IRS Denies Farmers Market Tax-Exempt Status

The ongoing confusion in locating the line between charitable/tax-exempt vs. non-charitable/taxable business activity for nonprofits was highlighted by the IRS’s October 2015 denial of 501(c)(3) tax-exempt status to a farmers market. (PLR 201601014) The ruling illuminates how the IRS determines whether an entity that plans to conduct business activities alongside (or as part of) its charitable activities qualifies for 501(c)(3) tax-exempt status.

THE FACTS

Here are the facts as the IRS summarized them:

The Organization’s Purposes:

1. 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; 

2. Contributing to healthy and sustainable lifestyles for all by promoting products and programs from regional farmers, businesses, and artisans;

3. Pursuing programs and partnerships that have environmental, social, and economic integrity;

4. Supporting the efforts of other charitable organizations by making the market space available for their promotion and outreach.

The Organization’s Activities:

Your organization provides the surrounding community with a marketplace where farmers, businesses, and artisans sell their goods directly to the public one day per week. You also provide:

  • Special events where local craft vendors can sell their products;
  • Cooking demonstrations and other educational programs for adults and monthly educational events for children one day per month.
  • Space at the market for local non-profits to promote their activities.

The IRS noted that food vendors were charged relatively minimal fees to participate (no more than $25/week), and that the organization promoted the market through its weekly newsletters, a website, and through the local farmers market community.

Governance:

You are managed through your board of directors and a contracted market manager. The board meets on a monthly basis to discuss the weekly markets and how to improve them, the various community and children’s projects, and marketing strategies.

The IRS further noted that at least two directors and officers were also vendors selling products at the farmers market.

Revenues and expenses:

Your organization is funded by community donations and vendor fees. Your expenses consist of insurance, marketing, supplies, professional fees, and expenses related to special events.

ANALYSIS

In denying the organization’s request for 501(c)(3) tax-exempt status, the IRS noted the following:

1.  The entity was operated “for the substantial purposes of providing private benefit to vendors of products at [its] market.”

The IRS found that, in comparison to the educational activity the entity conducted, “more than an insubstantial part of [its overall] activities are in furtherance of the non-exempt purposes of being a profitable outlet for [its] vendors.”

The IRS determined that the entity’s activities were effectively identical to those of an art gallery which exhibited and sold its members’ artwork. The art gallery was also denied tax-exempt status (Rev. Rul. 71-395). In that case, the IRS noted that although the exhibition and sale of paintings may be educational, the entity served the private purposes of its members more than incidentally.

2.  Because some of the entity’s board members are also vendors, their private benefit constitutes inurement.

The concept of inurement (more commonly known as private inurement) derives from Treasury Regulation section 1.501(c)(3)-1(c)(2), which states that, “no part of the net earnings of a section 501(c)(3) organization may inure to the benefit of any private shareholder or individual.” This restriction bars insiders of tax-exempt organizations (such as directors and officers) from unduly benefiting from the organization’s assets. The Private Letter Ruling does not provide any analysis on this particular finding. This conclusory statement is problematic. Conflict of interest transactions are generally a red flag when the IRS reviews applications for tax-exempt status, but they should not be a barrier to exemption if appropriate steps have been taken to ensure that such transactions were reviewed and approved by the independent board members as being fair, reasonable, and in the organization’s best interests.

3.  The organization’s educational programs are distinct from (and secondary to) the commercial operation of a farmers market.

The IRS pointed to Revenue Ruling 73-127, in which it held that an entity operating a reduced price retail grocery store located in a low-income area that allocated a small percentage (4%) of its earnings to provide job training for the difficult-to-employ did not qualify for tax-exemption. The IRS viewed the operation of the store as an independent objective of the organization, and the operation of the store was not a recognized charitable purpose. It also noted that the store operations were conducted on a scale larger than reasonably necessary for the performance of the organization’s training program. The IRS contrasted the entity operating the grocery store from that of another nonprofit organization which was formed to market the cooking and needlework of needy women, which qualified for tax-exemption. (Rev. Rul. 68-167) Unlike the grocery store business, which could function as a business independent of the job training program, the organization selling the cooking and needlework of women in need existed solely to fulfill the charitable purpose of giving these women a market to sell their products and a source of income. The IRS also noted that the organization was not self-sufficient, and depended on charitable donations.

The IRS analysis seems very straight forward, right? But wait! Farmers markets have frequently been granted 501(c)(3) status, or other tax-exempt statuses, including as 501(c)(4) social welfare organizations, 501(c)(5) agricultural organizations, and 501(c)(6) business leagues. (See this chart prepared by the Farmers Market Coalition, explaining how different organizational activities and emphases can lead to different tax designations). While any tax-exempt status is beneficial, organizations prefer 501(c)(3) status because it is the only designation that allows organizations to receive tax-deductible contributions. Farmers markets do serve charitable, and more specifically, educational, purposes, some of which were noted in the denial ruling. The Farmers Market Coalition provides some tips on how an organization can explain the charitable and educational aspects of a farmers market in order to demonstrate to the IRS that the primary benefit of the organization’s activities is for the public, and not the farmers. Given the IRS’s checkered history in awarding or denying 501(c)(3) status to different farmers markets, organizations should think carefully about their purposes and activities, and if seeking 501(c)(3) status, ensure that the educational nature of the organization is fully articulated in the 1023 application to the IRS across all facets of the organization, including its purposes, activities, finances, and governance.

When considering whether to structure a social purpose venture as a for-profit enterprise or a tax-exempt nonprofit, it is important to assess whether more than an insubstantial part of the entity’s activities further non-exempt purposes (such as generating profit for a non-charitable class of individuals or entities). Similarly, if charitable or educational activities are contemplated, consider whether those charitable/educational activities are distinct from, or inextricably intertwined with, the business activity. While a number of factors will drive a business’s decision about its legal structure, understanding the key requirements (or barriers) to qualify for federal tax-exempt status will help entrepreneurs determine the right path more quickly.

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who we work with

Our clients are diverse nonprofit organizations with a broad range of missions, as well as for-profit companies in evolving areas such as social enterprise, corporate philanthropy, joint ventures, technology-driven fundraising, and impact investing.

A.B. Data
AB InBev Foundation
Absolut Company
American Committee for the Weizmann Institute of Science
American Diabetes Association
American Friends of the Hebrew University
American Parkinson Disease Association
Association of Fundraising Professionals
Avalon Consulting
Baton Rouge Area Foundation
Black Lives Matter Global Network Foundation
Bleeding Blue for Good Fund
Bradley Cooper’s One Family Foundation
BrightFocus Foundation
Brooks Brothers
Chadwick Boseman Foundation for the Arts
Changing Our World
Charity Defense Council
Christian Appalachian Project
Doctors of the World/ Medecins du Monde
Doctors Without Borders/ Medecins San Frontieres
Drug Policy Alliance
Duke University
Emory University
Estee Lauder Companies, Inc.
Feed The Children
Food For The Poor
Gerald R. Ford Presidential Foundation
Grameen Foundation USA
Hope for New York
International Campaign for Tibet
International Crisis Group
International Justice Mission
J. Crew Group
Johns Hopkins University
Lautman Maska Neill & Company
Lawyers Committee for Civil Rights Under Law
LSU Foundation

Marts & Lundy
Meyer Partners, LLC
Milken Institute
NAACP Foundation
National Alliance on Mental Illness (NAMI)
National Marrow Donor Program
National Park Foundation
Natural Resources Defense Council
North Carolina State University
North Shore Animal League
Operation Smile
PBS Foundation
Pernod Ricard USA
PetSmart Charities
PopSockets
Population Action International
Project ORBIS International
Public Interest Communication
Rails to Trails
Redeemer Presbyterian Church
Rockefeller Philanthropy Advisors
Save the Children Federation
Sesame Workshop
Simon Wiesenthal
SOS Children’s Villages – USA
Subaru of America
The Little Market
Touro University
United States Equestrian Team Foundation
United Way Worldwide
University of Connecticut
University of Virginia
Vote.org
Whitney Museum of American Art
World ORT
World Wildlife Fund
YWCA USA

A.B. Data
Absolut Company
American Committee for the Weizmann Institute of Science
American Diabetes Association
American Friends of the Hebrew University
American Parkinson Disease Association
American Rivers
Association of Fundraising Professionals
Baton Rouge Area Foundation
BrightFocus Foundation
Burger King McLamore Foundation
Cancer Care
Carnegie East House and James Lenox House Association
Center for Car Donations
Changing Our World
Charity Defense Council
Christian Appalachian Project
Coca-Cola Scholars Foundation
Convoy of Hope
Cornell University
Doctors Without Borders/ Medecins San Frontieres
Drug Policy Alliance
Duke University
Emory University
Feed The Children
Gerald R. Ford Presidential Foundation
Grameen Foundation USA
Helen Keller Services
Hope for New York
Human Rights Watch
Humane Society of US
Indiegogo
International Campaign for Tibet
International Crisis Group
International Justice Mission
Japanese American National Museum
Johns Hopkins University
Lane Bryant Charities
Lautman Maska Neill & Company
Lawyers Committee for Civil Rights Under Law
LSU Foundation
Mattel
Meyer Partners, LLC
Milken Institute
National Breast Cancer Coalition
National Marrow Donor Program
Natural Resources Defense Council
North Carolina State University
North Shore Animal League
Obama Foundation
Operation Smile
PBS Foundation
Pernod Ricard USA
PetSmart Charities
Population Action International
Project ORBIS International
Public Interest Communication
Rails to Trails
Redeemer Presbyterian Church
Rock and Roll Hall of Fame and Museum
Rockefeller Philanthropy Advisors
Sesame Workshop
Simon Wiesenthal
SOS Children’s Villages – USA
Steinhardt Foundation
Subaru of America
United States Equestrian Team Foundation
University of Montana Foundation
University of Nevada, Las Vegas Foundation
Whitney Museum of American Art
World ORT
World Wildlife Fund
YMCA USA
YWCA of New York City
YWCA USA

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news & events

Our attorneys’ recent contributions to the media and nonprofit sector publications.

news & events

Check out our attorneys’ recent contributions to the media and industry publications.

Secure Your Data – Seriously, AFP New York Chapter News
As Jon Dartley, a data privacy and security attorney at Perlman and Perlman says, “It is vital to have the appropriate legal terms in the contract to protect your interests.”  Find out what your liability limit is.  Have it in writing who bears the responsibility and cost of a data breach.  And, have the vendor agree on a specific timeframe within which they need to advise you of a data breach.

Warning: Don’t Cut Legal Corners When Mixing Social And Business Impact,  Forbes
Particularly striking is that (Karen) Wu believes this is the “first multi-state regulatory activity involving cause marketing in almost two decades.”

Is stealing, then giving back, OK?
Cliff Perlman lends his advice on theft within a nonprofit.

Buyer Beware: Negotiating Terms in Technology Agreements
Jon Dartley provides tips on negotiating contracts with technology vendors.

Four Ways Charitable Giving Could Change with a Tax Overhaul
Cliff Perlman remarks on the possible threat of a change to charitable deduction.

How To Deal With Residual Data, Nonprofit Times
Jon Dartley’s advice on addressing “data exhaust”.

Secure Your Data – Seriously, AFP New York Chapter News
As Jon Dartley, a data privacy and security attorney at Perlman and Perlman says, “It is vital to have the appropriate legal terms in the contract to protect your interests.”  Find out what your liability limit is.  Have it in writing who bears the responsibility and cost of a data breach.  And, have the vendor agree on a specific timeframe within which they need to advise you of a data breach.

Warning: Don’t Cut Legal Corners When Mixing Social And Business Impact,  Forbes
Particularly striking is that (Karen) Wu believes this is the “first multi-state regulatory activity involving cause marketing in almost two decades.”

Is stealing, then giving back, OK?
Cliff Perlman lends his advice on theft within a nonprofit.

Buyer Beware: Negotiating Terms in Technology Agreements
Jon Dartley provides tips on negotiating contracts with technology vendors.

Four Ways Charitable Giving Could Change with a Tax Overhaul
Cliff Perlman remarks on the possible threat of a change to charitable deduction.

How To Deal With Residual Data, Nonprofit Times
Jon Dartley’s advice on addressing “data exhaust”.

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perlman & perlman philanthropic sector law firm blue and green logo

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who we work with

Our clients are diverse nonprofit organizations with a broad range of missions, as well as for-profit companies in evolving areas such as social enterprise, corporate philanthropy, joint ventures, technology-driven fundraising, and impact investing.

who we work with

Our clients are diverse nonprofit organizations with a broad range of missions, as well as for-profit companies in evolving areas such as social enterprise, corporate philanthropy, joint ventures, technology-driven fundraising, and impact investing.

A.B. Data
AB InBev Foundation
Absolut Company
American Committee for the Weizmann Institute of Science
American Diabetes Association
American Friends of the Hebrew University
American Parkinson Disease Association
Association of Fundraising Professionals
Avalon Consulting
Baton Rouge Area Foundation
Black Lives Matter Global Network Foundation
Bleeding Blue for Good Fund
Bradley Cooper’s One Family Foundation
BrightFocus Foundation
Brooks Brothers
Chadwick Boseman Foundation for the Arts
Changing Our World
Charity Defense Council
Christian Appalachian Project
Doctors of the World/ Medecins du Monde
Doctors Without Borders/ Medecins San Frontieres
Drug Policy Alliance
Duke University
Emory University
Estee Lauder Companies, Inc.
Feed The Children
Food For The Poor
Gerald R. Ford Presidential Foundation
Grameen Foundation USA
Hope for New York
International Campaign for Tibet
International Crisis Group
International Justice Mission
J. Crew Group
Johns Hopkins University
Lautman Maska Neill & Company
Lawyers Committee for Civil Rights Under Law
LSU Foundation

Marts & Lundy
Meyer Partners, LLC
Milken Institute
NAACP Foundation
National Alliance on Mental Illness (NAMI)
National Marrow Donor Program
National Park Foundation
Natural Resources Defense Council
North Carolina State University
North Shore Animal League
Operation Smile
PBS Foundation
Pernod Ricard USA
PetSmart Charities
PopSockets
Population Action International
Project ORBIS International
Public Interest Communication
Rails to Trails
Redeemer Presbyterian Church
Rockefeller Philanthropy Advisors
Save the Children Federation
Sesame Workshop
Simon Wiesenthal
SOS Children’s Villages – USA
Subaru of America
The Little Market
Touro University
United States Equestrian Team Foundation
United Way Worldwide
University of Connecticut
University of Virginia
Vote.org
Whitney Museum of American Art
World ORT
World Wildlife Fund
YWCA USA

A.B. Data
Absolut Company
American Committee for the Weizmann Institute of Science
American Diabetes Association
American Friends of the Hebrew University
American Parkinson Disease Association
American Rivers
Association of Fundraising Professionals
Baton Rouge Area Foundation
BrightFocus Foundation
Burger King McLamore Foundation
Cancer Care
Carnegie East House and James Lenox House Association
Center for Car Donations
Changing Our World
Charity Defense Council
Christian Appalachian Project
Coca-Cola Scholars Foundation
Convoy of Hope
Cornell University
Doctors Without Borders/ Medecins San Frontieres
Drug Policy Alliance
Duke University
Emory University
Feed The Children
Gerald R. Ford Presidential Foundation
Grameen Foundation USA
Helen Keller Services
Hope for New York
Human Rights Watch
Humane Society of US
Indiegogo
International Campaign for Tibet
International Crisis Group
International Justice Mission
Japanese American National Museum
Johns Hopkins University
Lane Bryant Charities
LSU Foundation
Mattel
Meyer Partners, LLC
Milken Institute
National Breast Cancer Coalition
National Marrow Donor Program
Natural Resources Defense Council
North Carolina State University
North Shore Animal League
Obama Foundation
Operation Smile
PBS Foundation
Pernod Ricard USA
PetSmart Charities
Population Action International
Project ORBIS International
Public Interest Communication
Rails to Trails
Redeemer Presbyterian Church
Rock and Roll Hall of Fame and Museum
Rockefeller Philanthropy Advisors
Sesame Workshop
Simon Wiesenthal
SOS Children’s Villages – USA
Steinhardt Foundation
Subaru of America
United States Equestrian Team Foundation
University of Montana Foundation
University of Nevada, Las Vegas Foundation
Whitney Museum of American Art
World ORT
World Wildlife Fund
YMCA USA
YWCA of New York City
YWCA USA
Lautman Maska Neill & Company
Lawyers Committee for Civil Rights Under Law

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