Tuesday, August 14, 2012
The IRS has recently released a determination letter denying recognition of federal income tax exemption to an organization claiming to be an on-line church ministry. The applicant, a nonprofit corporation, proposed to provide "Christian spiritual leadership and pastoral care to individuals and fellowships in the international community of believers” who visit its website. The entity would offer "free spiritual services through the website including, but not limited to sermon preparation, outlines, and spiritual illustrations; Bible study, prayer group, and leadership training materials; membership, statement of faith, and other church-building materials; articles and fictional reading materials; etc." The entity’s revenues would derive from the sales of religious and quasi-religious materials, including self-help “seminars” previously sold by the entity’s founder, and books that the entity’s founder anticipates writing. The copyright of these books would remain with the author, and the applicant would receive only ten percent of the sales proceeds. The entity adopted a statement of faith and a code of doctrine and discipline, but did not have a regularly scheduled religious service or an established place of worship. Although the applicant would have membership, it encouraged members to join local churches. At the time of its application, the entity’s certificate of formation failed to contain a dissolution clause irrevocably devoting assets to exempt purposes and failed to prohibit private inurement of its net earnings, but the applicant later stated that it would correct these deficiencies. The entity’s governing board consisted of its founder and two family members.
The IRS concluded that the entity had failed to demonstrate that it is exclusively operated for an exempt purpose. It had a significant non-exempt purpose of promoting the works of its founder. Observing that the Treasury regulations “clearly regard transfers of for-profit activity to an exempt organization as indicative of private benefit,” see, e.g., Treas. Reg. section 1.501(c)(3)-1(d)(1)(iii), Examples 2 and 3, the IRS noted that the applicant proposed to pay to produce and promote material from which its founder and other authors will primarily benefit. “Benefits directed to those who control an organization deserve special scrutiny,” said the IRS. Although “[a] community based board of people with no financial interests in the entity can help prevent it from operating for private rather than public benefit,” the applicant’s governing board was small and related to one another. Hence, reasoned the IRS, “combined with the private benefit demonstrated above, it creates greater cause to believe that you are operated for private, rather than public, interests.”
In what can be analogized to judicial dicta, the IRS also stated that the applicant would not be classified as a church had it qualified for exemption under Internal Revenue Code section 501(c)(3). After citing its 14-factor test to determine whether an entity is a church, the IRS reasoned as follows:
You lack the most important, associational characteristics of a church, as well as most of the other factors deemed important to church identity. A website on the internet does not qualify as a place of worship, nor do individuals accessing that website constitute a congregation assembled to worship [citation omitted] .... Additionally, you do not ordain ministers, do not have regular congregations or services, do not have schools for religious instruction, and do not perform any sacraments such as weddings, baptisms, or funerals. Also, you encourage members to maintain membership in other churches and be baptized by other ministers. Therefore, although your purposes and activities would be religious, we cannot recognize you as a church for the purposes of public charity status.
I consider this determination letter instructive in this respect – its ease of finding the presence of private benefit when an entity governed by a founder-dominated board will benefit both itself and its founder through a commercial relationship. The ruling highlights the importance of independent boards when conflict-of interest transactions are in issue and the charity has few stakeholders likely to monitor its affairs. For further analysis of the degree to which the IRS has promoted independent boards through its process of granting determination letters, see Benjamin Moses Leff, Federal Regulation of Nonprofit Board Independence: Focus on Independent Stakeholders as a 'Middle Way,' 99 Ky. L. J. 731 (2011).
As to the ruling’s dicta concerning the non-church status of the applicant, I believe that in future cases in which an applicant conducting an on-line ministry makes a stronger case for exemption, the IRS should remain open to the possibility that such an applicant can qualify as a “church.” Let us move beyond the actual facts of the determination letter and consider closer cases. Advances in technology enhance the ability of ministries to foster interaction among remote internet users, even in real time, thereby achieving a virtual assembly. This use of technology may be especially meaningful to people interested in pursuing a religious faith in countries where doing so publicly is illegal or culturally suspect. An on-line religious worship service may be the only church that some people can experience without fearing the loss of their lives or estrangement from their families. In my opinion, the IRS should not impose its 14-factor test narrowly in an age that affords ministries the ability to facilitate real corporate worship through virtual congregational services.
The determination letter is Priv. Ltr. Rul. 2012-32-034 (May 16, 2012), reported this week in Tax Notes Today (electronic citation: 2012 TNT 156-27).