Organization Operated for Significant Purpose to Benefit For Profit Business, Exempt Status Retroactively Lost

To retain status as a §501(c)(3) charitable organization, an entity must not only have been organized for charitable purposes (a requirement for initial qualification), it must also be operated exclusively for charitable purposes in order to retain that status.  A failure on the second test caused the organization in the case of Giving Hearts, Inc. v. Commissioner, TC Memo 2019-94[1] to retroactively have its status revoked by the IRS.

The case involves an attempt by a business that was negatively impacted by the National Do Not Call Registry, a program conducted jointly by the Federal Trade Commission and the Federal Communications Commission, to blunt the impact of that program.  The business, Windows Plus, relied primarily upon telemarketing calls to sell replacement windows and other home improvement services to homeowners.[2]

The Do Not Call Registry barred businesses from making unsolicited calls to any number an individual placed upon that list.  Not surprisingly, a large portion of numbers on the lists that Windows Plus used to generate leads through unsolicited calls quickly end up on that list. Windows Plus eventually reduced its telemarketing staff to one half the size it had been before the registry came into existence over the next few years.[3]

Ronald Carrier, a shareholder of Windows Plus, came up with a method he felt would allow the company to work around the National Do Not Call Registry.  The restrictions on calling phone numbers on the list did not apply to charitable organizations seeking to raise money.  Mr. Carrier decided that he could combine phone calls on behalf of a charitable organization with a method to enable him to generate sales leads for Windows Plus.[4]

Giving Hearts, Inc. was established to be the charity that would enable this program to proceed.  The organization applied for an application for exemption from taxation, filing Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, with the IRS.  The IRS subsequently granted the application for exemption, effective December 21, 2009.[5]  Its exempt purpose was to collect money and disburse it to charitable organizations.  For 2010-2016 it did collect contributions of $1,102 to $8,334 each year, and the overwhelming majority of those funds went to charitable organizations.[6]

Mr. Carrier set up a corporate sponsorship program that Giving Hearts would be a part of.[7]  Ultimately, while Mr. Carrier attempted to get other businesses to participate, Windows Plus was the only business that actually entered into a corporate sponsorship program with Giving Hearts, Inc.[8]

Windows Plus agreed to have its telemarketing staff make calls on behalf of Giving Hearts, Inc.  They solicited donations using the following script:

Hello * * * this is _______________ calling on behalf of Giving Hearts. We are a non-profit organization helping to fund local children’s charities. We have sponsored the Window Plus company for the purpose of fund raising. For every home owner that accepts a product demonstration and free estimate our charity [Giving Heart] will receive a donation from Window Plus. * * *

Well, for a limited time Window Plus is offering a onetime special offer of 30% off their triple-pane insulated replacement window which is guaranteed in writing to save a minimum of 40% on your annual heating cost. * * *

Not only will you be helping a charity receive a donation, you’ll also be getting the right advice and the right price on energy efficient products that will help save the planet while saving money off your ever increasing monthly utility bills. A Window Plus representative will leave you with a free estimate that is good for one full year. Please understand that you are under no obligation to purchase anything. They just want to show you their products and get you that free estimate so in the future if you decide to replace any windows, you’ll get back in touch with them. So, with this in mind, I will have the representative stop by DAY and TIME.[9]

Note that the charitable organization only received funds from Windows Plus if the person being called agreed to have an in-home demonstration and sales pitch.

A number of the recipients of the phone solicitations appear to not take kindly to being called.  The Michigan attorney general’s office contacted the IRS in December 2011, indicating it received a number of complaints that Giving Hearts was operating as “a front for a window sales operation.”  In April 2012 the IRS contacted Giving Hearts, indicating that it was starting an examination to look at the organization’s exempt status.[10]

The IRS concluded at the end of the exam that the exempt status should be revoked since the organization had not been operated exclusively for exempt purposes, as required under IRC §501(c)(3) and Reg. §1.501(c)(3)-1.  Rather, it was operated for substantial private and commercial purposes.[11]

The Tax Court agreed with Giving Hearts that it operated in part to further a charitable purpose, and that the IRC does not bar a charity from using a for profit organization to solicit contributions.  But the Court notes that the law requires more than this.

Rather, IRC §501(c)(3) provides (note the highlighted section):

(3) Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h)), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office. (emphasis added)

Reg §1.501(c)(1)-1(c)(1) goes on to give more details about operating exclusively for a charitable purpose:

(c) Operational test — (1) Primary activities. — An organization will be regarded as “operated exclusively” for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in section 501(c)(3). An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose. (emphasis added)

The Tax Court notes that there was clearly a second purpose to this call operation beyond simply soliciting contributions:

Petitioner’s corporate sponsorship agreement, by design and in effect, permits for-profit businesses (such as Window Plus) to invoke its name as part of a telemarketing pitch intended, first and foremost, to generate sales leads and revenues. In other words, although telemarketing calls are ostensibly made on petitioner’s behalf, the real purpose of the calls is business promotion. As the corporate sponsorship agreement and the telemarketing pitch make clear, see supra ap. 6-7, a participating business would be obliged to make a charitable contribution to petitioner only when a potential customer agreed to an in-home product demonstration. Considering all of the facts and circumstances, the Court concludes that petitioner was primarily engaged in generating sales leads (and ultimately revenues) to advance a commercial enterprise, with charitable donations arising only as a function of the businesses’ success in securing in-home product demonstrations and presenting project estimates to potential customers.[12]

Generating sales leads for a for profit company is not an exempt purpose and it is not substantially related to any exempt purpose per the Court.[13]

The Court also dismisses the organization’s complaint that they meant for other businesses to participate and that the investigation by the Michigan attorney general and referral to the IRS is why only their controlled businesses benefited. The problem in this case was not that a related business was the only one that benefitted. 

Rather the Court noted that “whether other for-profit enterprises participated in petitioner’s corporate sponsorship program would not alter the fact that petitioner was not operated exclusively for one or more exempt purposes as discussed herein.”[14]  That is, even if Windows Plus had not participated at all in this program, and only wholly unrelated businesses had taken part, Giving Hearts would still have faced the loss of its exemption.

[1], July 29, 2019, retrieved July 30, 2019

[2] Ibid, p. 2-4

[3] Ibid, p. 3

[4] Ibid, p. 3-4

[5] Ibid, p. 4

[6] Ibid, p. 9

[7] Ibid, p. 5

[8] Ibid, p. 8

[9] Ibid, p. 7

[10] Ibid, p. 5

[11] Ibid, p. 9

[12] Ibid, p. 13

[13] Ibid

[14] Ibid, p. 14