Tax Court Finds Substantial Private Inurement in a Booster Club's Fees Offset Program
Booster clubs have long been used as fundraising arms for affiliated sports organizations. Establishing a booster club as a 501(c)(3) public charity provides the added benefit of enabling contributors to booster clubs to claim a tax deduction for their contributions. However, a recent case has called into question the practices of booster clubs whose contributions are used to benefit a small group of members rather than the sports club as a whole.
In Capital Gymnastics Booster Club, Inc. v. Comm'r, the U.S. Tax Court upheld the IRS’s position revoking the tax-exempt status of a booster club under I.R.C. § 501(c)(3). A gymnastics booster club, organized to foster amateur sports competitions and operated to support Capital Gymnastics National Training Center, a private for-profit corporation, lost its tax-exempt status because it was found to provide substantial private benefit to the insiders and outsiders of the club. The membership of the booster club was comprised of the parents of young athletes that competed on the teams operated by the Training Center.
Unlike many booster clubs supported by outside parties, this one was supported entirely by profits from fundraising activities and member dues and assessments. The members were entirely parents of youngsters participating in gymnastic activities through the club. Parents were required to pay annual dues and fees that covered the child athlete’s competition costs; fees varied based on the athlete’s competitive level. Instead of paying the fees in cash, however, parents and athletes could choose to voluntarily participate in the club’s fundraising program which permitted members to earn points and offset their individual dues assessments.
After the IRS examined the club’s returns for FY 2003, the IRS revoked the club’s tax-exempt status stating that the club had failed to establish that the club's income “did not inure to the benefit of private individuals and shareholders, which is prohibited by I.R.C. § 501(c)(3).” Capital Gymnastics Booster Club, 2013-193, 11. The Tax Court affirmed the IRS’s adverse determination and denied the club’s petition seeking a declaratory judgment.
The Court analyzed private benefit and private inurement rules applicable to private foundations (not directly applicable to purported public charities such as the club at issue) and found that the club did not operate exclusively for tax-exempt purposes because its earnings inured to the benefit of the members in violation of I.R.C. § 501(c)(3). I.R.C. § 501(c)(3) provides that “no part of the net earnings of . . . [the organization may] inure to the benefit of any private shareholder or individual.” The Court interpreted this prohibition to apply to an insider of an organization such as a member or an officer.
In addition, the Court analyzed that a more general inquiry into private benefits for non-insiders had to be made to determine whether an organization was operated exclusively within its tax-exempt purpose. To meet this requirement, an organization must 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.” Treas. Reg. § 1.501(c)(3)-(1)(d)(1)(ii).
The club argued that although the parent-members were “insiders” under IRC § 501(c)(3) and "exerted direct or indirect control over the organization," there was no constructive distribution to the members because the club never paid any money to the members but instead spent its funds “exclusively on competition-related expenses of the athletes.” Capital Gymnastics Booster Club, 2013-193, 17.Thus, the club argued that "the true recipient of its generosity was not the parents but instead a ‘well-defined charitable class of school age children.’” Id.
The Tax Court disagreed and found substantial private inurement to the parent-member-insiders who fundraised because by providing points to such members, the club was providing relief from an economic burden to the parents. The Court observed that in substance, the club authorized parent-members to raise funds for their own benefit but under the club’s name. Because the club failed to show that the parent-members were in financial distress or were otherwise members of a charitable class, yet its members received 93% of the fundraising profits, the Court ruled that the club’s fundraising “constituted a substantial non-exempt purpose.” Id. at 25.
In light of this Tax Court decision, booster clubs that operate within a similar framework by providing incentives to its members, which results in rendering of an economic benefit to those members, may be at risk of losing their tax-exempt status unless they consider other alternatives to achieving their fundraising goals. Some of the alternatives may include changing the tax-exempt status of an organization, changing the membership requirements and incentives for the club's members, or broadening the support base to disinterested parties.