Monday, January 26, 2009

NC Court of Appeals Denies Tax Exemption to 501(c)(3) Summer Educational Camp: Should Below Market (or Cost) Fees Be Required for Tax Exempt Status?

In what seems like a continuing trend, a North Carolina court recently ruled that an educational summer camp exempt under IRC 501(c)(3) was still not entitled to property tax exemption as a charitable organization under state law.  Here is the sum and substance of the Court's analysis:

“The first step in an analysis under section 105-278.7(a) is to determine that the entity seeking an exemption qualifies as oneof the types of agencies entitled to an exemption pursuant to section 105-278.7(c).” Totsland, 180 N.C. App. at 164, 636 S.E.2d at 295. Relying exclusively on Totsland, the Foundation argues that it is an agency entitled to an exemption because its articles of incorporation and bylaws state that the Foundation is to “use its funds exclusively for . . . charitable purposes[,]” and because the Foundation is exempt from federal income tax under Section 501(c)(3) of the Internal Revenue Code. Although the Totsland Court concluded that the taxpayer in that case was a charitable institution based in part on the purposes stated in the taxpayer's organizational documents and on the fact that the taxpayer was a 501(c)(3) organization, the Totsland Court also noted that the taxpayer provides day care services to the children of low-income individuals. The day care services are offered at significantly reduced rate[s] to the parents, all of whom qualify for government subsidies. The parents are required only to pay a small portion of the cost of the day care services, and the county Department of Social Services (“DSS”) provides subsidies for the remaining portion of the cost of care. Totsland's services are not limited to a specific segment of the community, and are available to parents in three counties. Totsland does not have any control over how much it charges for day care services, or how much each parent is required to pay, as the cost of its day care services is set by DSS. In addition, Totsland does not operate its child care center for the purpose of making money, and it is not engaged in commercial competition with other area child care centers.   Id. at 166, 636 S.E.2d at 297. In the case at bar, by contrast, the Foundation operates a semester-long school for select highschool students, charging each student approximately $15,000.00 per semester. The Foundation also operates a camp which, according to the Foundation's executive director, charged campers “[m]arket rate[.]” Furthermore, the Commission found that the Camp charged its campers $150.00 per day and that, from the Camp's revenue of $390,108.07, the Foundation provided only about $20,000.00, or approximately 2% of the Camp's revenues, to campers in the form of financial aid. Finally, although neither “charitable association” nor “charitable institution” are defined in Section 105-278.7, “charitable purpose” is defined as a purpose “that has humane and philanthropic objectives; it is an activity that benefits humanity or a significant rather than limited segment of the community without expectation of pecuniary profit or reward.” N.C. Gen. Stat. § 105-278.7(f)(4) (2005). The Commission's conclusion that the Foundation did not meet its burden of proving that it is a charitable association or institution is supported by substantial evidence in the record. The Foundation, therefore, is not entitled to a property tax exemption under Section 105-278.7.

The interesting part of the opinion is that it seems to suggest that even an educational organization -- though not a formal educational institution -- must offer services at less than market rates in order to obtain tax exemption.  Note too that the organization apparently had no problem achieving federal income tax exemption as a charitable organization.  The trend, not an entirely new one, is that federal examiners rather routinely grant tax exempt status so long as the 1023 is properly completed and does not touch on any hot button issues (such as joint ventures).  By contrast, the states seem to be restricting the definition of "charity" to suit whatever economic conditions prevail (though in this case the denial originally issued in 2006 when the party was still going on).  I wonder if the states will ultimately force a reconsideration of the term "charity."  I agree that "charity" is a fluid concept that ought not to require any single factor in every case but I can't disagree with the notion that charging market rates is a factor that makes an organization less deserving of tax exempt status.  In fact, until I see the tragic case that proves otherwise, I have no problem at all with a trend that returns the concept of charity to that which inevitably and primarily assists the poor (as in, charging less than market or cost for services).

dkj

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