Service Gets Community Economic Development Wrong in Latest PLR
If a group of community minded altruists came to you for advice on whether the following described organization meets the requirements for (c)(3) or (c)(4) tax exemption what would you advise?
You formed as a corporation on [any date] in [Rural Town]. Your Articles of Incorporation state that your general objects and purposes are to promote economic development and the general welfare to the business, professional, and community interests of the inhabitants of Rural Town, and the territory surrounding Rural Town. The primary purpose is conserving, improving, developing, promoting, advancing, and expanding existing industrial, commercial and professional enterprises in Rural Town; to attract and aid in securing the location of new industries and business to Rural Town; to promote economic development in Rural Town by advertising and publicizing the industrial, cultural, labor, social and educational and physical advantages of Rural Town, and to assist and acquire the establishment thereof by locating, developing and making available suitable industrial sites and business locations.
According to your application, you provide economic development possibilities to Rural Town ranging from residential, commercial, and industrial. You promote the common good and general welfare of Rural Town by the development of residential and commercial lots to further community development in a rural area. You believe that you meet the community benefit standard because your efforts and activities are not controlled to any significant degree by those benefitted. You feel that by bringing opportunities to Rural Town, you will allow for residential, industrial, and commercial land usage to allow employees and employers to grow within the community. You state that funding will be provided in the form of grants from Rural Town, with the remainder provided in the form of loans from a local community bank. Lots will be sold at or below cost to attract businesses and residents to the community.
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Typical sales have been to individuals for family home building and/or commercial business owners that are looking to expand their businesses in the area. Pricing is typically focused on cost recovery. You will take into account land acquisition costs, infrastructure costs and incorporate TIF programs to allow for lot pricing that will hopefully encourage lot sales and development of lots. You stated that you are different than for-profit entities that engage in lot sales because you have a completely volunteer board that receives no compensation for any activities that occur. Because Rural Town is a small rural town that is in constant competition with neighboring communities, your goal is not to maximize return, but to encourage community development with the hope that you will recover the costs of these developments.
In Private Letter Ruling 202317021 (April 28, 2023), the Service ruled that this organization does not qualify for exemption under IRC 501(c)(4). The stated reason is that the organization sells lots just like a for-profit land developer. Wait what? For profit land developers set prices at or below cost? I think the conclusion is wrong and the organization should seek reconsideration, and if that doesn’t work it should get a declaratory judgement. Either the ruling leaves out some important facts or the author doesn’t quite understand the whole “community economic development” concept.
One factor the Service found significant enough to mention is that “there are no government designations of Rural Town as ‘deteriorated’ or ‘blighted’ and you did not establish that the median income is less than state or national averages.” I find reliance on this both strange and irrelevant, though the factors are derived from previous revenue rulings holding CED organizations exempt if they served an area designated as such by local government or suffering from government recognized unemployment problems. To make this a requirement, though, is almost to reserve to the Service the right to determine whether the organization’s activities are necessary. Apparently the Service will defer to a government designation, but in the absence of one it will presume an organization’s efforts are unnecessary, and that presumption works against tax exemption. Its almost as if the Service is saying, “what you are doing is great, but its not Rural Town government didn’t ask for help so you don’t deserve tax exemption.
I just don’t think the ruling is correct because it ignores a fundamental precept. Pluralism means grass roots organizations, not the government, get to determine need so long as what they determine necessary is neither illegal nor against public policy. The Community Economic Development Law Group, for example, “is an Ohio-based nonprofit legal services organization that specializes in providing business and legal education and coordinating legal assistance for start-up businesses and nonprofit organizations, as well as those that are growing and developing.”
If the charitable goal is economic development, is an organization disqualified from tax exemption because it directs its beneficial impact to otherwise capable consumers whose participation is indispensable to economic development? Clearly not, because to achieve its desired public benefit (community economic benefit), the organization must necessarily convey private benefit. Public good is not achieved without private benefit. Public benefit is simply [necessary] private benefit aggregated. The only limitation, of course, is that the private benefit be necessary to achieve the public benefit and is allocated strictly in accordance with methods to achieve the charitable goal. It appears the Service thinks the benefit to be derived by the private businesses and individuals whose economic presence is necessary to achieve is actually unnecessary because Rural Town is neither poor, distressed nor blighted. Is community economic development reserved for those areas alone. I would be very surprised if that were the case.
The regulations under 501(c)(3) never uses “community economic development” but it does specify that combatting community deterioration is a charitable purpose. The regulations regarding scientific research regulations indicate that “scientific research carried on for the purpose of aiding a community or geographical area by attracting new industry to the community or area, or by encouraging the development of or retention of, an industry in the community or area.” Clearly, economic development includes providing assistance — in a charitable manner and for charitable purposes — to people and businesses that aren’t charitable in the classic sense. But even through their own selfish desires, business owner opening in a depressed area, and low interest loan recipients foregoing a home in Squirrel Hill to instead buy in the Hill District, for example, are as important to achieving the charitable goal as a very well-payed physician at a tax exempt hospital or a highly paid professor at a university. The businesses and individuals participating in community economic development are basically the service providers whose efforts are necessary to economic development. Here is how one national exempt organization describes community economic development:
Most often, CED projects fall into one of three categories: real estate, business development or financial services.
- The real estate category includes affordable housing, as well as retail, commercial, industrial, community service or mixed use projects. Their commonality is that they use land and buildings to create a community asset that helps fill a need. Many people equate “real estate” only with “affordable housing” projects – those projects that result in housing that is developed at prices affordable to lower-income people. And while nonprofit housing developers produce a great deal of affordable housing – one national study1 suggests that nonprofits produce about 100,000 units of housing annually, or a total of over 1.6 million units in the last dozen years – they also develop a significant amount of other real estate. That same national study indicates that nonprofits developed over 21-million square feet of commercial and industrial space in the years 2005 to 2008.
- The business development category includes creating small businesses, or providing assistance to entrepreneurs – through technical help, lending or investing – to form or expand their business. These businesses often provide a good or service in the community, and also offer employment opportunities for residents. Of course there can be overlap between this category and the real estate category – such as the creation of business incubators that provide space and assistance to small businesses within the community.
- Financial services is a diverse category. It can include providing loans and investments to various community projects, or to individuals (for such uses as home improvement or purchase). It can also include providing financially-oriented services to community residents, including financial literacy and asset building programs.
The Service is just plain wrong on this one.
darryll jones