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![handle is hein.crs/goveqix0001 and id is 1 raw text is: Con re &on I Research S
informing I leqi I ive de a ~ in e 1914
August 14, 2024
The Illegality Doctrine and 501(c)(3) Organizations
Courts and the Internal Revenue Service (IRS) have long
recognized an implied requirement that organizations
exempt from taxation under Internal Revenue Code (IRC)
Section 501(c)(3) must not have an illegal purpose. As
explained by the Supreme Court in Bob Jones University v.
United States, 461 U.S. 574 (1983), the origins of this
illegality doctrine emanate from the law of charitable trusts.
Loss of government revenues from tax exemption is often
justified on the grounds that tax-exempt organizations serve
desirable public purposes and lessen the government's costs
and burdens. As a corollary to this public benefit principle,
tax exemption is not justified when an organization has an
illegal purpose because the organization does not serve a
public purpose and the organization increases the
government's costs and burdens. The illegality doctrine
helps ensure that the government is not subsidizing activity
that it aims to prevent. When an organization provides some
public benefit but engages in substantial illegal activity, the
IRS principally relies on the statutory text of IRC Section
501(c)(3)-requiring organizations to be organized and
operated exclusively for one or more enumerated exempt
purposes-to deny 501(c)(3) status.
This In Focus examines how and when courts and the IRS
have used the illegality doctrine to deny organizations
501(c)(3) status.
11ega Purpose
To qualify for tax exemption under IRC Section 501(c)(3),
an organization must be organized and operated exclusively
for religious, educational, scientific, charitable, or other
enumerated purposes. As explained by the Supreme Court
in Better Business Bureau of Washington, D.C., Inc. v.
United States, 326 U.S. 279 (1945), in which the Court
interpreted a provision akin to IRC Section 501(c)(3), the
presence of a single [nonexempt] purpose, if substantial in
nature, will destroy the exemption regardless of the number
or importance of truly [exempt] purposes. In general, when
a taxpayer challenges the IRS's denial of tax-exempt status,
the taxpayer bears the burden of proof to show that it is
entitled to tax exemption.
In Church of Scientology of California v. Commissioner, 83
T.C. 381 (1984), the Tax Court held that a church did not
qualify as a 501(c)(3) for certain tax years on several
grounds, including an illegal purpose. The Tax Court found
that the church conspired to impede the IRS in
investigating, assessing, and collecting taxes from the
church and affiliated churches. The church filed false tax
returns, burglarized IRS offices, stole IRS documents, and
harassed, delayed, and obstructed IRS agents who tried to
audit the Church's records. The Tax Court determined that
the church's course of conduct constituted a conspiracy to
defraud the United States in violation of 18 U.S.C. § 371
and demonstrated that the church had a substantial illegal
purpose.
The church argued that there were less restrictive ways for
the government to purge misconduct than withholding its
tax exemption. It claimed criminal prosecution of specific
church officials could have vindicated the government's
interest with less intrusion into its church members' First
Amendment associational and free exercise rights. The Tax
Court concluded neither the First Amendment nor
charitable trust principles limited the government's remedy
to criminal prosecution. The Tax Court remarked:
[T]he Government's interest in ferreting out crime
is not the only interest at stake here. The
Government also has an interest in not subsidizing
criminal activity. Were we to sustain [the church's]
exemption, we would in effect be sanctioning [its]
right to conspire to thwart the IRS at taxpayer's [sic]
expense. We think such paradoxes are best left to
Gilbert and Sullivan.
ngagin n ea Activt es
The operational test in Treasury Regulation Section
1.501(c)(3)-1, which some courts have embraced, makes
plain that an organization will not be regarded as operating
for exempt purposes if more than an insubstantial part of
its activities further a nonexempt purpose. The IRS has
applied the operational test to stress that even an
organization with a legal purpose will not qualify for tax
exemption under IRC Section 501(c)(3) if it engages in
substantial illegal activity.
Treasury Regulation Section 1.501(c)(3)-1(d)(2) clarifies
that an organization is not precluded from qualification
under IRC Section 501(c)(3) if, in carrying out its primary
purpose, the organization advocates for social or civil
change or opines on controversial issues with the intent to
mold public opinion or gain public acceptance so long as it
is not an action organization. In general, an organization
is an action organization if (1) a substantial part of its
activities is attempting to influence legislation; (2) it
participates or intervenes in a political campaign on behalf
of or in opposition to a candidate for public office; or (3) its
main or primary objective or objectives can only be
accomplished by legislation or a defeat of proposed
legislation and it advocates or campaigns for the attainment
of that objective.
In Mysteryboy, Inc. v. Commissioner, T.C. Memo 2010-13,
the Tax Court held that an organization did not qualify as a
501(c)(3), in part, because it found that the organization's
proposed activities caused the organization not to be
operated exclusively for a tax-exempt purpose. The
organization's](ViewImageLocal?handle=hein.crs/goveqix0001&div=1&collection=&method=preview&ext=.png&size=3)