Commercial Activity and the Operational Test

Abstract

A continuing issue for charitable nonprofit tax-exempt organizations is whether or not their current or planned activities violate the operational test, which states that an organization must operate “exclusively for one or more exempt purposes” in order to qualify for tax exemption as an IRC § 501(c)(3) organization. It is the language that follows this statement, that “an organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose,” that has led to a good deal of confusion for organizations. The test is cited by the IRS in its administrative rulings and letters and is also cited in court decisions; but the IRS has been inconsistent, and the courts have continued to issue contradictory decisions. A flurry of private letter rulings (PLRs) have been issued in the last several years by the IRS, citing revenue rulings (RRs) and case law, and still organizations seek counsel on what is appropriate and what is legal as they further their missions in new ways. This article will set out recent decisions by the IRS issued through PLRs, discuss seminal case law decisions, set forth available statistics, and render some guidance on the state of affairs in this area of the law.

Keywords: Charitable Organizations, Commerciality Doctrine, Tax Exempt Organizations, PLR, Nonprofit Organizations, Operational Test