Demystifying Private Inurement
What exactly IS private inurement? Well, I was uber excited to finally figure it out. That is, until I typed it into a database search box, and had dozens of treatises comprised of hundreds of pages appear all on this ONE subject.
Somewhat undeterred, I felt it important to at least touch on the subject as it really is incredibly important. As an integral factor in obtaining (and maintaining) tax-exempt status, not truly understanding what private inurement is has led to behemoth, and small non-profits, losing or failing to attain their tax-exempt status. However, I think it goes without saying that the need for dozens of court treaties interpreting dozens of court decisions, reinterpreting dozens of court treaties means no one truly knows what they hell is going on. Consequently, in order to evade both your and my boredom in writing pages of circular dribble, this will basically serve as a quick introduction to what private inurement is.
As most of you probably already know, 501(c) basically lays out a blue-print for charitable organizations trying to attain tax-exempt status. Within the statute, it requires that:
“A section 501(c)(3) organization must not be organized or operated for the benefit of private interests, such as the creator or the creator’s family, shareholders of the organization, other designated individuals, or persons controlled directly or indirectly by such private interests. No part of the net earnings of a section 501(c)(3) organization may inure to the benefit of any private shareholder or individual. A private shareholder or individual is a person having a personal and private interest in the activities of the organization.”
(26 U.S.C. § 501(c)(3))
This, ladies and gentlemen, is the doctrine of private inurement. The statute appears deceptively simple by requiring several classes of people to not “inure” the earnings of a charitable organization. But there is SO much more to it then that.
When trying to understand a legal doctrine it always helps to break down the concept itself. The word “inure” means to use, or transfer something. We are all pretty accustomed to what “private” means and the court’s have, for the most part, maintained its popular and literal use. That being, belonging to, of, or for the use of one person or a group. So private inurement basically means the transferring or use of a non-profits earnings (earnings being income, assets, benefits, etc.) for personal reasons. I’ll quickly note another interesting concept I noticed in much of the literature as to how close an individual needs to be to an organization for the doctrine to be applicable. In other words, does the doctrine apply solely to private shareholders and those with a private interest as listed? Can it apply to a family member? A vendor? These are things that I won’t even touch here, but interesting questions nonetheless.
I think that a primary point of confusion is what can or cannot be inured. And more importantly, how does a person go about inuring this thing? Well, it doesn’t help that the courts seemed to be just as confused on this point as most of us are. But from what I was able to glean, private inurement does not mean individuals affiliated with a non-profit organization can not derive a benefit or payment from the non-profit. In fact, those affiliated with non-profits (directors, founders, members and in the rare case shareholders) may even “deal” with their non-profits directly in various transactions.
*cue a synced and contrived “ahhhhh”*
The key is not the transaction itself, rather the “reasonableness” of the transaction. Now, if you’re someone involved in the practice of law than that little tidbit probably made you giggle a little, scoffing “of course”. For those who aren’t in on the joke, probably 95.526861% of the law is measured by “reasonableness”. There really are no true standards, you’re just expected do what is “reasonable”. The trick of course is who you’re dealing with at the time and what they think is reasonable. I assure you Dennis Rodman and my concepts of “reasonableness” probably differ in some respects…but I digress.
Basically, if ever there is a transaction between a group or individual (whether it be payment, benefits, etc.) all of whom are close to a non-profit, that transaction is then tested on a spectrum of reasonableness. The primary question being, “What would customarily be paid or given to a like group, for a like service, in like circumstances?” The moment the transaction begins to appear lop-sided is the moment an agency might begin to question whether inurement has occurred. The evolution of this concept is what has led to officers being awarded deferred benefits, shareholders being paid for contract work, and presidents being paid what many are paid present day.
Mind blown yet? If not, what I found really interesting is there are different categories of inurement, those being:
1. Compensation for Services
2. Rental Agreements
3. Lending Agreements
4. Sale of Assets
5. Equity Distributions
6. Assumptions of Liablility
7. Employee Benefits
8. Services Rendered
9. Provisons of Goods or Services
10. Retained interests.
I won’t even begin to start on all of these, but suffice it to say that in each there even more factors used to determine whether the transactions constitute as inurement or not.
I hope some of this has been helpful. As always, keep in mind that the case law/treaties I read were all encompassing. Not only do the tax courts have various letter and court rulings on the subject, but appellate courts do as well. And lest we not forgot that individual states may or may not have applicable laws as well. Also, it seems that understanding the doctrine is not only important while an entity is operating, but becomes even more important upon its dissolution. In fact, some states require that incorporation documentation state how funds will be dispensed with upon an organizations dissolution, with the failure to do so perceived as planned inurement. Yep.
For cases I used that provide discussion of inurement see:
-Variety Club Tent No. 6 Charities, Inc. v. Comm’r, 74 T.C.M. 1485 (1997).
-Ginsberg v. Comm’r 46 T.C. 47 (1966).
-Harding Hospital, Inc. v. United States, 505 F.2d 1068 (6th Cir. 1974)
-Northwestern Municipal Ass’n v. United States, 99 F.2d 460, 463 (8 Cir. 1938)
For literature I used that discuss the subject see:
-Hopkins, The Law of Tax-Exempt Organizations (John Wiley & Sons, Inc., 2003) § 19.1. ( Da Bomb treatise by the way)
-The “Inurement of Earnings to Private Benefit” Clause of Section 501(c): A Standard Without Meaning?”, 48 Minn. L. Rev. 1149 (1963-1964).
-Jones, The Scintilla of Individual Profit: In Search of Private Inurement and Excess Benefit, 19 Vir. L. Rev. 576, 4.