Gargamel, the antagonist in the Smurfs, is the villain. Wile E. Coyote in the Road Runner, Raquelle in Barbie, Lex Luther in Superman, the Joker in Batman, Darth Vader in Star Wars. The list goes on.
That is one side of these stories. It’s the side of the story that is presented to us. It is the side of the story that makes sense to us at the time.
The other side of the stories is that the characters may have just been trying to earn a living, deal with a legitimate problem, etc. In many stories it is the need to build or construct something. To leave a legacy, which most of us hope to achieve even if in some small way. These themes are built into and hinted at in the stories to add an element of authenticity, but the full vantage point of the villain is hardly ever presented.
There is a parallel in real life. There is a age at which we come to realize that the story has another side to it. And, with some reflection, the other side may be a side that we can relate to more than the one that was actually presented.
Nonprofit tax has these underpinnings. What qualifies as a charitable purpose may seem clear. The organizations that violate the rules may seem blameworthy and overreaching. But with some reflection, it may not always be the case.
The Korean-American Senior Mutual Association Inc. v. Commissioner, T.C. Memo. 2020-129, case involves a nonprofit that collects membership fees and uses them to help pay funeral expenses for the members. The IRS has taken the position that paying funeral costs for members is not an exempt function. The court considered the IRS’s position in this case.
Facts & Procedural History
This case involves a nonprofit located in New York. The nonprofit provides burial benefits and assistance to its members surviving family members.
It’s exempt purpose listed in the Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, is as follows:
(1) KASMA is organized as a membership organization open to seniors ages 55 to 90 residing in the New York metropolitan area who pay its membership dues and support KASMA’s purposes; and
(2) To become a member a senior must submit an application for membership and pay the following membership dues: a $100 application fee for seniors ages 55 to 70 or a $150 application fee for seniors ages 71 to 90; a $30 annual fee; and a $10 fee every time a member dies.
The court case notes that members received the following benefits in exchange for their payment of dues:
(1) [the nonprofit] paid a burial benefit to the surviving family and encouraged other members to attend the funeral services and
(2) members received a discount on funeral expenses and received information on burial plots and funeral arrangements.
The IRS recognized the nonprofit as a 501(c)(3) in 1998. The IRS recognized the entity as a Section 509(a)(1) public charity in 2001.
The IRS audited the nonprofit in 2014 for its 2013 tax year. The IRS audit resulted in the issuance of a final adverse determination letter in 2017 revoking its nonprofit status.
The nonprofit petitioned the U.S. Tax Court to contest the revocation of its nonprofit status.
501(c)(3) Status
An organization that qualifies as a 501(c)(3) is exempt from Federal income tax. Donors who make contributions to the organization are able to deduct the contributions against their Federal income taxes.
The organization has to meet several criteria to be a 501(c)(3) nonprofit. This includes the requirement that the organization be organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes. The “operated exclusively” language is referred to as the “operational test.”
Operated Exclusively
For the operational test, the presence of a single substantial purpose that is not an exempt purpose disqualifies the organization under 501(c)(3).
In the present case, the court concludes that the nonprofit did not operate exclusively for a permitted purpose. It reached this conclusion based on its determination that the nonprofit:
- Was not operated to serve a charitable class,
- Operated in a commercial manner, and
- Its activities served a private rather than public interest.
According to the court, the nonprofit failed the charitable class requirement and the public interest requirement because it only paid benefits for its members. It did not serve the general public as stated in its Form 1023.
The court found that the nonprofit operated in a commercial manner “by providing burial benefits on the basis of payments over time by its members of membership dues and other fees.” This type of benefit is akin to services a for profit company might provide, such as a private insurance company.
The nonprofits finances also did not seem consistent with its nonprofit mission. The ruling notes that the nonprofit received $2,135,774 in membership dues in 2013 and paid out $1,990,574 in benefits that year. A few years prior to this, the nonprofit purchased a $817,362 office for cash. This suggests that the nonprofit was earning a profit.
The Takeaway
The ruling in this case is consistent with the IRS’s long standing approach to organizations that provide assistance to members for funeral costs.
It does not address the fact that funeral costs can be quite expensive. They cost can be quite burdensome for surviving family members. When not paid by the family members or others, the cost falls on the state and local governments. By encouraging pre-payments and gathering funds from loved ones, organizations like the one in this ruling can help reduce the costs incurred by the state and local governments.
Those wanting to structure a nonprofit to provide these services should consult with a tax attorney, as there are ways to structure these entities so that they qualify as nonprofits.
There may be other options that should be considered as well. Rather than 501(c)(3)’s, many of these same services can be provided by churches, family fundraisers, or through gofundme accounts. These options can provide viable alternatives in many cases.
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