May 13, 2008

IRS Denies Tax-Exempt Status to Group That Spends Too Little Money on Charitable Programs

In a ruling that could have implications for many charities, the Internal Revenue Service has denied a tax exemption to an organization in part because the group did not spend enough of its money on charitable programs.

This is the first public sign that the revenue service is measuring how much charities spend by using a controversial approach that the government has recently decided to apply.

The IRS said the organization did not carry on a charitable program “commensurate in scope” with its financial resources.

As is its policy, the IRS did not identify the group. But the organization was identified as the National Foundation of America, in Franklin, Tenn., by the Web site of a state government receiver in Tennessee who has been closing the organization.

The IRS ruling was released at a time when the tax agency has been signaling that it plans to take a more-aggressive approach to making sure the nation’s nonprofit organizations are not hoarding or wasting money.

Steven T. Miller, commissioner of the IRS’s tax-exempt and government-entities division, said in a speech last month that the agency would apply a standard that it had briefly embraced years ago but then set aside — a so-called commensurate test — to help determine whether charities were spending money efficiently and effectively.

Less Than 1% to Charity

In its private-letter ruling the IRS said the organization had said in its application for tax-exempt status that it planned “to coordinate and conduct, through its staff, evangelistic campaigns in a number of countries wherein the people are receptive to the Gospel of Jesus Christ.” The group’s initial two-person board of directors was a husband and wife.

But the revenue service said the organization’s primary focus, described on the organization’s Web site, was helping families create a “financial legacy” through “asset exchange programs.” The programs allowed people to exchange annuities, real estate, securities, bonds, and cash for a “tax-deductible installment plan” with a guaranteed payout for a period of time.

The IRS said records that the organization filed with a state government showed that money the organization received and counted as contributions over a year was “primarily from the sale of annuity plans.”

These state records also showed that the money that the organization reported spending on its charitable program during the year was less than one-half of 1 percent of its total revenue and about 3 percent of its total expenses.

Last year, the Tennessee Department of Commerce and Insurance said that the National Foundation of America had been running an insurance business without a licence. State authorities said that the organization promised consumers that its annuity product would entitle purchasers to significant tax benefits because of its federal status as a charity, even though it had not been approved as a charity by the IRS.

In its ruling, the IRS concluded that the organization did not qualify as a charity because it was organized and operated for the primary purpose of running a business. “You do not carry on a charitable program that is commensurate in scope with your financial resources,” the IRS said.

The IRS noted that state authorities who were liquidating the organization wanted the tax agency to make a formal ruling about whether the group would have qualified for charity status.

Some nonprofit officials and legal experts worry that the IRS’s use of a commensurate test could force organizations to prove they spend enough money on their programs or lose their tax exemptions.

Other officials say the application of such a standard is a legitimate tool for the government to use to decide if an organization actually does charitable work.