In PLR 201814009, the IRS has ruled that an organization that provides an internet crowdfunding platform to facilitate the funding of charitable organizations in exchange for a fee does not qualify for tax-exempt status under Section 501(c)(3).

Facts

The sole activity of the organization at issue (ORG) is to provide clients with an internet crowdfunding platform that the clients, in turn, can use to raise funds for charitable programs. ORG makes its services available to any client willing to pay its fees, although its Platform Licensing Agreement limits use of the platform to campaigns for the benefit of organizations that are tax-exempt under Section 501(c)(3).

In exchange for use of its platform, ORG collects platform management fees (a percentage of charitable contributions received) and third-party payment processing fees (a certain amount per transaction). ORG sets the amount of the fees it charges based on its business expenses and an analysis of fees charged by similar organizations. ORG is supported solely by these fees.

Ruling and analysis

The IRS determined that ORG does not qualify for tax exemption under Section 501(c)(3), because its sole activity is the conduct of a trade or business for the production of income. Similarly, the IRS ruled that ORG failed to meet the operational requirements to qualify under Section 501(c)(3) because more than an insubstantial part of its activities is not in furtherance of an exempt purpose.

The IRS compared ORG's activities to those of organizations addressed in several court cases, identifying a number of relevant factors in its determination that ORG has a substantial non-exempt purpose. Specifically, the IRS noted that ORG:

1. Competes directly with other commercial internet crowdfunding platform service providers
2. Makes it services available to any client willing to pay its fees
3. Does not offer below-cost services to clients based on ability to pay
4. Receives all its funding from fees and receives no public funding from grants or charitable contributions
5. Carries on an activity (providing crowdfunding services for a fee) that is not in and of itself charitable
6. Conducts an activity that is ordinarily carried on by commercial ventures
7. Sets fees at a level high enough to recoup costs and make a profit

In addition, the IRS concluded that ORG does not qualify for tax exemption under Section 501(c)(3), because it is a feeder organization described in Section 502. Section 502 provides that carrying on a trade or business for profit is not an exempt purpose on the grounds that the profits are payable to Section 501 exempt organizations. Thus, the fact that the funds raised on ORG's platform are provided solely for Section 501(c)(3) organizations is insufficient to characterize ORG's activities as charitable.

Implications

In recent years crowdfunding has become a valuable tool for both nonprofit and for-profit organizations. Small and large organizations can use crowdfunding to generate revenue and reach a larger number of potential donors that are willing to contribute to a particular cause. While ORG offers its crowdfunding services for the benefit of charitable organizations, this PLR indicates that the IRS views the business of crowdfunding for charitable organizations for a fee as a trade or business ordinarily carried on for profit. The IRS looks to the actual operating activities of entities seeking tax-exemption under Section 501(c)(3) and not just to the amount of funds that are ultimately transferred to tax-exempt organizations as a result of the platform management services being provided.

As noted previously, ORG did not meet the operational test described in Treas. Reg. Section 1.501(c)(3)-1 to qualify as a tax-exempt organization because its sole activity was to conduct a trade or business for the production of income. ORG makes crowdfunding platforms available to Section 501(c)(3) organizations, but operates like a commercial, for-profit organization. In addition, ORG is a Section 502 feeder organization that provides profits to tax-exempt organizations, but does not conduct sufficient charitable activity to qualify for tax exemption under Section 501(c)(3).

PLR 201814009 provides a concise summary of the elements and factors, established through case law and revenue rulings, that the IRS considers to determine if an entity operates with a substantial commercial purpose and therefore fails to qualify as a tax-exempt organization under Section 501(c)(3). For instance, ORG does not receive public funding, is supported solely by the fees that it charges to its clients, and carries on an activity (providing crowdfunding services for a fee) that is not charitable per se. Based on the nature of ORG's operating activities, nearly all of the factors outlined by the IRS suggest that ORG should not qualify for tax exemption under Section 501(c)(3).

Tax-exempt organizations should be aware that, when using crowdfunding as a means to solicit donations, a number of issues can arise in the process, including: (1) requirements to register as a charitable organization in particular states, (2) private inurement risks, and (3) the need to increase charitable contribution thresholds to account for the fees owed to crowdfunding organizations for platform management.

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.

Please contact your Ernst & Young LLP tax professional with any questions.

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— For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg

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