Farmer's Market Denied Tax Exempt Status Due to Having a Substantial Non-Exempt Purpose

An organization that ran a farmer’s market was found by the IRS to not qualify as a tax exempt §501(c)(3) organization in Private Letter Ruling 201601014

The organization operates a marketplace where farmers, businesses and artisans sell their goods directly to the public.  It also organizes special events where local craft vendors sell their goods, cooking demonstrations and other educational programs for adults, monthly educational events for children, and space at the market for local non-profits to promote their activities.

The organization stated its purposes are:

  • Strengthening the natural products economy by developing model processes, practices, and procedures to contribute to the sustainability and development of markets that make fresh and healthy foods available to all people;
  • Contributing to healthy and sustainable lifestyles for all by promoting products and programs from regional farmers, businesses, and artisans;
  • Pursuing programs and partnerships that have environmental, social, and economic integrity;
  • Supporting the efforts of other charitable organizations by making the market space available for their promotion and outreach.

Based on those purposes the organization applied for §501(c)(3) tax exempt status from the IRS.

The IRS declined to approve the application for exemption.  While the organization has certain laudable purposes, having some exempt purposes is not enough to obtain an exemption.  As the IRS notes:

Section 1.501(c)(3)-1(a)(1) of the Income Tax Regulations ("regulations") provides that, in order to be exempt as an organization described in section 501(c)(3) of the Code, an organization must be both organized and operated exclusively for one or more of the purposes specified in such section. If an organization fails to meet either the organizational test or the operational test, it is not exempt.

Section 1.501(c)(3)-1(c)(1) of the regulations provides that an organization will be regarded as "operated exclusively" for one or more exempt purposes only if it engages primarily in activities that accomplish one or more of such exempt purposes specified in section 501(c)(3) of the Code. An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.

Section 1.501(c)(3)-1(d)(1)(ii) of the regulations provides that an organization is not organized or operated exclusively for exempt purposes unless it serves a public rather than a private interest. To meet this requirement, it is necessary for an organization to establish that it is not organized or operated for the benefit of private interests.

The problem in this case is that the organization provides a market for private interests to be able to make money selling their wares.  As the IRS notes:

Contrary to section 1.501(c)(3)-1(d)(1)(ii) of the regulations, you are operated for the substantial purpose of providing private benefit to vendors of products at your market. Although the market includes educational events, more than an insubstantial part of your activities are in furtherance of the non-exempt purpose of being a profitable outlet for your vendors. This is evident by the fact that you state "these businesses are given the opportunity to sell their products with minimal overhead and marketing expenses." You not only provide the outlet for them to sell their products, you provide marketing and cover overhead expenses that the vendors would otherwise have to expend. Because your governing body members are also vendors, this private benefit constitutes inurement.

The ruling notes that finding the tipping point isn’t easy, and a number of revenue rulings and court cases have dealt with this issue.  The ruling specifically cites Revenue Ruling 61-170, Revenue Ruling 67-216, Revenue Ruling 68-167, Revenue Ruling 71-395, Revenue Ruling 73-127, Revenue Ruling 80-287, Better Business Bureau of Washington, D.C., Inc. v. United States, 326 U.S. 179 (1945), American Institute for Economic Research v. United States, 302 F.2d 934 (Ct. Cl. 1962), and Living Faith, Inc. v. Commissioner, 950 F.2d 365 (7th Cir. 1991) for guidance on finding the “tipping point” where the “substantial purpose” test is violated.

The ruling finds that the organization is virtually identical to that described in Revenue Ruling 71-395 which is described as follows:

In Revenue Ruling 71-395, 1971-2 C.B. 228, a cooperative art gallery was formed and operated by a group of artists for the purpose of exhibiting and selling their works and did not qualify for exemption under section 501(c)(3) of the Code. It served the private purposes of its members, even though the exhibition and sale of paintings may be an educational activity in other respects.

In denying the application the IRS concludes:

By providing a profitable outlet for local farmers and vendors, you are primarily serving the private interests of the businesses and individuals who come to your market to sell their products. The facts show the gathering of local residents for educational purposes is secondary to the commercial activities that occur at your market.