There is an obvious market for ride-sharing companies like Uber and Lyft. They provide a much-needed alternative to public transportation, self-driving and taxis. There’s certainly a community benefit aspect to what these companies are doing, but is it enough to warrant charitable status? RideAustin, one of the new ride-sharing companies in Austin, believes their method is charitable. With so much direct competition in a very commercial industry, will RideAustin succeed in convincing the IRS that their organization does not violate the commerciality doctrine for nonprofits?
To maintain exempt status, an organization must operate primarily for an exempt purpose. The commerciality doctrine basically allows the IRS to claim that a nonprofit does not qualify for exempt status if it is operating in a manner that is substantially similar to a for-profit organization providing similar goods and/or services (ie. the nonprofit is directly competing with for-profits). While business activities, even commercial ones, are acceptable in nonprofits, these activities cannot be a substantial part of the organization’s activities without jeopardizing the exempt status. The IRS tends to favor organizations that are offering services below cost as opposed to those charging fair market rates or even cost. However, simply offering commercial goods and services below cost will not inherently be an exempt purpose – the organization must show that it is serving an under-represented market, providing goods/services not commonly provided by for-profits and/or operating in a manner that is not in direct competition with for-profits.
The commerciality doctrine originated with the Revenue Act of 1950 after nonprofits were abusing the ability to start commercial businesses and undercut for-profit competitors because the nonprofits had the advantage of not owing taxes. The most well-known example was New York University, which had several business holdings including pasta manufacturing, a leather company and a piston ring manufacturer, all of which were exempt simply because the profits were distributed to the university. Congress ended this unfair advantage with the unrelated business income tax rules, which state that the use of the proceeds for exempt purposes doesn’t matter – the business activity itself must be related to the exempt purpose of the organization in order to qualify for tax-free treatment. Factors that the IRS considers indicative of commercial purposes (and thus taxable) include:
Pricing to maximize profits
Accumulation of unreasonable reserves
Use of commercial advertising methods
Discontinuance of money-losing programs
Using paid staff rather than volunteers
Donations are not a significant percentage of total support for the organization
Proponents of the social enterprise movement tend to encourage nonprofits to engage in all of the above activities and operate more like for-profits. Many organizations are being told that donations are unreliable and risky, creating an unsustainable organization. They’re told that substantial earned income is the only way to create a sustainable organization, but if that were true – why do so many for-profit businesses fail? Nothing is guaranteed – both earned income and a donations require time and effort with a solid foundation of programming that people care about. Like any tax laws, the commerciality doctrine has grey areas and each situation is assessed based on the specific facts and circumstances. Paid staff don’t necessarily make an activity commercial and nonprofits have to consider fiscal health when making decisions about whether certain program activities are justifiable. The key is to make sure that the majority of the organization’s activities directly serve the exempt purpose and that those activities are accessible to the community that needs them.
RideAustin is pursuing charitable status in order to provide lower cost rides for patrons and higher earnings for drivers; they’re able to do this because they aren’t aiming to make a profit and won’t have a federal tax burden. They also plan to provide free and reduced price rides to low income elderly and the disabled, made possible by donations from the public. Will this be enough to warrant charitable status? Free rides definitely sound like a community benefit, but if they’re only offered to a small portion of their total market, will the lower cost to other patrons be enough to overcome the issue of direct competition with for-profit businesses in an industry that is not inherently charitable? The free portion of the business model absolutely sounds charitable, but how much of the total activities will that portion of the business make up? Maybe safe late night rides for people leaving downtown bars is a charitable venture as well?
The IRS has been closely monitoring commercial activities over the past few years as social enterprises test the limits of business activities in nonprofits. Will cheaper ride-sharing options merit charitable status? More importantly, will the community be willing to donate enough to keep prices low for everyone else? Will government grants soon fund ride-sharing programs? The nonprofit industry is ever-evolving and always full of possibilities.
