Skillman Family Reunion Fund, The v. Commissioner
Citation: 196 F. Supp. 2d 543 (N.D. Ohio 2002)
Summary of the Case
A federal district court held that a nonprofit organization formed to promote social activities among members of a family cannot be tax-exempt as a social club because its funding is derived wholly from investment income.
Summary of the Facts
The purpose of the Skillman Family Reunion Fund (Fund) is to bring the members of the Skillman family into closer association through social activities, collect and preserve family records, organize and conduct social activities, and distribute communications of family interest. It is administered by four Skillman family trustees, each of which contributed $38,906.75 to the Fund. No other contributions, fees, or dues have been paid by the Fund’s members.
The Fund is wholly funded by investment income. The IRS originally recognized the Fund as a tax-exempt social club, then revoked its exempt status based on the investment income funding. The IRS also alleged private inurement.
The Fund argued that it should maintain its tax-exempt status as long as its members spend time pursuing its stated purposes. The IRS equated the Fund’s investment income activities with engaging in forbidden for-profit endeavors and contended that the Fund may not receive more than 35 percent of its income from investment sources.
Summary of the Law
A tax-exempt social club must be organized for pleasure, recreation, and other nonprofit purposes. Substantially all of its activities must be conducted in advancement of these purposes. Guidelines established by Congress in 1976 generally limit the amount of outside income, including investment income, a social club may receive to 35 percent of total income. The history of these guidelines stated that they clarified then-existing law to “permit somewhat larger amounts of income to be derived by exempt social clubs from nonmembers and also from investment income sources.”
These guidelines amount to a “safe-harbor” rule. That is, tax-exempt status is not automatically lost if this percentage is exceeded. If the terms of the guidelines are exceeded, the legislative history states that all of the facts and circumstances are to be taken into account in determining whether the organization qualifies for exempt status. Indeed, the IRS has been known analyze cases of this nature by reviewing facts and circumstances first and then, if necessary, applying the safe harbor guidelines (e.g., Tech. Adv. Mem. 199912033). The agency once ruled that the overarching standard here is whether the activity or support is “necessary to preserve the assets of the “[c]lub used for exempt purposes” (Priv. Ltr. Rul. 9533015). On another occasion, the IRS used this facts and circumstances test to enable the club involved to retain its tax exemption because of a “lack of profits” (Priv. Ltr. Rul. 8426001).
Investment activity undertaken by a tax-exempt organization for itself is not an unrelated business.
The court did not make a determination as to the “precise percentage of investment income” that exceeds the permissible limit in the case; it concluded that “one-hundred percent certainly is beyond any permissible limit.”
It cited a pre-1976 case for the proposition that the courts “regard the percentage of investment income, in relation to an organization’s total gross receipts, as an indicator of whether the organization is conducting ‘substantially all’ of its activities for statutorily permissible non-profit purposes” (emphasis in original). In that case, the court wrote that the “source of a club’s revenues, as well as their destination, is crucial in determining the purposes for which the club is ‘organized and operated’” (United States v. Fort Worth Club of Fort Worth (5th Cir. 1965)).
A commentary on this court decision is in the June 2002 issue of The Nonprofit Counsel.
Further information underlying this case is available at Hopkins, The Law of Tax-Exempt Organizations, Seventh Edition (John Wiley & Sons), § 14.3.
Information concerning this area of the law, on an ongoing basis, is available in Bruce R. Hopkins’ Nonprofit Counsel, a monthly newsletter published by Wiley.