The Commerciality Doctrine is Alive and Well


In 2013, the IRS issued at least 36 rulings based, in whole or in part, on the commerciality doctrine. What started as a series of court rulings has developed into one of the more important tools for the IRS to address exemption and unrelated trade or business income issues. The commerciality doctrine can be summarized as follows: Operating in a commercial manner (activities substantially the same as for-profit organizations) may not be deemed as furthering the charitable organization’s exempt purpose. A finding that the commerciality doctrine applies may lead to the generation of unrelated business income or denial or revocation of an organization’s exempt status.

We bring this topic up today to reiterate the importance of analyzing new activities for exemption and tax issues, as well as strategic planning in the exemption application phase. Knowing what characteristics the IRS is likely to challenge in an exemption application is key to getting that 501(c)(3) recognition letter.

At a high level, an organization should ask itself: does this activity resemble an activity conducted by a for-profit organization? If so, are there attributes of your activity that differentiate them from those of similar for-profit organizations. In other words, is there a charitable component? Answering these questions before partaking in a particular activity is key to protecting your organization’s exempt status.

Historically, factors that have led to the application of the commerciality doctrine were competition with for-profit organizations, size of an organization’s profits, and the presence of substantial marketing.

In light of the recent rulings in this area, the following factors should also be considered. While the presence of one factor is dispositive, a substantial non-exempt purpose could prove fatal. We recommend that your organization consider the primary drivers of the commerciality doctrine mentioned above, as well as the points below, when considering expanding your current activities or taking on a new venture.

  • Identify parties who benefit from services provided. Define your charitable class. Are your services limited to the poor and distressed? Are substantial private interests served?
  • Is the scale of operations larger than necessary to accomplish exempt purpose? Or, is your organization’s exempt purpose too broad so as to encompass commercial activities?
  • Do you provide services that are managerial or administrative in nature? Fee-based consulting or management services are often a red flag.
  • Is training a charitable component? Is the training your primary activity or limited compared to the size of a commercial component?
  • If you conduct educational activities, are they useful to the individuals or beneficial to the community as a whole? To what extent do your educational activities contain product information? What percentage of your budget is directed to educational activities, and have you retained appropriate documentation? The IRS is particularly active with respect to mortgage mitigation and credit counseling services.
  • Do staff job descriptions resemble that of a like for-profit organization? Are your hours of operation similar to those of for-profit organizations? Are there volunteers and to what extent do they participate?
  • Are fees the only source of revenue? Is there an expectation to solicit outside contributions? Do all or most funds received primarily pay the salary of one or a few individuals?
  • If your organization provides healthcare services, to what extent do they benefit the community? Are they limited to profitable specialty services?
  • Are fees charged below cost? Does the activity target an economically disadvantaged group?
  • Lastly, are there exceptions or other factors that may be relevant? For example, are there no comparable services provided in the community? Is there a substantial community impact component?

If you would like more information or have questions about this article, please contact Ryan Fischer at rfischer@windes.com or (562) 435-1191.