Economic Development Organizations – exempt status requirements

G. ECONOMIC DEVELOPMENT CORPORATIONS: Charity Through the Back Door (1992 EO CPE Text)

IRS Publication by Robert Louthian and Marvin Friedlander

– Charitable purposes: “Charitable” includes the relief of the poor and distressed, lessening the burdens of government, and the promotion of social welfare by organizations designed to lessen neighborhood tensions, eliminate prejudice and discrimination or combat community deterioration and juvenile delinquency.) (IRS Regs. 1.501(c)(3)-1(d)(2))

– Economic development corporations: Economic development corporations “generally are established to assist existing and new businesses located in a particular geographic area through a variety of activities including grants, loans, provision of information and expertise, or creation of industrial parks.” (Louthian and Friedlander, 2) While they are established to stimulate economic activity in depressed areas,  economic development organizations are for-profit entities and thus not exempt under Internal Revenue Code (IRC) 501(c)(3).

In order for economic development organizations to be become exempt under 501(c)(3), the organization must demonstrate that it is both organized and operated exclusively for charitable purposes. We must ask ourselves, “are these activities likely to accomplish exempt purposes?”

In all, the ultimate good received by the general public must outweigh the private benefit afforded to the direct beneficiaries. THE ACTIVITIES MUST SERVE A PUBLIC RATHER THAN A PRIVATE INTEREST. Per Louthian and Friedlander’s article, “the organization should demonstrate its specific criteria in eligibility and show how said criteria furthers public [not private] interests.”

The following factors are necessary to conclude that an economic development corporation is primarily accomplishing charitable purposes:

(1) Assistance is targeted

(a) to aid an economically depressed or blighted area;

(b) to benefit a disadvantaged group, such as minorities, the unemployed or underemployed; and

(c) to aid businesses that have actually experienced difficulty in obtaining conventional financing

i. because of the deteriorated nature of the area in which they were or would be located or

ii. because of their minority composition,

(2) Assistance is targeted to aid businesses that would locate or remain in the economically depressed or blighted area and provide jobs/training to the unemployed or underemployed from such area only if the economic development corporation’s assistance was available.

The following organization were granted exemption under IRC 501(c)(3) because their activities were accomplishing the following exempt purposes: relieving poverty and lessening neighborhood tensions caused by the lack of jobs in the area; combating community deterioration by establishing new businesses, rehabilitating existing ones, and eliminating conditions of blight; and lessening prejudice and discrimination against minorities.

1. Rev. Rul. 74-587, 1974-2 C.B. 162: The organization

a. devoted its resources to programs to stimulate economic development in economically depressed, high-density, urban areas, inhabited mainly by low-income minority or other disadvantaged groups, qualified for exemption under IRC 501(c)(3);

b. made loans and purchased equity interests in businesses unable to obtain funds from conventional sources because of financial risks associated with their location and/or because of being owned by members of a minority or other disadvantaged group;

c. established that its investments were not undertaken for profit or gain, but to advance its charitable goals;

d. funds for its program were obtained from foundation grants and public contributions.

2. Rev. Rul. 76-419, 1976-2 C.B. 146: The nonprofit organization

a. purchased blighted land in an economically depressed community and converted the land into an industrial park;

b. induced industrial enterprises to locate new facilities in the park through favorable lease terms that required employment and training opportunities for unemployed and underemployed residents of the area.

Some organizations were NOT granted exemption because “their overall thrust was to promote business as an end in itself rather than to accomplish exclusively exempt purposes.” (Louthian and Friedlander, 4) Operating in  an economically depressed area is not sufficient to receive exempt status.

3. Rev. Rul. 77-111, 1977-1 C.B. 144: One organization wanted to attract customers in an economically depressed area that is mainly minority groups. The organization used various marketing and advertising tools to attract potential shoppers. Another organizations wanted to revived retail sales in an area in economic decline. This organization constructed a retail center via private developer that is required (by the city) to employ minorities for the construction and operation of the project. The organizations:

a. did not limit their assistance to businesses located in a deteriorated area that could not obtain conventional financing;

b. did not limit its aid to businesses that are owned by members of a minority group or to businesses that would only locate within the area because of the existence of the center;

c. did not target benefits for businesses that were actually disadvantaged because of their minority-owned composition or location;

d. did not target benefits for businesses that would only locate or remain in an economically depressed or blighted area and provide jobs to unemployed area residents on account of the organization’s activities.

United States. Internal Revenue Service. G. ECONOMIC DEVELOPMENT CORPORATIONS. By Robert Louthian and Marvin Friedlander. Internal Revenue Service, 1992. Web. 8 Jan. 2014. <http://www.irs.gov/pub/irs-tege/eotopicg92.pdf&gt;

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