TE/GE Advisory Committee: Regulations Needed on Commerciality Test

In its 2014 Report of Recommendations, the IRS Advisory Committee on Tax Exempt and Government Entities specifically recommended:

 The IRS Exempt Organizations Division should recommend that Chief Counsel and Treasury open a regulation project so that profits from a substantial commercial activity will not preclude exemption under I.R.C. § 501(c)(3) as long as an organization’s income and its financial resources are used commensurate in scope with its charitable program.

The advisory panel specifically explained:

The IRS should open a regulation project to: (1) formalize the commensurate test articulated in Rev. Rul. 64-182; and (2) to reject application of the commerciality test. Recent court cases and IRS rulings have been applying a “commerciality test” to determine: (1) when certain business activity conducted by a Section 501(c)(3) organization will preclude tax exemption; and (2) what constitutes unrelated business generating taxable income. Neither the tax law nor the implementing regulations provide support for a commerciality test.

The report ultimately concludes that the commerciality doctrine “is not only unsupported by the Internal Code or its implementing regulations, the doctrine is also inconsistent with the common law of charitable trusts,” upon which current regulations are based (referring to §1.501(c)(3) -1(c)(1) and -1(e)(1) promulgated in 1959).  The advisory panel concludes that the primary purpose test in the Regulations has basically been replaced with a commerciality test in the IRS’s determination of an organization’s extent of business activity.

The advisory panel also recommended IRS cooperation with the Chief Counsel’s office and the Treasury Department to promulgate a comprehensive revenue ruling on various other unrelated business income issues including activities that will be considered related and unrelated; preparatory time spent on activities; and situations evolving from the IRS’ college and university compliance project, such as facility rentals and dual-use properties. 

Most practitioners would clearly find such guidance helpful as well as definitive IRS guidance reconciling the commensurate test with the regulatory primary purpose test and their interaction with the UBIT rules.

(See also:  Daily Tax Report) 

Nicholas Mirkay