[NEohioPAL] Filmmaking as Part of a Nonprofit Organization - Installment #1

[Mary Ellen Tomazic]

                             Filmmaking as part of a Nonprofit Organization

                                  By Mary Ellen Tomazic



Installment I. Intro and Background of Nonprofit Laws



        Can a nonprofit organization exempt from taxation under I.R.S.
§501(c) (3) make a profit? And if so, what kind of trades or businesses can
it operate at a profit and still keep its tax exempt status? This question
came from a filmmaker whose father has a tax exempt ministry, and who wants
to make a film related to the ministry and finance it by selling
advertising on a YouTube channel which would show the movie and other
videos related to it. Since the documentary is about the ministry, would
the YouTube channel advertising income come under the exemption of the
nonprofit organization? Before analyzing the options the ministry has for
financing its film, it is instructive to discuss the underpinnings and
history of the §501(c) (3) tax exempt status for nonprofit organizations
and how it has evolved over the last sixty years.

        Nonprofit organizations have two concerns under the federal income
tax law about running a business: 1) whether the activity adversely affects
the organization’s tax exempt status; and 2) if not, will or should the net
income of certain businesses run by nonprofits be taxed, and how far should
this tax extend?

        As a simple rule of thumb, in order to receive an exemption from
federal income tax, the profitable trade or business run by the nonprofit
must be “related” to the purposes for which the nonprofit received its tax
exempt status. Over the years, there was controversy over what “related”
meant, and whether the trade or business was allowed to be carried on
regularly or just for a brief
time.[1]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%231.docx#_ftn1>Previous
to the Revenue Act of 1950, the requirement was only that profits
garnered by exempt organizations be used in furtherance of the tax exempt
purposes, without regard to the source of the profits. Nonprofits quickly
took advantage of the old rules, carrying on full-fledged commercial
enterprises in competition with corporations whose profits were fully
taxable. For example, in the case of *C.F. Mueller Co. v.
Commissioner*,[2]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%231.docx#_ftn2>Mueller,
the largest manufacturer of noodles and macaroni in the U.S.
qualified for tax exemption under §501(c)(3) because all its pasta profits
were distributed to its sole shareholder, New York University, for the
exclusive benefit of its law school. NYU also owned Howes Leather Company,
American Limoges China and Ramsey Corporation, a manufacturer of piston
rings. As this case was working its way through the courts, the U.S.
Congress was debating the first bill on the Unrelated Business Income Tax
(UBIT.) In the hearings one representative warned of a “macaroni monopoly”
by the university, where all the noodles in the country would be produced
by corporations held or created by universities, depriving the Treasury of
any tax revenue from an entire
industry.[3]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%231.docx#_ftn3>The
hearings eventually produced Internal Revenue Code § 502 and rules for
the “Unrelated Business Income Tax”, providing that an income-producing
activity (other than passive investment) that is regularly carried on and
not “substantially related” to an organization’s exempt purposes, apart
from the need for income to support its charitable or other exempt mission,
will be taxed as a regular business. Under § 502, an organization operated
for the primary purpose of carrying on a trade or business for profit shall
not be exempt from tax under § 501 on the ground that all of its profits
are payable to one or more tax exempt organizations. Thus, § 502 denies
exemption to so-called “feeder corporations” like the Mueller macaroni
company, and other entities that operate a business as their sole activity
and typically are obligated to pay over their profits to an affiliated
§501(c) (3) organization.[4]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%231.docx#_ftn4>The
Congress was concerned mainly with unfair competition with for-profit
businesses which can use only their profits remaining after taxes, while
the tax-free status of §501(c) (3) organizations allow them to use their
profits tax-free to expand their operations. The House and Senate Reports
both gave examples of these organizations actually using their tax
exemptions to buy businesses, acquiring the business with little or no
investment of their own part and paying for it in installments out of
subsequent earnings, which could not be done if the business were taxable.
[5]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%231.docx#_ftn5>

        Most of the changes in the tax law relating to nonprofit
organizations after 1950 have been piecemeal, but the theme of preventing
unfair competition between nonprofits and for profit companies continued.
Nonprofits benefited from not only their federal tax exempt status, but
also from state and local tax exemption, lower subsidized postal rates,
antitrust exemptions, and the “aura” of a government imprimatur which
helped as a marketing tool and a method of quality control and protection.
[6]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%231.docx#_ftn6>The
Congress was willing to allow otherwise qualified organizations to
keep
their exemption from taxation as long as the businesses they engaged in
were “insubstantial” in relation to their charitable activities, even if
they were unrelated to the organization’s exempt
purposes.[7]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%231.docx#_ftn7>This
so-called “commerciality doctrine” was imputed by the courts and
commentators into §501(c) (3). However, although the organization is
allowed to retain its tax exempt status, such unrelated business activity
is still taxable under the UBIT.













Mary Ellen Tomazic is an attorney in Cleveland specializing in entertainment
issue such as copyright, trademarks, contracts and licenses for musical
groups and filmmakers.


------------------------------

[1]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%231.docx#_ftnref1>
See
generally James L. Fishman and Stephen Schwarz, Nonprofit Organizations
Cases and Materials 596-597 (3d Edition 2006).

[2]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%231.docx#_ftnref2>190
F.2d 120 (3d Circuit 1951).

[3]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%231.docx#_ftnref3>Remarks
of Rep. John Dingell, Hearings Before the House Comm. On Ways and
Means, 81st Cong., 2d Sess. 579-580 (1950).

[4]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%231.docx#_ftnref4>
Id.
fn.1.

[5]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%231.docx#_ftnref5>H.R.Rep.
No. 2319, 81
st Cong., 2d Sess. 38 (1950); S.Rep. No. 2375, 81st Cong., 2d Sess. 28-29
(1950).

[6]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%231.docx#_ftnref6>From
statement of Joseph O’Neil, Chairman, Business Coalition for Fair
Competition, at Hearings Before the Subcommittee on Oversight, House Ways
and Means Committee, 100th Congress, 1st Sess. 217-220 (Ser. 100-26, 1987).

[7]<file:///C:/Users/Maryellen/Documents/Filmmaking%20as%20part%20of%20a%20Nonprofit%20Organization%20-%20Installment%20%231.docx#_ftnref7>Treas.
Reg. § 1.501 (c)(3)-1(b)(1)(iii).