Private benefit has been defined as “nonincendental benefits conferred on disinterested persons that serve private interests.”[1] The concept of private benefit is not explicitly stated in the Internal Revenue Code. It is derived primarily from the Treasury regulations, which provide that an organization is not organized and operated exclusively for one or more charitable purposes “unless it serves a public rather than a private interest.”[2] This means that even if a nonprofit has activities that further exempt purposes, it will not qualify for tax exemption if it ultimately serves private interests.
In this context, “private benefit” does not necessarily mean “for-profit benefit.” Private benefit may also be conferred on other tax exempt organizations that are not 501(c)(3) organizations. For example, the U.S. Tax Court has held that a nonprofit corporation that audits structural steel fabricators in conjunction with a quality certification program conducted by a related 501(c)(6) association does not qualify for exemption as an organization that lessens the burden of government.[3] In that case, the court held that the 501(c)(3) organization provided private benefit to the fabricators and the 501(c)(6) organization. Even though the 501(c)(6) organization was not a for-profit entity, this benefit was private benefit and therefore impermissible.
Distinguishing Private Benefit from Inurement
People often confuse private benefit with inurement, but the two concepts are different. Private benefit is broad enough to encompass anything that would constitute inurement, but extends beyond the organization’s insiders to restrict the provision of inordinate benefits to any private persons, including those who are not related in any way to the organization. In other words, the private benefit prohibition is broader than and subsumes the inurement prohibition.
But unlike inurement, incidental private benefit will not cause the loss of tax-exempt status. As long as any private benefit is both qualitatively and quantitatively incidental to the furtherance of the nonprofit’s exempt purposes, the organization’s tax exemption will not be in jeopardy. Any private benefit must (a) be insubstantial in comparison to the overall benefit conferred by the activity, and (b) be a necessary side-effect of achieving the organization’s charitable objectives.[4]
A Case Study in Private Benefit
The case of American Campaign Academy v. Commissioner[5] illustrates the application of the private benefit prohibition to revoke tax exemption. That case involved a school that trained individuals for careers as political campaign professionals. Almost all of the Academy’s graduates worked as consultants for various organizations or candidates of the Republican Party.
The Tax Court revoked exemption on the grounds that the school benefited private interests (the interests of the Republican Party and its candidates) to more than an insubstantial extent. The court held that the beneficiaries of the primary private benefit were the students and the beneficiaries of a secondary private benefit were the employers of the graduates. This secondary private benefit to the Republican Party and its candidates was the ground for revocation of exemption.
The Tax Court distinguished other rulings that held that institutions providing training to a particular industry or profession conferred a public, rather than a private, benefit. The court believed that those rulings dealt with organizations that provided a secondary benefit that was broadly spread among the members of an industry. In contrast, the Academy’s graduates primarily benefited a particular organization’s purposes, thereby resulting in impermissible private benefit.
This case illustrates how the private benefit prohibition can extend beyond activities that constitute inurement. The Academy had argued that because the Republican Party did not control the organization, there could be no private benefit. In other words, the Academy wanted to restrict the application of private benefit to insiders with control over the organization. This would have treated private benefit as inurement. But the Tax Court disagreed, holding that a nonprofit’s provision of nonincidental benefit to outsiders (those who didn’t control the organization) was enough to constitute impermissible private benefit.
[1] American Campaign Academy v. Commissioner, 92 T.C. 1043 (1989).
[2] Treas. Reg. §1.502(c)(3)-1(d)(1)(ii).
[3] Quality Auditing Co. v. Comm’r, 114 T.C. 498 (2000).
[4] See, e.g., Rev. Rul. 75-286, 1975-2 C.B. 210; Rev. Rul. 68-14, 1968-1 C.B. 243; Rev. Rul. 70-186, 1970-1 C.B. 128.
[5] 92 T.C. 1043 (1989).