Charitable Organizations:
Emerging Private Benefit Issues

by Marcus S. Owens, Esq., Director and Edward Gonzalez, Esq., Project Specialist
Exempt Organizations Technical Division, Internal Revenue Service, Washington, D.C.

Date: Fall, 1993

Reprinted from Tax-Exempt Organizations
Copyright 1993 Research Institute of America, Inc.
NOTE* The opinions expressed in this article are those of the authors and do not necessarily represent the views of the Internal Revenue Service.

INTRODUCTION
It is a principle fundamental to the law of tax exempt organizations that charitable organizations1 must serve public purposes. Thc trustees of a charitable trust are under a duty "to deal with the property for a charitable purpose." In the case of a private trust it is the duty of the trustees to deal with the property for the benefit of the designated beneficiary or beneficiaries. In the case of a private trust, property is devoted to the use of specified persons who are designated as beneficiaries of the trust. In the case of a charitable trust, property is devoted to the accomplishment of purposes, which are beneficial or may be supposed to be beneficial to the community.

This, indeed, is the fundamental distinction between private trusts and charitable trusts.2

In federal tax law, the principle that charitable organizations must serve the public finds its expression in the regulations underlying IRC §501(c)(3). The relevant regulation states, in part, that an organization will not qualify for exemption as a charity "unless it serves a public rather than a private interest."3 It is a virtually inescapable fact that even the most legitimate charitable endeavor will, to some degree, directly or indirectly, benefit non-charitable interests. Employees cannot be required to work without remuneration, rents must be paid, service providers employed, equipment purchased, and so forth. How much and what kind of such benefit is permissible?

There are few "hot topics" in the area of tax exempt charitable organizations that do not involve the issue of "private benefit." For example:

• Unreasonable compensation. When does the amount of compensation paid to essential, highly qualified management or staff cross the line and run afoul of the private benefit prohibition
• Physician recruitment and retention. In what forms and to what degree may a charitable hospital provide incentives to physicians to induce them to join the medical staff of the facility? What types of joint ventures may hospitals (as well as other types of exempt organizations) enter into with staff, physicians, or outsiders that will not endanger exempt status?
• Tax-exempt bonds. If a charity employs the proceeds from the public issuance of tax-exempt bonds to purchase or expand facilities, opportunities and temptations for misdirection of this pool of public funds are enhanced. When do the management fees, charges for building improvements or payments for the purchase of a facility from a private party become so large as to exceed the private benefit restriction?
• Charitable fund-raising. How much of the proceeds from a fund-raising effort can be used to compensate a professional fundraiser? Do the facts reflect that the fund-raising effort privately benefits the fundraiser?
• College and university audits. Are sponsored research programs, particularly programs that yield products or information that have a ready commercial application, serving private interests? Are salary payments to some professionals on campuses so excessive as to violate the private benefit prohibition?