2 prohibitions in the nonprofit realm that are often confused with each other are inurement, and private benefit. The terms are related, but distinct from one another. Private benefit is a broader concept that includes inurement, but also goes beyond it.

Inurement is typically a payment of money, and comes up in Reg. 1.501(c)(3)-1(c)(2) in the regulation against “net earnings inur[ing] in whole or in part to the benefit of private individuals.” This stems from 501(c)(3) status requiring that the organization be organized to serve one or more public interests rather than private interests. It is predominantly targeted at the organization’s insiders, such as officers, directors, and related parties. Any amount of inurement can result in an organization losing 501(c)(3) status, or its application for exempt status being denied.

In the case American Campaign Academy v. Commissioner, 92 T.C. 1053 (1989), the tax court distinguished private benefit as “nonincidental benefits conferred on disinterested persons that serve private interests.” This is broader than inurement in 2 senses – it’s not limited to only insiders of the organization, and is not necessarily a financial benefit.

The private benefit received may be financial, but not necessarily. For instance the American Campaign Academy trained people for careers in political campaigns, and its graduates went to work almost exclusively for organizations and candidates of the Republican Party. Its exemption was revoked because the private benefit received by the Republican Party and Republican candidates was more than insubstantial.

Activities that benefit the public often end up benefiting private individuals to some extent in the process, which isn’t automatically a problem, as long as the benefits are qualitatively and quantitatively incidental. For instance, if an organization works to improve the water in a lake that several communities use for recreation, and has public beaches and other public facilities, this effort will benefit lake front property owners. This is incidental, because the benefit necessarily arises as a byproduct of improving the lake water as a whole (see Rev. Rul. 70-186, 1970-1, C.B. 128). On the flip side, an organization that improves a specific block in a city, e.g. by planting trees and encouraging residents to pick up litter on the streets and sidewalks, produces excessive private benefit because it operates for the benefit of a very limited area (see Rev. Rul. 75-286, 1975-2 C.B. 210).

Surrounding circumstances of an organization’s activities are also taken into account. Some activities that seem to further an exempt purpose are, in fact, serving private interests. Westward Ho v. Commissioner, TCM 1992-192 (1992) considered an organization created by restaurant owners in Burlington, Vermont to give financial assistance to indigent people and enable them to leave the city. The Tax Court determined that the true goal was to improve the local business environment by getting rid of homeless people in the area.

The Nonprofit Law Blog cites a few red flags the IRS looks out for:

  • Serving too small a class of beneficiaries
  • Entering into transactions on terms that are unreasonable or unfavorable to the organization
  • Engaging in substantial activities that are not clearly furthering the organization’s exempt purposes
  • Conferring benefits to private parties beyond the scope necessary to further the organization’s exempt purposes
  • Establishing exclusive business dealings with a particular for-profit business
  • Failing to consider alternative sources or comparative prices when purchasing goods and services

The Nonprofit Law Blog gives additional information and examples, as do Andrew Megosh, Lary Scollick, Mary Jo Salins and Cheryl Chasin in their paper for the IRS. I used both of these as references for this post.