Section 501(c)(3) directs the IRS to consider whether an applicant is "organized and operated exclusively" for one or more of the eight exempt purposes set forth in the statute. Regulations promulgated by the Treasury Department state that this language creates two tests for exempt status, the "Organizational Test" and the "Operational Test." This page discusses the "Organizational Test"; read about the "Operational Test" here.
The Organizational Test
To be recognized by the IRS, an entity must be formally organized under the laws of a particular state. Although the specific procedure will vary from state to state, this will always involve the drafting and filing of organizational documents (whether referred to as "articles of organization," "articles of incorporation," a "charter," "by-laws," or another form of document). For more information on forming a non-profit organization, see the Digital Media Law Project's Legal Guide.
However, when forming a nonprofit for which you intend to seek tax-exempt status, there are separate requirements imposed by the IRS; simply forming as a non-profit entity under state law is not sufficient. Specifically, the IRS's Organizational Test scrutinizes the purposes for which a non-profit is created and the powers granted to the non-profit in its organizational documents. [FN1] The Treasury Regulations governing the Organizational Test state:
(i) An organization is organized exclusively for one or more exempt purposes only if its articles of organization (referred to in this section as its articles) ... :
(a) Limit the purposes of such organization to one or more exempt purposes; and
(b) Do not expressly empower the organization to engage, otherwise than as an insubstantial part of its activities, in activities which in themselves are not in furtherance of one or more exempt purposes.
(ii) In meeting the organizational test, the organization's purposes, as stated in its articles, may be as broad as, or more specific than, the purposes stated in section 501(c)(3). ... [If] the articles state that the organization is formed for charitable purposes, such articles ordinarily shall be sufficient for purposes of the organizational test ... .
(iii) An organization is not organized exclusively for one or more exempt purposes if its articles expressly empower it to carry on, otherwise than as an insubstantial part of its activities, activities which are not in furtherance of one or more exempt purposes, even though such organization is, by the terms of such articles, created for a purpose that is no broader than the purposes specified in section 501(c)(3). ...
(iv) In no case shall an organization be considered to be organized exclusively for one or more exempt purposes, if, by the terms of its articles, the purposes for which such organization is created are broader than the purposes specified in section 501(c)(3). The fact that the actual operations of such an organization have been exclusively in furtherance of one or more exempt purposes shall not be sufficient to permit the organization to meet the organizational test. Similarly, such an organization will not meet the organizational test as a result of statements or other evidence that the members thereof intend to operate only in furtherance of one or more exempt purposes. [FN2]
More succinctly, the organizational documents for a tax-exempt entity must meet a two-prong test: first, they must reflect that the entity's purpose is no broader than the eight purposes set forth in Section 501(c)(3); and second, they must reflect that the entity has not expressly been granted powers to carry on activities outside of the scope of the Section 501(c)(3) purposes.
1. Do your organizational documents state only tax-exempt purposes?
The first prong is easily met; a non-profit can satisfy this requirement by reciting some or all of the Section 501(c)(3) purposes as its purpose in its articles of organization. A news organization should be careful if it mentions its journalistic mission in the statement of its purpose, because journalism is not automatically considered to be educational in nature. This does not, of course, mean that a 501(c)(3) organization cannot engage in journalism. However, to qualify for a tax exemption, the purpose of the organization must be one or more of the eight 501(c)(3) purposes, and journalism may be the method by which those purposes are fulfilled (instead of a purpose unto itself). Applicants should also beware of using boilerplate language that states that the organization is created "for all legal purposes," or similar language; the scope of "legal purposes" is far broader than the scope of tax-exempt purposes.
2. Do your organizational documents grant powers inconsistent with tax-exempt purposes?
The second prong is also relatively straightforward, and simply means that the organization cannot expressly be granted powers inconsistent with the 501(c)(3) purposes. In other words, if an organization claims that it is intended for "charitable" purposes, it should not be specifically empowered to conduct other business for profit.
Note that the second prong of the Organizational Test focuses on whether any of the organization's granted powers are expressly intended for non-exempt purposes. The United States Tax Court has stated that an applicant should not fail the second prong merely because it is granted broad powers that could be used for either exempt or non-exempt purposes; rather, the IRS should consider the actual motivations in granting those powers and how the organization has used them. [FN3]
Because the Organizational Test might require the IRS to consider how an organization's granted powers are actually used [FN4], it overlaps with the Operational Test. However, it is important to remember that the Operational Test does not trump the Organizational Test. If the granted powers of a non-profit explicitly exceed the exempt purposes set forth in Section 501(c)(3), the non-profit cannot satisfy the Organizational Test by limiting itself in practice to exercising its powers in furtherance of exempt purposes. [FN5]
1 Treas. Reg. § 1.501(c)(3)-1(b) (as amended in 2008).
2 Treas. Reg. § 1.501(c)(3)-1(b)(1)(i-iv) (as amended in 2008).
3 Peoples Translation Serv./Newsfront Int'l v. Comm'r, 72 T.C. 42, 48 (1979) ("The issue of ‘organized' is primarily a question of fact not to be determined merely by an examination of the certificate of incorporation but by the actual objects motivating the organization and the subsequent conduct of the organization. ... The mere existence of power to engage in activities other than those set out in section 501(c)(3) does not in itself prevent petitioner from meeting the organizational test.")
4 See Presbyterian and Reformed Pub. Co. v. Comm'r, 743 F.2d 148, 155 (3rd Cir. 1984) ("If, for example, an organization's management decisions replicate those of commercial enterprises, it is a fair inference that at least one purpose is commercial, and hence nonexempt.").
5 Treas. Reg. § 1.501(c)(3)-1(b)(1)(iv) (as amended in 2008).
