As discussed in previous posts, the Internal Revenue Service (IRS) requires that a public charity in the U.S. be organized and operated exclusively for charitable purposes. It may not be organized or operated for the benefit of private interests (private benefit), and no part of its net earnings may benefit private parties (private inurement). To better understand the distinct meanings of private benefit and private inurement, this post will note two key differences and provide a few illustrative examples.
Private Benefit Is Broader than Inurement
A major distinction between private benefit and inurement is that the former is construed broadly. Inurement pertains to a narrow category of disqualifying actions, while private benefit is permitted in limited instances. As the IRS points out:
[i]nurement and private benefit are often incorrectly used interchangeably. This can cause confusion and lead to incorrect analysis. The critical distinction is that "private benefit" is broader than "inurement." Thus, all inurement is private benefit, but not all private benefit is inurement.
Internal Revenue Manual 188.8.131.52. (February 23, 1999) (discussing inurement, private benefit, and intermediate sanctions)
The Existence of Private Benefit Activities Is Permitted in Limited Situations — Inurement Is Not
The broader private benefit proscription excludes incidental self-serving activities.
Although even a minimal amount of inurement results in disqualification of an exempt organization, private benefit will not jeopardize tax-exempt status if it is incidental to accomplishment of exempt purposes. However, an activity that primarily serves private interests may jeopardize an organization's exempt status if it is carried on to a degree that is more than an insubstantial part of the organization's activities.
The IRS has explained that
the word "incidental" in this context has both qualitative and quantitative connotations. … [I]t is qualitative in the sense that to be "incidental," the private benefit must be a necessary concomitant of the activity which benefits the public at large; in other words, the benefit to the public cannot be achieved without necessarily benefiting certain private individuals.
One seminal case that applied the qualitative and quantitative private benefit analysis involved an organization that was formed by lakefront property owners to improve the condition of the water in the lake. See Rev. Rul. 70-186, 1970-1 C.B. 129 (Jan. 1, 1970).
The IRS analyzed whether the resulting increases in property value to homeowners and personal enjoyment from the improved condition of the lake were incidental or substantial. It found that the
benefits to be derived from the organization's activities flow principally to the general public through the maintenance and improvement of public recreational facilities. Any private benefits derived by the lake front property owners do not lessen the public benefits flowing from the organization's operations. In fact, it would be impossible for the organization to accomplish its purposes without providing benefits to the lake front property owners.
It follows that some private benefit is qualitatively permitted when the byproducts of the organization's charitable activities "flow principally to the general public," and any private benefit conferred is impossible to avoid.
On the other hand, the narrow inurement proscription only applies to an individual, private shareholder, or insider having a "personal and private interest in the activities of the organization." Treasury Regulation sections 1.501(c)(3)-1(c)(2) and 1.501(a)-1(c).
One case that makes this distinction clear is United Cancer Council, Inc. v. Commissioner, 165 F.3d 1173 (7th Cir. 1999). There the court held that an exclusive contract between a charity and a fundraiser, with terms favorable to the fundraiser, was not private inurement because the fundraiser was not an insider. The latter only pertains to those who exercise power of ownership over the organization, such as an executive officer, high-level employees, and directors.
Reasonable Payments for Goods or Services Rendered Are Neither Private Benefit Nor Inurement
The proscription against private inurement arises "solely by virtue of the individual's relationship with the organization, and without regard to accomplishing exempt purposes." I.R.S. Gen. Couns. Mem. 38,459 (July 31, 1980).
Conversely, when a good or service is provided in accomplishing the charitable organization's operations, reasonable compensation is permitted. World Family Corp. v. Commissioner, 81 T.C. 958 (1983) (individuals operating charitable organizations are entitled to reasonable compensation); Treasury Regulation section 53.4958-4(b)(1)(ii).
Other countries' laws governing nonprofit entities typically contain similar restrictions or prohibitions on private benefit and inurement. For this reason, it is rare for an organization to fail to be deemed equivalent due to excess private benefit, or private inurement, if it is structured as a nonprofit organization in its home country.
- NGOsource Guide to Equivalency Determination (PDF)
- Overview of Inurement/Private Benefit Issues in IRS 501(c)(3), 1990 EO CPE Text (PDF)
- Internal Revenue Manual 184.108.40.206. (February 23, 1999)
This article is for general informational purposes only and does not represent legal advice as to any particular set of facts. Please seek legal counsel as you deem necessary.