Reforming internal revenue code provisions on commercial activity by charities

Fordham Law Review

Volumn 76, Issue 2, 2007, Pages 667-691

  Colombo, John D ^a  

^a UNIVERSITY OF ILLINOIS AT URBANA CHAMPAIGN   (United States)

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EID: 38049160703     PISSN: 0015704X     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Conference Paper

References (105)

1. Stephanie Strom, Nonprofit Groups Reach for Profits on the Side, N.Y. Times, Mar. 17, 2002, at A32.
2. Press Release, Yale Sch. of Mgmt., Yale School of Management Receives Twin Grants Totaling $4.5 Million from the Goldman Sachs Foundation and the Pew Charitable Trusts to Foster Business Growth Among Nonprofit Organizations (Feb. 8, 2002) available at http://www.ventures.yale.edu/ pr_2_6_02.asp.
3. Luisa Kroll, MegaChurches, MegaBusinesses, Forbes.com, Sept. 17, 2003, http://www.forbes.com/2003/09/17/cz_lk_0917megachurch.html. World Changers Ministries, for instance, operates a music studio, publishing house, computer graphic design suite and owns its own record label. The Potter's House also has a record label as well as a daily talk show, a prison satellite network that broadcasts in 260 prisons and a twice-a-week Webcast. New Birth Missionary Baptist Church has a chief operating officer and a special effects 3-D Web site that offers videos-on-demand. It publishes a magazine and holds Cashflow 101 Game Nights. And Lakewood Church, which recently leased the Compaq Center, former home of the NBA's Houston Rockets, has a four-record deal and spends $12 million annually on television airtime. Id.
4. Elizabeth Bernstein, Holy Frappucino!, Wall St. J., Aug. 31, 2001, at W1.
5. To Profit or Not to Profit (Burton A. Weisbrod ed., 1998).
6. Nonprofits and Business: A New World of Innovation and Adaptation (Joseph J. Cordes & C. Eugene Steuerle eds., forthcoming).
7. One of the more famous recent cases illustrating a complex structure was Geisinger Health Plan v. Commissioner, 100 T.C. 394 (1993). As explained by the U.S. Tax Court, Petitioner owned and operated a health maintenance organization (HMO) under the Pennsylvania Health Maintenance Organization Act . . . . Petitioner was one of nine related organizations. The eight other organizations, referred to collectively as the Geisinger system and described below, were the Geisinger Foundation (the foundation), Geisinger Medical Center (GMC), Geisinger Clinic (the clinic), Geisinger Wyoming Valley Medical Center (GWV), Marworth, Geisinger System Services (GSS), and two professional liability trusts. Each of these eight entities was recognized by the Internal Revenue Service as an exempt organization described in sections 170(b)(1)(A)(iii), 501(c)(3), and 509(a)(1). . . . . The foundation controlled petitioner and the other entities in the Geisinger system, as well as three for-profit corporations. The foundation had the power, under the articles of incorporation and bylaws of petitioner, GMC, GWV, GSS, the clinic, and Marworth, to appoint the corporate members of those entities, who in turn elected their respective boards of directors. The foundation's board of directors was composed of civic and business leaders who were representative of the general public in northeastern and north-central Pennsylvania and were public-spirited citizens. The foundation raised funds for the Geisinger system's numerous charitable purposes and activities. Id. at 395-96. Although a large percentage of complex structures come from the health-care sector, they exist in other sectors as well. See, e.g., I.R.S. Priv. Ltr. Rul. 95-06-046 (Nov. 17, 1994) (ruling on a case in which a business league exempt under § 501(c)(6) established first- and second-tier subsidiaries to construct and operate a golf course); I.R.S. Gen. Couns. Mem. 39,776 (Jan. 24, 1989) (analyzing a situation in which an exempt university controlled a § 501(f) organization that in turn controlled a taxable subsidiary).
8. See generally Frances R. Hill & Douglas M. Mancino, Taxation of Exempt Organizations ¶¶ 27-1, 27-46 (2006) (discussing exempt organizations' use of complex structures of related exempt and taxable entities);
9. James J. McGovern, The Use of Taxable Subsidiary Corporations by Public Charities - A Tax Policy Issue for 1988, 38 Tax Notes 1125 (1988) (discussing use of taxable subsidiaries by exempt organizations).
10. Parts of this section are copied or adapted from John D. Colombo, Commercial Activity and Charitable Tax Exemption, 44 Wm. & Mary L. Rev. 487 (2002) [hereinafter Colombo, Commercial Activity],
11. and John D. Colombo, Regulating Commercial Activity by Exempt Charities: Resurrecting the Commensurate-in-Scope Doctrine, 39 Exempt Org. Tax Rev. 341 (2003) [hereinafter Colombo, Commensurate-in-Scope].
12. See generally James J. Fishman & Stephen Schwarz, Nonprofit Organizations 593-96 (3d ed. 2006);
13. Colombo, Commercial Activity, supra note 8, at 491.
14. Fishman & Schwarz, supra note 9, at 593; Bruce R. Hopkins, The Law of Tax-Exempt Organizations 727-41 (9th ed. 2007);
15. Colombo, Commercial Activity, supra note 8, at 491.
16. Trinidad v. Sagrada Orden, 263 U.S. 578, 582 (1924).
17. Fishman & Schwarz, supra note 9, at 596; Hill & Mancino, supra note 7, ¶ 21.01; Hopkins, supra note 10, at 732; Colombo, Commercial Activity, supra note 8, at 498-99.
18. See, e.g., C.F. Mueller Co. v. Comm'r, 190 F.2d 120 (3d Cir. 1951) (finding that a corporation that made macaroni was exempt from paying income tax because revenues were paid to New York University's law school).
19. I.R.C. §§ 502, 511-514 (2000). A "feeder" is an entity that operates a commercial business but is obligated to pay the net revenues of that business over to an exempt charity. See Fishman & Schwarz, supra note 9, at 596.
20. Fishman & Schwarz, supra note 9, at 596; Hill & Mancino, supra note 7, ¶ 27.04; Hopkins, supra note 10, at 720; Colombo, Commercial Activity, supra note 8, at 500.
21. Indeed, Professor Ethan Stone has argued that the UBIT was largely political symbolism. His review of the history of the UBIT indicates that there was little complaint about unfair competition prior to the enactment of the UBIT, and that the law really was a political response to for-profit firms using charities as tax shelters, along with some highly publicized cases of charities undertaking decidedly uncharitable activities. Thus, he argues that the UBIT was largely designed to keep charities from wandering too far from traditional good works that defined the charitable sector. See generally Ethan Stone, Adhering to the Old Line: Uncovering the History and Political Function of the Unrelated Business Income Tax, 54 Emory L.J. 1475 (2005). Stone's analysis supports the proposition that related business activity should have no bearing on exempt status, and that Congress believed it adequately responded to the threat of unrelated activity by taxing it, rather than revoking exemption because of it. Id. at 1505. The counterargument here is that if Congress really did view the UBIT as mostly a "border-patrol" measure (a phrase first used by Professor John Simon in describing the various tax rules applicable to exempt organizations), then perhaps excessive unrelated business should cause loss of exemption due to inappropriate border crossing.
22. I.R.C. § 513(a) (2000). For a more extensive discussion of the UBIT rules, see Michael S. Knoll, The UBIT: Leveling an Uneven Playing Field or Tilting a Level One?, 76 Fordham L. Rev. 857 (2007).
23. Treas. Reg. § 1.513-2(a)(4) (2006).
24. Id. § 1.501(c)(3)-1(b)(1)(i)(B).
25. Id. § 1.501(c)(3)-1(c)(1).
26. Id. § 1.501(c)(3)-1(e)
27. See Jessica Pena & Alexander L.T. Reid, A Call for Reform of the Operational Test for Unrelated Commercial Activity in Charities, 76 N.Y.U. L. Rev. 1855, 1863-64 (2001).
28. See Ellen P. Aprill, Lessons from the UBIT Debate, 45 Tax Notes 1105, 1107 (1989).
29. 1964-1 C.B. 186.
30. Id. at 187.
31. I.R.S. Gen. Couns. Mem. 39,862 (Oct. 9, 1963).
32. Id.
33. Id.
34. As summarized by the counsel's office in General Counsel Memorandum 34,682 (Nov. 17, 1991), "the Council's supporting Appendix also indicated that, aside from the 'primary purpose' requirement of the regulations, the better logic in cases in which the business activity does not in fact provide any significant funds for charitable use is that the organization is not being operated exclusively for charitable purposes."
35. I.R.S. Gen. Couns. Mem. 34,682 (Nov. 17, 1971) (footnotes omitted).
36. Id.
37. Id.
38. 285 F.2d 800 (Ct. Cl. 1961).
39. Id. at 802.
40. Id. at 804.
41. Id. at 802 ("The defendant contends with equal vigor that plaintiff's purpose is the preparation and sale of religious literature, and that it is therefore not 'operated exclusively' for religious and charitable purposes.").
42. Id. at 804-05.
43. Id.
44. Id. at 806.
45. Inc. Trs. of Gospel Worker Soc'y v. United States, 510 F. Supp. 374, 381 (D.D.C. 1981), aff'd, 672 F.2d 894 (D.C. Cir. 1981); Elisian Guild, Inc. v. United States, 292 F. Supp. 219 (D. Mass. 1968), rev'd, 412 F.2d 121, 126 (1st Cir. 1969); Fides Publishers Ass'n v. United States, 263 F. Supp. 924 (N.D. Ind. 1967); Presbyterian & Reformed Publ'g Co. v. Comm'r, 79 T.C. 1070 (1982), rev'd, 743 F.2d 148, 159 (3d Cir. 1984).
46. Presbyterian & Reformed Publ'g Co., 79 T.C. at 1083.
47. Living Faith v. Comm'r, 950 F.2d 365, 367 (7th Cir. 1991) ("According to its articles of incorporation, Living Faith was established for the purpose of keeping with the doctrines of the Seventh-day Adventist Church. . . . Good health, according to Seventh-day Adventists, promotes virtuous conduct, and is furthered by a vegetarian diet and abstention from tobacco, alcohol, and caffeine.").
48. Id. at 373-75.
49. 743 F.2d 148.
50. Presbyterian & Reformed Publ'g Co., 79 T.C. at 1083.
51. Presbyterian & Reformed Publ'g Co., 743 F.2d at 158.
52. Aid to Artisans, Inc. v. Comm'r, 71 T.C. 202 (1978). The organization claimed that its charitable purposes were "(1) [h]elping disadvantaged artisans in poverty stricken countries to subsist and to preserve their craft; and (2) furnishing services to tax-exempt museums by providing museum stores with representative handicrafts from disadvantaged countries." Id. at 209.
53. Indus. Aid for the Blind v. Comm'r, 73 T.C. 96 (1979). The charitable purpose was to provide employment for the blind and thus came within the regulations' statement that a charitable purpose includes "[r]elief of the poor and distressed or the underprivileged." Id. at 101. See Treas. Reg. 1.501(c)(3)-1(d) (2006).
54. Goldsboro Art League v. Comm'r, 75 T.C. 337 (1980).
55. Elisian Guild, Inc. v. United States, 412 F.2d 121, 125 (1st Cir. 1969).
56. See generally Virginia Richardson, Roderick Darling & Marvin Friedlander, Health Clubs, in IRS, Exempt Organizations Continuing Professional Education (CPE) Technical Instruction Program for Fiscal Year 2002, at 2, 13-14 (2001), available at http://www.irs.gov/pub/irs-tege/ eotopica00.pdf (noting that the operation of a health club by a university or hospital generally does not affect exempt status and that income from memberships sold to the general public - as opposed to students and faculty or patients and staff - is generally taxable under the UBIT).
57. I.R.S. Tech. Adv. Mem. 96-36-001 (Jan. 4, 1995). The organization started its publishing activities to supply its own schools with textbooks, but soon expanded to provide religious-oriented textbooks to schools worldwide. Revenues from the publishing business constituted over half the total gross revenues of the organization, and its profit margins were as high as 75%, though expenditures on the publishing business were less than half the organization's total expenditures. Finding that the publishing activities were virtually indistinguishable from those of a commercial religious publisher and that they were not substantially related to the educational activity of operating its own religious schools, the Internal Revenue Service (IRS) concluded that the profits of the activity were subject to the UBIT. At the same time, however, the IRS concluded that the obviously substantial nature of the publishing business did not endanger the taxpayer's exempt status because "[t]here is no evidence that any of the funds generated by [the publishing business] were not properly used to further the organization's education purposes in some manner." Id. Accordingly, the taxpayer was entitled to exemption "because it [was] carrying on an exempt program commensurate in scope with its financial resources." Id.
58. I.R.S. Tech. Adv. Mem. 97-11-003 (Nov. 8, 1995); see also D. Benson Tesdhal, Letter Ruling Alert: IRS Applies Liberal Primary Purpose and Commensurate Tests, 16 Exempt Org. Tax Rev. 617 (1997). The organization represented that 50% of its time and resources were dedicated to bingo games, although over 95% of its gross income was used for bingo operations; expenditures on charitable activities ranged from about 1.4% to 3.5% during the years in question. Nevertheless, the IRS summarily dismissed the notion that this organization had any commensurate problems, noting that for thirty years the organization had been assisting developmentally disabled children and spent over 40% of its time and resources doing so. Accordingly, the commensurate in scope test "would not be applicable since the Association has a substantial charitable program in addition to its fundraising activities." Id. at 628. In the ruling, the IRS noted that although income from bingo games was specifically excluded from the UBIT in I.R.C. § 513(f) (2000), that exclusion "was not intended to result in exemption for organizations whose primary activity is the conduct of bingo. Bingo remains an activity unrelated to exempt purposes and alone cannot support exemption . . . ." Id. at 627.
59. I.R.S. Priv. Ltr. Rul. 2000-21-056 (Feb. 8, 2000). In this ruling, the IRS reasoned that an unrelated business that is used as a fund-raiser for an overall charitable purpose was operated in furtherance of a charitable purpose and did not constitute a substantial nonexempt purpose. Id. ("One way in which a trade or business may be in furtherance of exempt purposes is to raise money for the exempt purposes of the organization, notwithstanding that the actual trade or business activity may be taxable under sections 511 through 513."). Similarly, in I.R.S. Field Service Advice 1999-10-007 (Nov. 24, 1998), the IRS concluded that an organization operating a sports tournament whose net proceeds were turned over to another charity met the commensurate in scope requirement. For additional analysis of the checkered history of the commensurate in scope test, see Evelyn Brody, A Taxing Time for Bishop Estate: What Is the I.R.S. Role in Charity Governance?, 21 U. Haw. L. Rev. 537, 575-76 (1999).
60. See, e.g.. Airlie Found, v. IRS, 283 F. Supp. 2d 58 (D.D.C 2003) (holding that an organization that rented conference facilities to other charities and helped with conference logistics is not exempt because its activities were conducted in a commercial manner).
61. See, e.g., I.R.S. Priv. Ltr. Rul. 2007-04-041 (Oct. 30, 2006) (finding that an organization that provided down-payment assistance to U.S. Department of Housing and Urban Development-qualified home buyers was not exempt). "The manner in which you operate your down-payment assistance program indicates that you facilitate the sales of homes in a manner that is indistinguishable from an ordinary trade or business." Id.; see also I.R.S. Priv. Ltr. Rul. 2006-51-037, at 6 (Sept. 28, 2006) (holding that an organization formed to sell items for individuals and to transfer proceeds to the charity of an individual's choice was performing services as an agent for a donor "which are characteristic of a trade or business and ordinarily carried on by for-profit commercial businesses").
62. Moline Props., Inc. v. Comm'r, 319 U.S. 436 (1943). In Moline Properties, the taxpayer argued that a corporation that sold certain real estate should be disregarded, and the proceeds of sale should be taxed directly to the corporation's sole shareholder. The U.S. Supreme Court ruled that the tax system must respect the separate identity of a corporation formed for valid business reasons, thus protecting the integrity of the corporate income tax. In General Counsel Memorandum 39,326 (Jan. 17, 1985), the IRS applied the Moline Properties doctrine in assessing the exempt status of a nonprofit parent that owned a for-profit subsidiary, concluding that the subsidiary's activities would not be imputed to the nonprofit parent. See Colombo, Commercial Activity, supra note 8, at 515. For an extended discussion of the Moline Properties doctrine in the context of tax exemption, see Hill & Mancino, supra note 7, ¶ 27.02. A subsidiary corporation of an exempt parent can sometimes claim tax exemption as an integral part of the parent's exempt activities. In general, the IRS position is that the integral part test is available only to captive subsidiaries that perform services exclusively for the exempt parent, such as a subsidiary that generates electrical power for its parent. Treas. Reg. § 1.502-1(b) (2006). For general discussions of the integral part doctrine, see Hill & Mancino, supra note 7, ¶ 27.04;
63. John D. Colombo, The IHC Cases: A Catch-22 for Integral Part Doctrine, A Requiem for Rev. Rul. 69-545, 34 Exempt Org. Tax Rev. 401 (2001).
64. See, e.g., Rev. Rul. 98-15, 1998-1 C.B. 718, 720-21.
65. See, e.g., Butler v. Comm'r, 36 T.C. 1097, 1106 (1961) (holding that a partner in a partnership was engaged in the business of the partnership and therefore qualified for a bad-debt deduction). "By reason of being a partner in a business petitioner was individually engaged in a business." Id. For a general discussion of the aggregate concept in partnership taxation, see William S. McKee, William F. Nelson & Robert L. Whitmore, Federal Taxation of Partnership and Partners ¶ 1.02 (4th ed. 2007).
66. One private ruling issued in 2004 suggests (in the mode of the commensurate in scope doctrine discussed above) that an exempt parent must somehow use revenues or assets of its for-profit subsidiaries to further its charitable purpose, or else it may run afoul of the primary purpose test. In Technical Advice Memorandum 2004-37-040 (June 7, 2004), the IRS examined whether large accumulations of value in a for-profit subsidiary of an exempt church would result in loss of exempt status. While the IRS ruled that it would not under the particular facts presented, its analysis suggests an ongoing obligation for an exempt parent to use revenues/assets from a for-profit subsidiary to expand charitable outputs, à la the commensurate in scope doctrine. In this private ruling the IRS stated, In post-audit years, it appears that the subsidiary grew rapidly - perhaps beyond X's expectations. It is now worth several times X's investment in the subsidiary, although it apparently had not earned an operating profit through * * *. This growth presents a continuing obligation on X to translate this valuable asset into funds, and use those funds for the expansion of its charitable religious activities. For example, X may have to give consideration to selling some of the subsidiary's assets, or selling a portion of the stock of the subsidiary, to an unrelated party. The proceeds of such transactions must be used to fund or expand X's charitable or religious activities. The subsidiary should give highest priority to repaying X's investment loans once it begins generating cash flow or earnings and profits, so that these funds can be used for X's charitable or religious activities. X cannot be allowed to focus its energies on expanding its subsidiary's commercial business and assets, and neglect to translate that financial success into specific, definite and feasible plans for the expansion of its charitable religious activities. . . . The fact that the assets are being accumulated in a for-profit company under the formal legal control of X does not excuse X from using such assets for charitable religious purposes. I.R.S. Tech. Adv. Mem. 2004-37-040 (June 7, 2004).
67. See supra Part II.A.
68. For example, we know from recent case law that a contract-model HMO will find it difficult to obtain exemption under 501(c)(3) if the HMO business is in a separate corporation. See, e.g., IHC Health Plans, Inc. v. Comm'r, 325 F.3d 1188 (10th Cir. 2003). It is not clear, however, whether revenues from an HMO that was operated as a division of a nonprofit corporation that operated an exempt acute care hospital would be taxable or not; one could certainly argue that such revenues are substantially related to the hospital's exempt purpose of providing health care for the general benefit of the community, although some older IRS rulings suggest that if a hospital receives revenues from persons other than hospital patients, such revenues would be unrelated. See, e.g., I.R.S. Gen. Couns. Mem. 39,830 (Aug. 30, 1990) (suggesting that an HMO might be considered an unrelated business in the hands of a hospital corporation since the HMO provides services to persons who are not patients of the hospital).
69. As part of hearings on the UBIT in the late 1980s, known as the Pickle hearings, the Oversight Subcommittee of the House Ways and Means Committee circulated a draft report that recommended aggregating the activities of a parent nonprofit and any eighty-percent-owned subsidiary for purposes of applying the "primary purpose" test of exemption. See generally Hill & Mancino, supra note 7, ¶ 27.03[4]; Aprill, supra note 23, at 1106; Evelyn Brody, Business Activities of Nonprofit Organizations: Legal Boundary Problems, in Nonprofits and Business: A New World of Innovation and Adaptation, supra note 6.
70. I.R.S. Gen. Couns. Mem 39,598 (Jan. 23, 1987).
71. See, e.g., I.R.S. Gen. Couns. Mem. 39,862 (Nov. 22, 1991).
72. See, e.g., Jerry O. Allen & Alan D. Duffy, Solving the Low-Income Tax Credit Housing Partnership Dilemma, 49 Exempt Org. Tax Rev. 319 (2005);
73. J. Christine Harris, Tax-Exemption and Low-Income Housing Ventures: Irreconcilable Differences?, 47 Exempt Org. Tax Rev. 329 (2005);
74. J. Christine Harris, Tax Law Professors Say Recent Joint Venture Ruling Doesn't Break Ground in Housing, 47 Exempt Org. Tax Rev. 21 (2005) [hereinafter Harris, Tax Law Professors];
75. Michael I. Sanders & Celia A. Roady, EO Practitioners Suggest Way to Expedite Exemptions for Low-Income Housing Orgs, 37 Exempt Org. Tax Rev. 127 (2002).
76. See, e.g., Rev. Rul. 2006-27, 2006-21 I.R.B. 915.
77. See generally John D. Colombo, In Search of Private Benefit, 58 Fla. L. Rev. 1063 (2006).
78. In 2004, the IRS did clarify that certain ancillary partnerships between an exempt charity and a for-profit company would not create private benefit problems, though the ruling is largely devoid of analysis and leaves open as many questions as it answers. Rev. Rul. 2004-51, 2004-22 I.R.B. 974. See generally Colombo, supra note 68, at 1077-79; Harris, Tax Law Professors, supra note 66.
79. Colombo, Commercial Activity, supra note 8, at 529-46.
80. Id. at 529-30. Professor Michael S. Knoll's contribution to this Symposium, in fact, questions whether there is any economic advantage to a nonprofit engaging in a commercial business. See Knoll, supra note 17.
81. Id. at 544-46.
82. See Burton A. Weisbrod, The Nonprofit Mission and Its Financing: Growing Links Between Nonprofits and the Rest of the Economy, in To Profit or Not to Profit, supra note 5, at 1-7.
83. See Fishman & Schwarz, supra note 9, at 593; Colombo, Commercial Activity, supra note 8, at 525-29. The empire-building concern is what led the Treasury to propose an aggregation rule for determining if a particular nonprofit had a primary charitable purpose in the Pickle hearings in the late 1980s. See Brody, supra note 63, at 32-33.
84. See, e.g., IHC Health Plans, Inc. v. Comm'r, 325 F.3d 1188 (10th Cir. 2003); John D. Colombo, The Failure of Community Benefit, 15 Health Matrix 29, 30-37 (2005).
85. This category is one where confusion over the difference between charitable purposes and charitable activities is most problematic. One might argue, for example, that a nonprofit pharmacy has a charitable purpose to promote health. See, e.g., Rev. Rul. 69-545, 1969-2 C.B. 117 (stating that promotion of health for the general benefit of the community is a charitable purpose). If none of its activities can be classified as charitable, however, then it seems obvious that its primary purpose is not charitable but something else. See, e.g., Fed'n Pharmacy Servs. Inc. v. Comm'r, 625 F.2d 804 (8th Cir. 1980) (holding that a nonprofit pharmacy, which sells drugs at cost to the elderly and poor, is not exempt because such activity is a commercial activity, not a charitable one); see supra notes 33-39 and accompanying text. Similarly, this conflation of charitable purpose and charitable activities can explain the different results in the Scripture Press and Presbyterian & Reformed Publishing cases discussed in the text. In Scripture Press, the U.S. Claims Court appeared to view religious publishing as not being a charitable activity, at least when conducted with a commercial hue, despite the fact that publishing religious texts would seem to functionally advance a charitable purpose of promoting religion. See supra notes 33-39 and accompanying text. In contrast, the Court of Appeals for the Third Circuit in Presbyterian & Reformed Publishing clearly did view religious publishing as a charitable activity that promoted a religious purpose. See Presbyterian & Reformed Publ'g Co. v. Comm'r, 79 T.C. 1070 (1982), rev'd, 743 F.2d 148, 158 (3d Cir. 1984) ("Although we recognize that the Tax Court is entitled to deference in determining the existence of a substantial, non-exempt purpose, that court must focus on facts which indicate a purpose falling outside the ambit of section 501(c)(3). In this case, the Tax Court focused primarily on two factors - the lack of affiliation with a particular church and the accumulation of profits. As we have shown, neither factor indicates the presence of a non-exempt purpose here.").
86. Henry Hansmann, Unfair Competition and the Unrelated Business Income Tax, 75 Va. L. Rev. 605, 626-28 (1989).
87. See id. at 627-28.
88. See Weisbrod, supra note 73, at 1-7.
89. Corporations pay entity-level tax on their earnings at a maximum rate of thirty-five percent, whereas proprietorships and partnerships (or limited liability companies that choose to be taxed as partnerships) pay no entity-level tax. That means that in theory, a corporation must earn a higher pretax return on equity to compete with other investments in the market on an after-tax basis. If a charity could acquire a corporate business and avoid the corporate-level tax, it would be able to capture this higher pretax rate of return for itself simply as a result of the ownership change.
90. I.R.S. Tech. Adv. Mem. 2004-37-040 (June 7, 2004).
91. See Jodi Upton, Contract Could Bring Congressional Inquiry, USA Today, Jan. 4, 2007, at 9C.
92. Of course, if one believes that big-time college football and basketball programs are themselves charitable activities, then this example is really a Category One case, not a Category Five case. An issue that arises with the analysis in the text is exactly how one distinguishes between a commercial activity and a charitable activity that produces revenue. For a discussion of this issue, see infra text accompanying notes 90-91.
93. I have in the past suggested that tax exemption is appropriate only in cases of combined market failure and government failure; if a "charity" is engaged in an activity that is simply participating in a private market, there is no market failure and no need for exemption. See generally John D. Colombo & Mark A. Hall, The Charitable Tax Exemption (1995).
94. Colombo, Commensurate-in-Scope, supra note 8, at 351-52.
95. This proposal is not new. The idea of replacing the substantially related test with a commerciality test stretches back at least to the Pickle hearings by the Oversight Subcommittee of the House Ways and Means Committee in the late 1980s. See Brody, supra note 63; see also James Bennett & Gabriel Rudney, A Commerciality Test to Resolve the Commercial Nonprofit Issue, 36 Tax Notes 1095 (1987). The proposed rationale for this reform at the time, however, was to prevent unfair competition by nonprofit charities, which to the small business community really meant any competition. As noted in the text, several other policy concerns present better rationales for taking this step. See supra text accompanying notes 70-72.
96. See Hansmann, supra note 77, at 627. Taxing all commercial activity also should satisfy Susan Rose-Ackerman's concern that the current system distorts economic activity by encouraging nonprofits to invest more in related than unrelated activity. Susan Rose-Ackerman, Unfair Competition and Corporate Income Taxation, 34 Stan. L. Rev. 1017, 1038 (1982). Rose-Ackerman suggested getting rid of the UBIT because of this distortion, but subjecting all commercial activity to taxation should also eliminate this problem.
97. Making all commercial activities subject to taxation, rather than just unrelated activities, might also reduce the ability of charities to game the system by allocating costs from charitable and related businesses to unrelated businesses, thereby reducing (often eliminating) any tax liability for unrelated activities. See, e.g., Evelyn Brody, Charities in Tax Reform: Threats to Subsidies Overt and Covert, 66 Tenn. L. Rev. 687, 733 (1999);
98. Joseph J. Cordes & Burton A. Weisbrod, Differential Taxation of Nonprofits and the Commercialization of Nonprofit Revenues, in To Profit or Not to Profit, supra note 5, at 97-100;
99. Robert J. Yetman, Tax-Motivated Expense Allocations by Nonprofit Organizations, 76 Acct. Rev. 297 (2001).
100. Once again, this proposal is not new and harkens back to the Pickle hearings of the late 1980s. The Treasury proposal at that time suggested aggregation for eighty-percent-owned subsidiaries. See supra note 63. I have suggested a far broader test of aggregation based upon the supporting organization tests in I.R.C. § 509(a)(3) (2000). Colombo, Commercial Activity, supra note 8, at 565.
101. I do not mean to suggest here that for-profit entities in a complex structure would somehow be converted for tax purposes to nonprofit status. Rather, I mean only that any nonprofit organization in a complex structure would be tested for its primary purpose based upon the activities of the group as a whole, and not on their individual activities.
102. Colombo, supra note 68, at 1088-90.
103. Of course, as with all other legal tests, there will be inevitable disagreement at the edges. For example, are Division I college football and basketball programs commercial under this test? They certainly produce substantial revenues for their schools, but whether they compete with substantially similar for-profit goods and services (e.g., professional for-profit sports) is an open question. The Supreme Court, for example, has suggested in the antitrust context that college football does not compete with professional football. See NCAA v. Board of Regents, 468 U.S. 85, 101-02 (1984). Of course, tax law would not necessarily have to adopt precedents from antitrust law for this purpose. Particularly in light of the policy concerns of managerial diversion and economic efficiency, one could argue that the test for what is a commercial activity in the tax-exemption world should be somewhat broader than what the courts may find to be competing products in the antitrust field. Viewing markets and competing goods narrowly in antitrust law generally has the effect of protecting competition, which is the purpose of antitrust law. Drawing similar narrow lines in tax-exemption law does not similarly advance the policy concerns noted above with commercial activity by charities.
104. See supra text accompanying notes 41-43.
105. See supra text accompanying notes 75-76.