ALI-ABA Course of Study Resort Real Estate and Clubs: Formation, Documentation, and Operation. July 12-13, 2007 San Francisco, California

Transcription

1 19 ALI-ABA Course of Study Resort Real Estate and Clubs: Formation, Documentation, and Operation July 12-13, 2007 San Francisco, California The Roles of Tax-Exempt Organizations in Resort Governance By Jo Anne P. Stubblefield Hyatt & Stubblefield, P.C. Atlanta, Georgia

2 20 2

3 21 The Roles of Tax-Exempt Organizations in Resort Governance By Jo Anne P. Stubblefield Hyatt & Stubblefield, P.C. I. Introduction There has been increasing interest among resort developers in using tax-exempt entities organized under Section 501(c) of the Internal Revenue Code to provide educational programs, coordinate land management and conservation activities, and provide other services and funding for various programs, projects, services, and activities that can benefit the residents, resort visitors, and the local community. Among the activities that such an entity might engage in are: (i) activities; (ii) cultural, artistic, and educational programs, festivals, and holiday celebrations and learning centers and computer centers; (iii) charter clubs and other volunteer organizations and activities; (iv) recreational leagues; (v) social services, educational programs, community outreach programs, and other charitable causes; (vi) the preservation and maintenance of natural areas, wildlife preserves, or similar conservation areas and sponsorship of educational programs and activities that contribute to the overall understanding, appreciation, and preservation of the natural environment within and surrounding the resort development; (vii) grants and contributions to other nonprofit or tax-exempt entities; and (viii) other programs and activities which enhance the welfare, benefit, and lifestyle of residents within and outside of the resort. Section 501(c) of the Code provides that tax-exempt status may be conferred on specific organizations that are not organized or operated for profit. Of the enumerated organizations granted this tax-exempt status, those specified in Sections 501(c)(3) and 501(c)(4) generally would be the most appropriate to perform these types of functions within a resort development. An understanding of the differences between these types of organizations and the benefits of each is helpful in determining the most appropriate and beneficial structure for a particular resort. Section 501(c)(3) of the Code provides tax-exempt status to entities which are organized and operated exclusively for one or more of the following purposes: religious, charitable, scientific, 1200 Peachtree Center South Tower Peachtree Street, N.E. - Atlanta, Georgia Telephone (404) Telecopier (404)

4 22 literary, educational, fostering national or international amateur sports competition, prevention of cruelty to children or animals and testing for public safety. Section 501(c)(4) confers tax-exempt status upon "civic leagues" or other non-profit entities organized exclusively to promote the social welfare of a community and the net earnings of which are devoted to charitable, educational, or recreational purposes. Both types of organizations must serve the public and not private interests. Thus, the net earnings may not inure to the benefit of any private shareholder or individual. For example, an entity formed by a developer to maintain parks and open space in order to relieve itself of a contractual obligation to maintain the areas would not qualify, since the developer would be receiving a private inurement. The size of the private inurement is irrelevant. While both types of entities may qualify for exemption from income taxation, voluntary contributions made to a 501(c)(3) organization are deductible to the contributor, whereas contributions made to a civic league or other organization are not tax deductible. However, there are significant differences in the scope of activities that each may engage in. II. 501(c)(4) Organizations. A 501(c)(4) organization is established to serve the "common good and general welfare of the people of a community" and primarily operates to bring about civic betterments and social improvements. In order to qualify for tax-exempt status, the entity (1) must serve a community that bears a reasonable relationship to an area ordinarily identified as governmental, (2) must not conduct activities directed to the exterior maintenance of private residences, and (3) must make property and facilities it owns available for use by the general public. The benefits provided can be those ordinarily supplied by a profit-making business, as long as the organization itself doesn't operate for profit and it provides a service for the general public. IRS rulings permit the use of 501(c)(4) tax-exempt organizations to maintain roads, parkways, sidewalks, and streetlights, among other things, that are accessible to or benefit a community recognizable as a governmental unit, subdivision, or district. IRS rulings also permit such entities to engage in a wide variety of other activities, including operating a bus service, broadcasting civic and cultural radio programs, sponsoring festivals, conducting a community art show, operating a volunteer fire department, contracting with a third party to provide enhanced security within the community, providing financial counseling, publishing a free community newspaper, preserving and beautifying public parks, sponsoring community recreational activities and youth sports leagues, conducting qualified public entertainment activities, and engaging in education-related activities. In addition to maintaining "public" land, such as conservation areas and open space, a 501(c)(4) organization has the flexibility to undertake a wide variety of activities to promote and encourage community interaction and create a sense of "community." While use of its facilities and participation in its programs must be available to the general public and generally cannot be limited to residents of a particular development, the fact that they primarily benefit the residents of a particular development will not make the organization ineligible for tax-exempt status. 2

5 23 III. 501(c)(3) Organizations. Entities organized under I.R.C. Section 501(c)(3) can be created as independent organizations or organized under the "umbrella" of a 501(c)(4) organization to perform specific roles in the community. Although its permissable purposes and activities are more limited in scope than 501(c)(4) organizations, a 501(c)(3) organization could still be very useful in the context of a resort development, since a 501(c)(3) organization can solicit tax deductible contributions from the residents of the development, local businesses, other charitable or civic foundations, and the general public, to help fund its activities. Restrictive covenants may authorize the imposition of assessments and require the payment of transfer fees to a 501(c)(3) organization in order to provide funding in the event that voluntary contributions are not adequate to fund the desired activities. Such assessments and fees would be tax-exempt income to the organization. However, as opposed to the contributions from the general public that may be tax deductible to the contributor, the assessments or fees mandated by the restrictive covenants would not be tax deductible, since they lack the requisite "donative intent." The IRS and the courts have concluded that a contribution required by a contractual obligation is not voluntary and does not meet the requirements of a charitable contribution. As stated above, 501(c)(3) entities must be organized and operated exclusively for one or more of the following purposes: religious, charitable, scientific, literary, educational, fostering national or international amateur sports competition, prevention of cruelty to children or animals and testing for public safety. A 501(c)(3) organization has the burden of establishing that it is organized and operated for an exempt purpose. To satisfy this burden, the organization must pass both an organizational test and an operational test. If the organization fails to meet either test, it is not exempt. A. Organizational Test. The focus of the organizational test is whether the articles of organization limit the organization to one or more exempt purposes and do not expressly empower the organization to engage in other activities that are not in furtherance of one or more of the organization's exempt purposes. However, the articles may permit a non-exempt purpose which is an insubstantial part of the organization's activities. Two criteria must be met to satisfy the organizational test: (a) the purpose for which the organization is created cannot be broader than the purposes specified in Section 501(c)(3), irrespective of actual operations; and (b) the articles cannot expressly empower the organization to carry on substantial activities that are not in furtherance of one or more exempt purposes. For example, if the articles of organization provide for the maintenance of the park and open space, but also provide that maintenance will be provided to residents of the adjoining community for a fee, the organization would fail the organizational test because the articles allow the organization to carry on a substantial activity which is not in furtherance of its tax-exempt purpose. B. Operational Test. Having met the organizational test, the organization also must meet the operational test. The operational test centers around the actual primary activities of the organization. The organization will be regarded as operating exclusively for an exempt purpose if it engages primarily in activities that would accomplish one or more of the exempt purposes 3

6 24 established by Section 501(c)(3). The organization will not be regarded as operating exclusively for an exempt purpose if more than an insubstantial part of the activities is not in furtherance of an exempt purpose. Of the purposes authorized under Section 501(c)(3), such an organization established as part of the overall governance structure for a resort development would be most likely to engage in activities that would be categorized as either charitable or educational. Charitable purposes would include those that promote the common good and general welfare of the community. "Community" in this context is used in its larger sense to include the general public. Therefore, any services which it provides cannot be exclusively or primarily for the benefit of residents or property owners within a particular development. If the purpose of the organization is to serve and enhance the lifestyle of the residents and the benefit to the public at large is merely incidental, the organization will not qualify as a tax-exempt organization. Therefore, the taxexempt organization must be structured such that its activities benefit the general public and not simply the residents of a particular development. Examples would include performing conservation and environmental activities such as the preservation of open space, helping local governments deal with water and air pollution, planting trees, and engaging in activities benefiting parks and park lands; housing related activities including the provision of low income housing and housing for the elderly; and the promotion of the arts and historical preservation. Services that "lessen the burdens of government" also may qualify as charitable purposes. Generally, in determining whether the organization's activities lessen the burden of government, a two-part inquiry is involved: (1) Does the governmental unit consider the activity to be its burden and recognize the organization as acting on its behalf? and (2) Do the organization's activities actually lessen the burden of government? Activities that could be considered to lessen the burden of government may include maintaining parks for public use, or the creation and operation of a transportation system within the community but serving the general public. An educational purpose is one that relates to the instruction or training of the individual to improve or develop his capabilities or the instruction of the public on subjects useful to the individual and beneficial for the community. For example, an entity that serves educational purposes may be one that promotes arts in the community or other public places, a museum that showcases local history or artifacts, or a group that educates the community on matters of environmental significance. An organization with an educational purpose might also "adopt" and support the local schools. The presence of an exempt purpose is not, in and of itself, sufficient to achieve exempt organization status under Section 501(c)(3). The organization must have as its primary activity the performance of an exempt function. A 501(c)(3) organization may perform non-exempt activities without the loss of its exempt status only if such activities are merely incidental to the organization's principal function. 4

7 25 IV. Control Over the Tax-exempt Organization There are no specific requirements regarding who may control a tax-exempt organization and thus, the issue of control should not influence the decision as to which type of tax-exempt entity to create. However, in establishing a tax-exempt organization, the issue of control can factor in to whether the organization satisfies the requirement that it serve a public rather than a private interest. Private interests include designated individuals, the creator of the organization, shareholders, and persons controlled (directly or indirectly) by these private interests. While control does not necessarily relate to benefit, in all likelihood, the IRS would look very carefully at an organization controlled completely by a single entity, e.g., a tax-exempt organization controlled by the developer and used to develop and maintain infrastructure within a development. The nexus between the developer and the organization could cause a neutral third party (a court) to conclude that a private and not a public interest was being served. Therefore, it will be important for those in control of the tax-exempt organization to be aware of their role and their duties to the general public. V. Summary Although there is significant overlap in the scope of activities in which 501(c)(3) and 501(c)(4) organizations may engage, a 501(c)(4) does have broader authority to engage in activities that primarily benefit the members of a particular community as long as it does not exclude the general public. A 501(c)(3) organization must be organized and operate exclusively for one or more of a more limited number of exempt purposes, which in the context of a planned community would most likely be charitable and educational purposes. Its activities must promote the common good and general welfare of the broader community, i.e., the general public. Thus, if its activities primarily benefit particular property owners and residents and the benefit to the public at large is merely incidental, it will not qualify for tax-exempt status. If the role of the organization will be limited to purposes qualifying under Section 501(c)(3) and its activities will be directed to the general public, then the ability of a 501(c)(3) organization to solicit and accept voluntary contributions which are generally tax deductible to the donor makes it an attractive choice. However, one must keep in mind that any assessments or transfer fees which are paid pursuant to a legal obligation established by restrictive covenants generally would not be deductible since they lack the necessary "donative intent." 5

8 26 2