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No "insider" inurement finding reinstates charitable exemption.

A 1969 letter ruling held that the United Cancer Council, Inc. (UCC) was a tax-exempt organization and an eligible charitable donee. In 1984, UCC entered into a five-year contract with Watson & Hughley Co. (W&H), a professional fundraiser. From 1984-1989, W&H helped UCC conduct a nationwide direct-mail fundraising campaign. Under the contract, UCC received approximately $2.3 million in net fundraising revenue. W&H received more than $4 million in fees from UCC and derived substantial income from exploiting the co-ownership rights in UCC's mailing list that had been granted under the contract.

On Nov. 2, 1990, the IRS revoked the favorable letter ruling retroactively to June 11,1984. UCC initiated a Tax Court petition for a declaratory judgment that it qualified as a tax-exempt organization and an eligible charitable donee.

In United Cancer Council, Inc., 100 TC 162 (1993), the Tax Court found That W&H was an "insider" for purposes of the inurement prohibitions of Secs. 501(c)(3) and 170(c)(2)(C). There was an inurement of net earnings to W&H. Thus, the Tax Court held that UCC failed to qualify as a tax-exempt organization and an eligible charitable donee. The Tax Court also held that the Service's retroactive revocation of the favorable ruling was not an abuse of discretion.

On Feb. 10, 1999, the Seventh Circuit reversed the Tax Court's decision, holding that the Tax Court's classification of W&H as an insider was based on the fundraising contract. Nothing in the facts supported the finding that W&H seized control of UCC and became an insider--triggering the inurement provision and destroying the exemption. The case was remanded to determine if UCC was being operated to a significant degree for W&H's private benefit.

Sec. 4958 imposes excise taxes on excess benefit transactions, an intermediate sanction on certain tax-exempt organizations. (See Tax Clinic, "Reasonable Compensation Rules," p. 300, this issue.) However, Sec. 4958 is generally effective for excess benefit transactions occurring after Sept. 13, 1995--subsequent to the years involved in United Cancer Council, Inc.

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Article Details
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Author:Josephs, Stuart R.
Publication:The Tax Adviser
Geographic Code:1USA
Date:May 1, 1999
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