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Friday September 24, 2021

Article of the Month

Charitable Class and Disaster Relief

In order to qualify as a charity under IRS Code Sec. 501(c)(3) and obtain or maintain tax-exempt status, a non-profit organization must serve a "charitable class." In the wake of natural and man-made disasters, and now in the midst of the coronavirus pandemic, many charities are created. In addition, existing charities are reaching out to serve those who are in need due to current events. However, charities need to ensure they are protecting their tax-exempt status by assisting an appropriate charitable class.

Nevertheless, guidance from the IRS is unclear as to what constitutes a charitable class. In many instances, guidance from IRS Regulations and individually issued Private Letter Rulings (PLRs) determine what does not qualify as a "charitable class," as opposed to a definition stated in the affirmative. This article discusses the historical requirement of a charitable class, specific IRS and Congressional guidance issued after September 11, 2001, the prohibition against private benefits and a different route for qualification for tax-exempt status based on the standard of "lessening the burdens of government."

Tax Code Charitable Class Requirement

To maintain tax-exempt status under Sec. 501(c)(3) of the Internal Revenue Code (IRC), an organization must be organized and operated exclusively for exempt purposes set forth in Sec. 501(c)(3), and none of its earnings may inure to any private shareholder or individual. Exempt purposes are defined in Sec. 501(c)(3) as charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals. The IRC explains that "charitable" purpose is used in its generally accepted legal sense and includes relief of the poor and the distressed, or the underprivileged; and lessening the burdens of government. Reg. 1.501(c)(3)-1(d)(2).

However, the IRS acknowledges that these categories can and have changed over time since the regulations were issued in 1959. Additionally, the tax regulations do not specifically mention a charitable class. As scholars have noted, there is a lack of guidance on point regarding a charitable class and private benefits. Essentially, the IRS requires a charity to serve a charitable class without providing much guidance for charities on how to ensure compliance with the requirement.

According to IRS Publication 3833, "Disaster Relief: Providing Assistance Through Charitable Organizations," a charitable class is "a group of individuals that may properly receive assistance from a charitable organization. A charitable class must be either large enough that the potential beneficiaries cannot be individually identified, or sufficiently indefinite that the community as a whole, rather than a pre-selected group of people, benefits when a charity provides assistance."

While potentially helpful in deciphering the definition of a charitable class, it is important to note that IRS publications are not authoritative, but merely instructive. The IRS holds, and a line of court cases agree, that the authoritative tax law is embodied only in official statutes, regulations and judicial decisions. Unraveling IRS requirements can leave charities in a dilemma when trying to assist individuals in need, especially when the need is due to a disaster that requires swift assistance.

IRS and Congressional Guidance After September 11

The IRS and Congress have set forth parameters on the topic of charitable classes in the past. Following the events of September 11, 2001 (9/11), the IRS issued Notice 2001-78, 2001-2 C.B. 576 to clarify disaster relief requirements for charities attempting to assist 9/11 victims and first responders. The Notice stated, "While Congress is considering legislation, the Service recognizes the need to provide interim guidance to charities regarding payments made by reason of the death, injury or wounding of an individual incurred as a result of the September 11, 2001 terrorist attacks against the United States."

In terms of a charitable class, the Notice provided "the Service will treat such payments made by a charity to individuals and their families as related to the charity's exempt purpose provided that the payments are made in good faith using objective standards." This guidance allowed charities to react quickly to the communities that needed assistance the most. Charities were able to mobilize using good faith, objective standards.

After the Notice's release, Congress enacted the Victims of Terrorism Tax Relief Act of 2001 (VTTRA). The VTTRA allowed charitable payments made by charities assisting those affected by 9/11 to "be treated as related to the purpose or function constituting the basis for such organization's exemption under Section 501 of such Code if such payments are made in good faith using a reasonable and objective formula which is consistently applied." This legislation statutorily solidified the IRS' earlier guidance for charities.

However, this legislation and IRS guidance are only applicable for charitable distributions made in response to 9/11 and the following anthrax attacks. Therefore, charities attempting to assist those in need due to other disasters, including the current pandemic, may not be able to use the "good faith objective" standard. Charities must instead follow the general standards set forth in the tax code.

Providing a Private Benefit

Congress has established through regulations (and the IRS has provided examples within regulations and PLRs, which are only binding on the parties seeking a ruling, but can be used to provide insight into IRS decision-making) that charities providing a "private benefit" risk their tax-exempt status. An organization is "not organized or operated [for a charitable purpose] unless it serves a public rather than a private interest. Thus…it is necessary for an organization to establish that it is not organized or operated for the benefit of private interests, such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests." Reg. 1.501(c)(3)-1(d)(ii).

The requirement to provide a public rather than a private benefit is meant to serve a charitable class with a large group of potential beneficiaries, or the community as a whole, rather than a pre-selected group of people. However, the IRS does not always directly connect the charitable class requirement to the prohibition against private benefit.

Public Rather than Private Benefit

Scholarships are frequently an issue the Service examines to ensure there is not a private benefit conferred upon an individual. In Reg.1.501(c)(3)-1(d)(iii), the Service provides the example of an educational organization whose purpose was to study history and immigration. However, the focus of the organization's study in history was the genealogy of one family. The organization solicited membership only for members of that one family and the organization performed research to locate members of that family and connect them with one another. The Service notes that the interests in a case like this primarily serve a private rather than a public interest. Therefore, tax-exempt status for this organization would be denied. While an organization may potentially have a large charitable class, if the facts and circumstances demonstrate that a private benefit rather than a public interest is being served, tax-exempt status may be jeopardized.

Indefinite Rather than Preselected Beneficiaries

Common law recognizes the need for a charitable class to include a group of indefinite beneficiaries. This means that charities set up for the public benefit - and therefore qualifying for tax exemption - must aid an indefinite number of people who cannot be particularly identified. However, this common law understanding has not been defined or codified by the IRS or Congress in any official documents. The absence of a large, indefinite class of beneficiaries may then cause problems for organizations attempting to assist a small, but potentially deserving group of people.

The case of Wendy L. Parker Rehabilitation Foundation Inc. v. Commissioner examines private benefit, but has also been cited in later cases as providing a benefit to a particularly identified individual. In Wendy L. Parker, the Tax Court examined private benefit in relation to a purportedly indefinite charitable class. The family of Wendy Parker, a coma victim, established a foundation to assist coma victims. However, 30% of the foundation's income was anticipated to be spent assisting Parker. The foundation was denied tax-exempt status because "a child of the founder and chief operating officer of the Foundation is a substantial beneficiary of the services contemplated by the organization. This constitutes inurement which is prohibited under Code Section 501(c)(3) and the Regulations there under."

While the class of individuals was indefinite, the anticipated private benefit to Parker defeated the request for exempt status. The Tax Court noted "the 'operated exclusively for exempt purposes' test and the 'private inurement' test are separate requirements, although there is substantial overlap." While the result may have been different with the exclusion of the private inurement to a disqualified person, the Service has also noted in other cases citing Wendy L. Parker that the services of a charity must not be provided for a preselected individual.

In PLR 201923026, the IRS cited Wendy L. Parker in denying an exemption to an organization formed to host a fundraiser for five orphaned siblings whose parents died within a year of each other under tragic circumstances. The fundraiser was to help offset the children's living expenses. The IRS held that the fundraiser was operated for the "private benefit of one family rather than operating to provide a public benefit. Despite the fact that funds are raised and expensed for orphaned children the beneficiaries are pre-selected and all from one family. This serves private rather than public interests."

The Service directly compared the case to Wendy L. Parker and stated, "You have set up a process whereby pre-named beneficiaries are able to collect funding. Regardless of whether the…children are related to any board members, or meet the definition of needy, they have been predetermined to receive your funding without documented cause, making them a direct beneficiary and recipient of your income, resulting in inurement."

Although the children were not disqualified persons to the organization, the Service held that the class of beneficiaries was too small and predetermined to receive aid to qualify. The results in Wendy L. Parker and PLR 201923026 are instructive as scenarios charities should avoid. Educational institutions often provide support to what may be a small class of individuals in the form of grants and scholarships, but the recipients are not typically pre-selected. When educational scholarship recipients are chosen, it is required that the recipients are selected based on objective qualifications with the goal of avoiding private benefit.

Determination of Need on an Individual Basis

In PLR 201509039, the IRS denied tax-exempt status to a nonprofit organization that was created to offer funds to small businesses in areas affected by natural or man-made disasters. The organization's purpose was to assist small businesses impacted by disasters by connecting them with consumers so that the business would be able to avoid closure and employee layoffs. According to the PLR, "In order for an organization to fulfill a charitable purpose, it generally must assist a charitable class of individuals. If an organization allows its activities to benefit individuals beyond a charitable class, then it is not a charitable organization. See Wendy Parker Rehabilitation Foundation, Inc. v. Commissioner. Small businesses in areas affected by a disaster are not a charitable class, per se. Some of these businesses may have large sums of cash in reserve." Therefore, the Service ruled that because the organization did not make a determination of need on an individual basis, the organization did not qualify for exempt status.

However, the requirement to determine individualized need is often burdensome for charities, especially those wishing to offer expedient assistance after disasters. For charities to assist those in need due to disasters, IRS guidance would require charities to perform an assessment to discover the individual needs of recipients. Many organizations are not equipped to determine individualized needs, especially when time may be of the essence in providing assistance.

IRS guidance in the past has focused on individualized needs because "maintaining a person's standard of living at a level satisfactory to that person rather than at a level to satisfy basic needs would overly serve private interests" and "an outright transfer of funds based solely on an individual's involvement in a disaster without regard to meeting that individual's involvement in a disaster or without regard to meeting that individual's particular distress or financial needs would result in excessive private benefit." IRS Disaster Relief Guidance Memorandum, in response to Oklahoma City Bombing, Aug.25, 1995.

This particularized determination of need can be difficult for charities to make, especially in the wake of disaster when quick action is necessary. After the Boston Marathon Bombing in 2013, One Fund Boston was established to assist those affected by the tragedy. The Fund distributed over $80 million received in donations to survivors and families on a "need-blind basis."

The One Fund team created a strategy, working with the mayor and the City of Boston to meet the criteria for tax-exempt status based on "lessening the burdens of government." This strategy is one method of qualifying as a Sec. 501(c)(3) organization where the IRS does not examine the extent of the charitable class. Instead, the IRS will seek to determine if 1) there is a certain activity the government considers to be its burden and 2) if the activity lessens the government's burden.

While this method was successful for this instance, it should be used with caution. This method has not been tested extensively in the area of disaster relief. Charities should seek further guidance from their counsel to determine if this route is appropriate.


Unless and until more guidance in the form of regulations and statutes is released, charities will need to continue to abide by current IRS rules. In order to follow the limited guidance related to charitable class, charities must avoid providing a private benefit and must seek to establish an individualized determination of need, otherwise their tax-exempt status may be compromised. The rules promulgated after the 9/11 attack through the VTTRA only applied for that particular disaster. For COVID-19 or other disaster situations, charities must look to general IRS requirements for guidance or request that Congress pass laws, as it did after 9/11, to provide clear instructions for charitable distributions.

Published September 1, 2020
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