusively for charitable purposes. This ruling provides a clear synopsis and application of basic Section 501(c)(3) public charity concepts relevant to the private inurement and private benefit doctrines, emphasizing that an organization may not qualify for Section 501(c)(3) status even when the activities of the organization appear charitable in nature. Although key portions of the ruling were redacted, the takeaway is clear; a public charity must serve a public rather than private purpose, and the presence of a substantial non-exempt purpose will preclude tax-exempt status as a public charity under Section 501(c)(3). In this ruling, the organization was planning to use its resources, at least a portion of which was contributed through fundraising and crowd sourcing, to develop and use open-source technology to create artificial and bionic limbs (with the eventual goal of making artificial and bionic limbs available in different sizes for both adults and children). However, the organization is currently developing an initial bionic hand for a family member of an officer of the organization. The open-source technology would also be freely available to commercial enterprises. Both of these activities were substantial in nature, and served private rather than public interests, overshadowing the potential of the organization to benefit the public. Open-source technology has come under recent scrutiny from the IRS. In PLR 201717048 and PLR 201720010 (see Tax Alert 2017-0946), the IRS held that open-source technology may violate the private benefit doctrine, because it is not directed toward benefitting a charitable class, even though made available to the public. In PLR 201717048, the IRS elaborated its position and examined the technology as analogous to scientific research. Under Treas. Reg. Section 1.501(c)(3)-1(d)(5), scientific research generally serves a public interest if: (1) the research is not incidental to commercial operations, (2) the research results are made available to the public, and (3) the research is directed toward benefiting the public. The IRS ruled that open-source software was similar to incidental and routine commercial software development, and not directed toward benefiting the public or a charitable class. While this technology appears open on its face, in substance it may actually be a collaboration of commercial users and developers that benefit from the results. Organizations seeking to secure tax-exempt status from the IRS must establish that they truly operate exclusively for exempt purposes, ensuring their net earnings do not inure to the benefit of private shareholders or individuals. A private letter ruling is a written statement issued to a particular taxpayer that interprets and applies tax laws to the taxpayer's specific, represented set of facts, and may not be used or cited as precedent by other taxpayers or by IRS personnel. Thus, although the ruling is instructive on how the IRS might rule regarding a particular matter, organizations are cautioned not to rely on the ruling as authority, and to consult with their tax advisors to determine the tax consequences of their own facts and circumstances. — For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg.
Document ID: 2018-0459 | |||||||||||||||||||
