ARNSTEIN & LEHR LLP Attorneys at Law

Nonprofit Organizations Update

About our Nonprofit

Practice Group
IRS Outlines Safe Harbor for Tax-Exempt Campaign
Arnstein & Lehr LLP provides legal services
to trade associations, professional societies, Groups Failing to Report Information About Contributors
public charities, private foundations, fraternal
organizations, group insurance trusts,
political action committees, schools,
In Revenue Procedure 2007-27, published in March, the Internal Revenue Service
hospitals, medical staffs, "captive" insurance outlined a safe harbor Section 527 tax-exempt campaign groups can utilize in showing
companies, and other organizations exempt that there is "reasonable cause" for failing to report the addresses, employers and
from federal income tax under Section
501(c) of the Internal Revenue Code. The
occupations of contributors on IRS Form 8872. Federal law requires Section 527
Firm's attorneys help such clients deal with a groups to list the names and addresses of all contributors, and the occupations and
wide array of issues, including: employers of individual contributors, on that form, with a possible penalty of 35% of
• Corporate and trust formation and each contribution for which disclosures have not been made. But the IRS is allowed to
maintenance waive the penalty if groups can show "reasonable cause."
• Development of bylaws
The IRS has noted that the safe harbor does not apply in cases where a group has failed
• Obtaining and maintaining federal and to report contributor names on Form 8872. However, the IRS also points out that it can
state tax exemptions
waive penalties outside of the safe harbor if it finds that failure to report any required
• Avoiding and minimizing unrelated information was nonetheless due to reasonable cause.
business income taxes

• Registrations and annual filings with
attorneys general and other
government officials
• Proper conduct of organization
elections
• Avoiding antitrust problems
The safe harbor includes the following terms:
1. All fund raising solicitations, by or on behalf of a group, must clearly and
conspicuously request contributor names, addresses, and the occupation and employer
for individual contributors. Each solicitation must also state that the group is required
to report the information by law, subject to penalties for nondisclosure.

• Fund raising campaigns, including use
of professional fundraisers
• Self-dealing, inurement and
intermediate sanctions
• Relations with subsidiary groups,
including group tax exemptions
• Protection of intellectual property
• Charitable gaming
• Limitations on political and legislative
activity
2. Within 30 days of receiving a contribution without the required information, a group
must request that information in writing or orally, with a written record of the
request. The information request can thank the donor, but cannot address any other
subject, and it must include the group's legal reporting responsibilities, as well as
either a pre-addressed return envelope or postcard or, for oral or electronic requests, a
mailing or Internet address.
3. If contributors do not respond by the due date for a group's filing of Form 8872, the
group must "fill in the blanks" itself, provided the group has the required information
on file.

• Professional ethics matters

4. If a group receives any missing or corrected contributor information, it must file an
amended Form 8872 within 30 days, but no later than two business days before an
• Public and member disclosure election (unless the contribution is received fewer than 2 days before an election).
requirements

• Deductions for donors 5. A group must disclose all required information on Form 8872 with respect to at least
85% of the total dollar amounts of contributions received during the calendar year.
• Nonprofit mailing permits

• Partnerships and joint ventures with for-

profits

• Employment issues
Continued on Page 2
• Insurance issues
Nonprofit Organizations Update | Summer 2007
 Federal Law Prohibiting Intentional Damage to
Computers Found Constitutional
as Applied to Attack on Nonprofit's Computer Network
Connected to Internet
The U.S. Court of Appeals for the Eighth Circuit has found
that it was not unconstitutional to apply a federal statute
prohibiting the intentional causing of damage to protected
computers in the case of an individual who was fired from
his job at the Midland Division of the Salvation Army and
then proceeded to launch an attack on the organization's
computer network that cost the organization over $19,000 to
repair. The attack included deleting files, shutting down a
computer-operated phone system, erasing files, inserting files
with obscenities directed toward the organization and
sending organization employees pop-up messages on their
computers indicating that "Trotter was here."
John Larkin Trotter essentially admitted committing the attack
on the organization's computer system at trial of this matter,
when he was charged with intentionally causing damage to a
protected computer without authorization, in violation of 18
U.S.C. §1030(a)(5)(A)(i). But he reserved the right to challenge
the constitutionality of that statute as applied to him. The
statute prohibits a person from knowingly causing "the
transmission of a program, information, code, or command,
and as a result of such conduct, intentionally caus(ing) damage
without authorization to a protected computer." A "protected
computer" is defined, in pertinent part, as a computer "which
is used in interstate or foreign commerce or communication."
Trotter's constitutional challenge to the statute, which was
brought to the Eighth Circuit, involved his contention that the
statute was overly broad in its application to him, because the
Salvation Army is a nonprofit organization, and so, he said,
was not involved in "interstate commerce," except to the
extent that "[n]early all computers [these] days are used
someway in interstate commerce through the [I]nternet or
private networks." But the Eighth Circuit found that the
Salvation Army's status as a nonprofit had no bearing on
whether the statute was constitutional, because the statute
focused on the characteristics of the computer or computer
network attacked, not the entity using the computer or
computer network.
In this case, the Eighth Circuit found that the Salvation Army's
computers were connected to the Internet and the computers
were thus part of "a system that is inexorably intertwined with
interstate commerce." In addition, Trotter had admitted that
the computers were used to communicate with other
computers in other states, so that the Salvation Army's
Nonprofit Organizations Update | Summer 2007 | Page 2
computer system was clearly "used in interstate…commerce or
communication." Thus, enactment of the statute was clearly
within Congress's constitutional power to regulate interstate
commerce, and application of the statute to Trotter was
likewise constitutional.
IRS Report on Executive Compensation Released
The Internal Revenue Service has issued a report on an
Executive Compensation Compliance Initiative undertaken in
2004 by the Exempt Organizations Office of the Tax
Exempt/Government Entities Division. The project involved
sending compliance check letters to over a thousand
organizations and examining Form 990 and related returns for
many other entities, including both private foundations and
publicly supported organizations.
According to the recently released report, there were
"significant reporting errors and omissions" by tax-exempt
organizations in specific areas, particularly excess benefit
transactions and transactions with disqualified persons, as well
as potential compliance issues related to loans made to officers.
Many of the organizations surveyed had failed to initially file
schedules detailing compensation paid to officers or
employees.
On the other hand, the IRS reported that its study did not
evidence widespread concerns other than reporting. High
compensation amounts were found in many cases, but the
Service found that they were generally substantiated based on
appropriate comparability data.
IRS Issues Interim Guidance Concerning Excise
Taxes on Nonprofits Participating in Tax Shelters
The Internal Revenue Service has issued interim guidance
concerning when tax-exempt organizations will be considered
a "party" to a "prohibited tax shelter transaction." The federal
Tax Increase Prevention and Reconciliation Act of 2005
imposed an excise tax on tax-exempt entities for the tax year in
which they become a party to such a transaction.
According to the recently issued IRS interim guidance, a tax-
exempt entity will be considered a "party" to a "prohibited tax
shelter transaction" if it facilitates a transaction because of its
tax-exempt, tax-indifferent or tax-favored status. The only
other circumstance in which a tax-exempt entity will be
considered a "party" is if it is identified in published guidance,
by type, class or role, as a party to a prohibited tax shelter
transaction.
The IRS guidance also addresses the amount and timing of net
income and proceeds attributable to a transaction, which would
determine the amount of excise taxes due, if any. Among
other things, the IRS notes that net income and proceeds
attributable to a transaction and allocated to a tax year ending
on or before August 15, 2006 will not be subject to the new
excise tax. For tax years including August 16, 2006, allocations
will be made based on two short tax years, one ending on
August 15, 2006 and the other beginning on August 16, 2006.
Tax Court Upholds Denial of Educational Organization
Exemption for Nonprofit Promoting Unsupported
Conspiracy Theory
The U.S. Tax Court has upheld a decision by the Internal
Revenue Service denying tax-exempt status for the Families
Against Government Slavery as an educational organization
under Section 501(c)(3) of the Internal Revenue Code. The
organization's governing documents stated that its purpose was
to educate the public about "injustices to minority [A]mericans"
and about "peacefully fight[ing] for freedom." But the IRS and
the Tax Court found that the organization's primary activity
was publicly promoting an unsupported conspiracy theory in a
way that did not qualify as education.
The Tax Court noted that the organization's activities consisted
primarily of public protests or demonstrations made solely by
the nonprofit's founder, in which he attempted to convince the
public that the FBI kidnaps Hollywood celebrities and that law
enforcement personnel and private gangs are joined in a
conspiracy to kill, trap and enslave such celebrities and
minorities "to gain more financial support" and to engage in
activities described as "blood sport." In addition, the
organization's documents alleged that government welfare and
housing programs force minority women to participate in the
above-alleged conspiracy.
The IRS had requested the nonprofit to submit evidence
supporting its claim for exemption, and the organization had
submitted over 1,000 pages of what the Tax Court
characterized as "nonsensical, emotionally charged, and
incomprehensible allegations." Referring to published guidance
from the IRS, the Tax Court noted that "educational" purposes
do not include activities principally involving the presentation
of unsupported opinion, and the Tax Court characterized the
activities of the organization in this case as such because (1) the
organization's viewpoints or positions were factually
unsupported, (2) the organization distorted facts, (3) the
nonprofit used inflammatory language and emotional and
irrelevant statements, and (4) the organization failed to provide
background information allowing the public to understand and
evaluate its material.
Even apart from the above factors, the Tax Court found that
the nonprofit's activities would not qualify as "educational"
under the generally accepted use of that term. Furthermore,
the Tax Court noted the organization's acknowledgment in its
application that it would engage in legislative and political
activities generally not allowed for Section 501(c)(3) entities.
IRS Revokes Tax Exemption of Nonprofit
Providing Shelter for Homeless Veterans
The Internal Revenue Service has revoked a federal income tax
exemption under Section 501(c)(3) of the Internal Revenue
Code for a nonprofit organization that provided shelter for
homeless veterans. The organization had received its
exemption in 1989 on the basis that it would provide a
homeless shelter, but later structured its operations to serve
only veterans.
In this case, the organization operated three homes that were
used for homeless veterans, all of which were owned by the
president and sole director and officer of the nonprofit. The
IRS concluded that the nonprofit had made some expenditures
related to operation of these shelters, including repairs, capital
construction, food for the homeless and other miscellaneous
costs. But the IRS revoked the organization's exemption
because its net income had inured to the benefit of the
president.
The IRS noted that the organization did not maintain good
internal controls or enter into arm's-length transactions. There
were no contracts for rental or lease of the buildings owned by
the president and used by the organization, and no other
contracts regarding any payments to the president as
compensation, although payments to the president were being
made. Since the basis for the payments was unexplained, the
IRS deemed them to be for a personal and private benefit and
not for the benefit of the organization.
Foundation's Termination of Educational Programs
and For-Profit Founder's Subsequent Provision of
Similar Programs Will Not Have Adverse Tax
Consequences for Nonprofit
In a pair of private letter rulings, the Internal Revenue Service
has found that a private foundation would not suffer adverse
tax consequences as a result of its terminating certain
educational programs, even if its for-profit founder
subsequently conducted similar programs, as long as the
foundation transferred no property to its founder in connection
with its cessation of the educational programs. The
foundation's purpose was to create economic opportunities and
revitalize neighborhoods across the United States, which it
Nonprofit Organizations Update | Summer 2007 | Page 3
accomplished, among other things, through educational
programs disseminating information to minority and under-
served groups. The for-profit, which contributed to the
foundation, also provided products and services to low and
moderate-income Americans.
Considering information presented by the nonprofit, the IRS
noted that the foundation was terminating some of its
educational programs because the foundation had
determined that they were no longer an effective tool for
delivering its educational message to the intended audience.
The for-profit, however, had indicated that it might wish to
sponsor or conduct similar programs, entirely with its own
resources, and without any transfer of property from the
nonprofit to the founder.
Given there would be no transfer of property from the
nonprofit to the founder, the IRS concluded that the
proposed cessation of the foundation's educational
programs, and the possible providing of similar programs by
the founder, would not jeopardize the foundation's exempt
status under Section 501(c)(3), as the foundation would
continue to engage in other educational activities. In
addition, the IRS concluded that the foundation would not
be providing an impermissible private benefit to the founder,
and the proposed activities would not involve the foundation
and its sponsor in prohibited self-dealing.
On the other hand, the IRS noted that the foundation would
be continuing to provide a different educational program
designed to offer educational information about a variety of
issues, which would be directed to a broad public audience,
with a particular focus on low- and moderate-income
individuals, minorities, new immigrants, and other under-
represented groups. The founder indicated that it wished to
engage in advertising activities in conjunction with the
nonprofit's operation of that educational program. But the
IRS declined to rule on whether the nonprofit would realize
adverse tax consequences from such activities because the
question of whether they might involve impermissible private
benefit to the founder, or cause the nonprofit and its founder
to engage in prohibited self-dealing, would depend upon the
facts and circumstances existing at the time of those activities.
Thus, the IRS concluded that it would be inappropriate to rule
on that issue hypothetically.
Nonprofit Operating Housing Project
Denied Illinois Sales and Use Tax Exemption
The Illinois Department of Revenue, in an administrative
hearing decision, has denied a state sales and use tax exemption
to a nonprofit organization that operated a subsidized HUD
Section 8 housing project and obtained a majority of its
revenue from bingo operations, pull-tab games, rents and
membership dues. Among other things, the Department noted
that membership in the nonprofit was not available to an
indefinite number of persons, the nonprofit had failed to
establish that it had been designated as an exempt entity under
Section 501(c)(3) of the Internal Revenue Code, and the
organization's financial statements were incomplete.
The Department addressed the organization's revenue sources,
pointing out that, in each case, its revenue was received from
people who paid money to the organization in return for a
definite benefit they themselves would receive. With regard to
the housing project, the Department noted that it appeared to
be making money, and while the organization's bylaws indicated
that it would not evict a tenant solely for non-payment of rent,
the organization had failed to show that the bylaws provision
would be implemented.
Finally, the Department addressed the allegedly charitable
nature of the organization's activities. Though the nonprofit
gave money to certain organizations, it did not provide
information about the charitable nature of those entities or
how they were chosen for financial aid.
IRS Proposes Revocation of Charity's Exempt Status
Due to Former Officer's Questionable Expenditures
The Internal Revenue Service, in a private letter ruling, has
indicated that the exempt status of a charity under Section
501(c)(3) of the Internal Revenue Code should be revoked
due to the questionable expenditures made by a former
officer of the organization. Because of those expenditures,
the IRS determined that the organization, which has been
disbanded and has no assets, previously operated
substantially for private benefit.
Among the questionable expenditures by the former officer
were payments to another now-dissolved organization for
which he served as president, a payment to a financial
institution for an individual's car, payments for telephone bills
of unknown origin, and checks drawn either to cash or to
another individual for "rents." In addition, the IRS pointed out
that it had received no evidence the charity's assets were
disposed of in the manner required for dissolution of a Section
501(c)(3) organization.
Nonprofit Organizations Update | Summer 2007 | Page 4
 IRS Revokes Exemption for "Educational"
Organization Engaged in Publishing
The Internal Revenue Service has revoked the tax-exempt
status under Section 501(c)(3) of the Internal Revenue Code
previously held by an organization whose primary activity was
producing a magazine, Flying Adventures: The Private Aircraft
Owners/Passengers Travel & Lifestyle Magazine. The IRS found
that the magazine could not justify the previously granted tax
exemption on educational grounds because an average of 5%
of the publication consisted of educational content, such as
articles or other information relating to flying safety. In
contrast, 25% of the publication consisted of paid advertising
and 70% consisted of articles about various travel destinations,
which were deemed to be primarily for entertainment
purposes. Furthermore, the publication contained the
following disclaimer: "We gotta tell you: This publication is
NOT for navigational use. Pilots must make their own
determination regarding safety. We are not responsible for
data about advertisers, sponsors, reviews, editorial, airports, or
safety messages. This publication is strictly for your
entertainment value."
A further ground for revoking the organization's exemption
was its failure to provide documentation to substantiate the
amount of $1,789,609 reported in its books as "Accounts
Payable and Accrued Liabilities," which appeared to represent
amounts owed to the founder and sole director and officer. It
could not be determined that the fees charged by the founder
to the organization, for which the organization had accrued
liability, were reasonable, because the founder had not provided
substantiating documentation for transactions listed as
"development/creation," "loans," "automobile mileage
reimbursement," "lease of personal aircraft," "lease of
equipment," and "commissions." Furthermore, the founder
had not demonstrated that the basis for his salary of $54,600
had been documented by the organization, and it appeared that
interest rates charged to the organization by the founder were
unreasonable, while transactions involving use of automobiles,
personal aircraft and equipment were of a personal nature and
for the benefit of the founder in violation of federal tax
regulations.
Scientific Research Organization Will Not Realize
Adverse Tax Consequences from Focusing Research
Efforts Toward Aiding Geographic Area, Attracting New
Industry and Encouraging Development
In a recent private letter ruling, the Internal Revenue Service
has held that a nonprofit scientific research organization
previously recognized as tax-exempt under Section 501(c)(3) of
Nonprofit Organizations Update | Summer 2007 | Page 5
the Internal Revenue Code will not realize adverse tax
consequences by amending its articles of incorporation so as
to allow it to focus the organization's research efforts toward
aiding a geographic area, attracting new industry to the area
and encouraging industrial development there. The nonprofit
was originally formed to conduct scientific research for the
understanding, measurement and prevention of problems
caused by inadequate indoor environments. But it expanded
the purpose clauses in its articles of incorporation to allow the
organization to become a vehicle for attracting companies,
generating new investments and bringing high-paying jobs to a
particular geographic area by transforming the area into an
innovative leader in the field of environmental research.
The IRS stated that while the nonprofit would continue with
its original scientific research into indoor environmental
problems, it would make a greater effort to ensure that the
results of its research would develop and encourage industry in
the geographic area served by the organization. This change
was characterized as a change in the emphasis of the
nonprofit's mission, and the IRS concluded that substantially
all research conducted by the organization or in the benefited
geographic area would be "scientific" research "carried on in
the public interest." In that regard, the IRS determined that
the "scientific" character of the organization's research would
not be changed by the fact that its amended articles of
incorporation would allow it to focus its research efforts
toward aiding the geographic area, attracting new industry to
the area and encouraging industrial development there.
Organization Under State's Business Corporation
Statute Creates Presumption Against Entity's
Entitlement to Exemption Under Internal Revenue
Code Section 501(c)(4)
The Internal Revenue Service has held that an entity organized
under a state's business corporation statute was not thereby
precluded from being considered exempt from federal income
tax under Section 501(c)(4) of the Internal Revenue Code.
However, the IRS ruled that such incorporation creates a
presumption that an entity is not entitled to exemption under
Section 501(c)(4).
In this case, the entity argued that it was entitled to an
exemption because it was actually operated in a manner that
made it a charitable trust under applicable state law.
Considering all of the facts and circumstances of this case,
however, the IRS concluded that the organization could not be
considered as "not organized for profit," within the meaning of
Section 501(c)(4), based on the following factors:
(1) it was organized under its state's business corporation law;
(2) neither the articles of incorporation nor the bylaws of the
organization limited its business powers, particularly with
respect to dividends;
(3) the entity had stock that was held by a for-profit
organization, to which it was required to distribute assets
upon dissolution, and there were no apparent ownership or
transfer restrictions with respect to the stock of the parent
or the subsidiary, and
(4) the organization could have incorporated under its state's
nonprofit corporation statute, unlike an entity in a
previously decided case that could not have been formed
as a nonprofit corporation under its state's laws.
Church-Affiliated Nursing Home
Facility Denied Property Tax Exemption
The Connecticut Superior Court has held that a church-
affiliated nursing home facility was not entitled to a state
property tax exemption because it was not used exclusively for
charitable purposes, since it generated large amounts of money
from private patients and provided rehabilitative services that
were not exclusively for the elderly. In addition, the court
found that the facility was not entitled to a religious property
exemption because, while the facility had a large chapel on the
premises, that chapel was merely incidental to the primary use
of the facility as a nursing home.
If you would like further information about
any of the topics mentioned in this
publication, please contact James F. Gossett
at jfgossett@arnstein.com or 312.876.7833.

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Nonprofit Organizations Update | Summer 2007 | Page 6