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Section 300
Private Inurement and Excess Benefit Transactions

¶301 Introduction

The doctrine of private inurement is the fundamental defining principle distinguishing nonprofit organizations from for-profit entities. As a statutory criterion for federal income tax exemption, it is applicable to nine types of tax-exempt organizations, including charitable organizations. The term charitable organizations means entities — including colleges and universities — described in Internal Revenue Code (IRC) § 501(c)(3). That is, aside from being organized and operated primarily for an exempt purpose and otherwise meeting the appropriate statutory requirements, an exempt organization subject to this doctrine must comport with the federal tax law proscribing private inurement.

The oddly phrased and antiquated language of the private inurement doctrine requires that a tax-exempt organization that is subject to the rule be organized and operated so that "no part of … [its] net earnings … inures to the benefit of any private shareholder or individual." In fact, it is rare for an exempt organization to have shareholders, and the private inurement doctrine can be triggered by the involvement of persons other than individuals. The meaning of the statutory language today is that none of the income or assets of a tax-exempt organization subject to the doctrine may be permitted to unduly benefit a person who has some close relationship to the organization. The law pertaining to the private inurement doctrine, while applicable to many categories of exempt organizations, is the most developed in connection with charitable organizations. It thus applies to tax-exempt colleges and universities, other than those operated by a government.

To date, the body of law reflected in the private benefit doctrine has been applied only to charitable organizations. (The IRS, however, on one occasion suggested that the doctrine is applicable with respect to tax-exempt social welfare organizations (Exemption Denial and Revocation Letter 20044008E)). The intermediate sanctions rules pertaining to excess benefit transactions are applicable to public charities and social welfare organizations.

Prior to the enactment of the excess benefit transactions rules (see ¶330), the IRS's only recourse for a violation of the private inurement doctrine was to revoke an organization's tax-exempt status. The intermediate sanctions rules provide a basis for penalizing those who extract an excess benefit from charitable and social welfare organizations without jeopardizing the entities' exempt status.

However, the IRS has made clear that in certain circumstances it will pursue both remedies, that is the imposition of intermediate sanctions (an excise tax) and revocation of tax-exempt status. See Treas. Reg. § 1.501(c)(3)-1, 73 Fed. Reg. 16519 (March 28, 2008).