Tax Court Warning: Fundraising Activities Can Cause Big Problems

If you serve on the board of or are otherwise actively involved with a booster club that supports your children’s or grandchildren’s activities, a recent Tax Court case may be of interest to you.

The case involved a parent-run booster club that was associated with a gymnastics program. Like a lot of similar entities such as a PTA or a band or sports organization booster club, the Capital Gymnastics Booster Club (Capital Gym) was organized as a charitable, tax-exempt organization and conducted various fundraising activities.

In 2005, the IRS audited the entity’s activities and when the audit was completed, it issued a notice to Capital Gym that it was revoking its tax-exempt status because the organization’s net profits inappropriately benefited private individuals (i.e., approximately half the organization’s 240 member families). After exhausting its appeal rights within the IRS, the organization eventually took its case to court. The Tax Court recently issued its opinion and unfortunately agreed with the IRS that the organization’s tax-exemption should be revoked.

What was the organization’s sin that was so severe that it lost its tax-exempt status—retroactive to its 2003 fiscal year? The answer is the IRS objected to the method by which it allocated the benefits of its fundraising activities.

In many organizations, some members participate in fundraising and others don’t. In fact, a lot parents who are pressed for time would prefer to just write a check for “their share” of whatever the organization is trying to raise and be done with it. In the Capital Gym case, those that participated in the fundraising received substantially all of the benefit of the funds that were raised, allocated based on how much they individually raised. The benefits were delivered in the form of points that were then used to lower the amount of assessments to cover their child’s entry fees for meets and share of the coaches’ travel expenses they would have otherwise been required to pay.

The Tax Court upheld the IRS’ determination that this approach to allocating fundraising profits was inconsistent with an organization eligible for Section 501(c)(3) (charitable) tax-exempt status. Thus, unless the organization successfully appeals the decision or changes its approach, it not only becomes a taxable entity, but also presumably becomes much less appealing for businesses to support and may also pay higher sales/use, property, and income tax at the local level, depending on the applicable location.

The take-away value of this case is that the IRS is likely to be embolden to challenge other organizations with similar fundraising models. However, there are things most organizations can do to protect themselves from such a challenge. If this issue is important to an organization you’re involved with, please contact us and we’ll be happy to help you consider various recommended options.