For Whose Charitable Purpose?

Competition Division of the Balloon Federation of America distributes approximately $70,000 to its members.

by Tom Hamilton

In 1986 a disagreement over control of competition in the Balloon Federation of America resulted in the mass resignation of the Events Committee. That act set in motion a series of events leading to the creation, in 1987, of a separate division within the BFA tasked to control the national sanctioning system.

Over the past decade the Competition Division has been responsible for oversight of the sanctioning process passed down from the National Aeronautic Association and the Fédération Aéronautique Internationale to the BFA. This process allows U.S. competitors access to international competition, including the World Championships. The division controls all sanctions, from weekend events through regional and state championships to the U.S. Nationals, which in turn determines eligibility for entrance to international events.

In late March the Competition Division mailed approximately 400 checks for $175.00 each to members in good standing as of December 31, 1997. The division chairman, David Lowe, wrote in part to those receiving checks, "From its inception the Competition Division Board and membership have attempted to attain certain goals in both the holding of Sanctioned Competitions (sic) and the wise management of Division resources... One of our many goals was to secure adequate reserve funds... Therefore, the Board of Directors of the Division, with the input of the Finance Committee, has voted to give a partial reimbursement of expenses to each member that held voting status as of December 31, 1997.

"Enclosed you will find a check in the amount of $175. This amount is in appreciation of your support and for recognition of your hard work and diligence on behalf of the Division..."

On the Saturday before these checks arrived in mailboxes, Mr. Lowe presented a division report to the BFA Board during a meeting in Phoenix, Arizona. At no time did Mr. Lowe indicate that funds were being distributed. Nor, does it appear that any BFA Board member was aware that the distribution was being made, including Allen Yost, BFA liaison to the Competition Division.

While this seems like a nice dividend for belonging to the Competition Division a question arises as to whether it is legal.

The Balloon Federation of America, of which the Competition Division is a part, is a tax exempt 501(c)(3) corporation chartered in the state of Iowa. The federal tax exempt status confers on the organization special treatment for tax purposes.

In order to obtain such status an organization must meet certain requirements which are detailed in the box nearby. Foremost among those requirements are:

"The exempt purposes set forth in §501(c)(3) are charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and the prevention of cruelty to children or animals; and

"No part of the net earnings of a §501(c)(3) organization may inure to the benefit of any private shareholder or individual. A private shareholder or individual is a person having a personal and private interest in the activities of the organization."

With the latter requirement in mind Balloon Life placed a phone call to the General Counsel for the BFA, David Rapp. Balloon Life asked if the distribution made by the CD was legal under the bylaws of the BFA? He deferred that question to the President, since he had not been asked to render an opinion.

Balloon Life then contacted Rob Schantz, President of the BFA. Mr. Schantz was not in a position to answer the question directly. By the next week the president had requested a formal legal opinion from the General Counsel.

Mr. Rapp in a written opinion said that the distribution of funds were not legal under the organization's tax exempt status.

Mr. Lowe, when contacted by the president, maintained that the distribution of funds was legal and he had an opinion from the division's attorney, although not in writing, saying so. This legal argument maintains that the distribution was a "reimbursement of expenses."

Balloon Life contacted the Iowa Secretary of State's office in Des Moines and asked if an Iowa tax exempt organization can disburse funds to its members. The answer: "legitimate" expense incurred by a member can be reimbursed by an organization. However, if the funds are for a "shame" expense or distribution of assets, it is not legal.

Mr. Schantz sought out several more opinions, all of which agreed with the General Counsel's opinion that this distribution was not legal. Schantz convened an emergency meeting of the BFA Board by conference call on Thursday evening, April 9. Balloon Life has learned that during that meeting there was considerable discussion over whose attorney was correct.

It was voted that a committee of three BFA Board members seek an outside legal opinion and report back to the Board in two weeks. Appointed to the committee were Messrs. Jim Thompson, Glen Moyer, and Koh Murai.

Balloon Life has learned that a legal firm in Reno, Nevada, specializing in tax exempt organizations was chosen to render an opinion. That legal opinion was presented to the full board in a conference call held the evening of April 23. It was the opinion of outside counsel that the distribution was not legal. The board then voted unanimously to request that the membership who received the distribution return the funds.

A letter for Messrs. Schantz and Lowe's signature was presented to the board and unanimously approved. Mr. Schantz contacted Mr. Lowe who has initially refused to sign the letter, maintaining that the CD did nothing improper.

The outside legal opinion also advised that any of the BFA Board's members who received one of the checks not only had to return the money but also pay a 25 percent excise tax penalty. This latter requirement is in keeping with IRS regulations regarding officers of a corporation that receive such payments.

What legitimate expenses can be reimbursed? Volunteers who provide services to the organization might incur telephone charges, postage costs, transportation expenses, or other monetary outlays. Typically the member would submit a reimbursement expense form listing the items together with receipts. The organization could also give all volunteers who show up at an event money to help defray their expenses. An example would be the U.S. National Championship. Observers and race officials usually incur considerable expense to attend and donate that time. Even the pilots participating would be eligible. The organization could give each of them a stipend to help defray their expense.

How does a year end "reimbursement of expenses" differ? According to legal opinions rendered in this case, once the income has been earned you can not then make a pro rata distribution of it.

David Lowe told Balloon Life that the CD Board agreed to make the distribution at the February CD board meeting held in Ft. Meyers, Florida.

Balloon Life asked Mr. Lowe why the CD chose not to use the money to fund other programs. "The CD is funding other programs like observers attending the Nationals and [Team Championships], officials seminar, prize money to two regional championships," Lowe said.

Mr. Lowe did not remember whose idea it was to distribute a disbursement to the membership.

Under the current structure the Competition Division acts as a separate entity with its own governing board, officers, and bank accounts. Questions have been raised as to whether the entire structure of the BFA, with separate division, multiple treasurers, and bank accounts is an appropriate way to do business. The CD currently contributes $20,000 per year to the BFA general fund to off-set administrative costs incurred by the division.

Article One of the division's bylaws states, "This division of the BFA shall be known as the Competition Division. It shall operate in accordance with the BFA charter and bylaws. The purpose of this division is to foster local, regional, national and international hot air balloon competition."

Whether co-signed or not, the BFA is expected to issue a letter requesting the return of the $175. That letter will likely state that the checks were sent out with good intentions and without malice. However, to protect the tax exempt status of the BFA, it is necessary to seek the return of money. The BFA Board has been advised that such a letter would help protect the tax exempt status should the IRS question the disbursement.

The tax exempt status of the BFA is important since contributions to the organization, whether monetary or gifts of equipment, are deductible on individual tax returns. The National Balloon Museum, which houses the BFA collection of equipment and artifacts, would suffer if people did not make donates to the BFA for the collection. Further, the BFA's own planned giving program would be in jeopardy.

Recovering the funds may be difficult. Some CD members have expressed an opinion that the money is theirs and they have no intention of giving it back. To recover the funds it is possible that the BFA Board would file a claim with their Directors and Officers insurance policy. The insurance company, if it pays the claim, then might seek return of the money to recoup their outlay.

It is likely that no matter what the outcome of this investigation it will take months or longer to resolve.

IRS §501(c)(3) Requirements

To be tax-exempt as an organization described in §501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for one or more of the purposes set forth in §501(c)(3) and none of the earnings of the organization may inure to any private shareholder or individual. In addition, it may not attempt to influence legislation as a substantial part of its activities and it may not participate at all in campaign activity for or against political candidates.

The organizations described in §501(c)(3) are commonly referred to under the general heading of "charitable organizations." Organizations described in §501(c)(3), other than testing for public safety organizations, are eligible to receive tax-deductible contributions.

The exempt purposes set forth in §501(c)(3) are charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and the prevention of cruelty to children or animals. The term charitable is used in its generally accepted legal sense and includes relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erection or maintenance of public buildings, monuments, or works; lessening the burdens of government; lessening of neighborhood tensions; elimination of prejudice and discrimination; defense of human and civil rights secured by law; and combating community deterioration and juvenile delinquency.

To be organized exclusively for a charitable purpose, the organization must be a corporation, community chest, fund, or foundation. A charitable trust is a fund or foundation and will qualify. However, an individual or a partnership will not qualify. The articles of organization must limit the organization's purposes to one or more of the exempt purposes set forth in § 501(c)(3) and must not expressly empower it to engage, other than as an insubstantial part of its activities, in activities that are not in furtherance of one or more of those purposes. This requirement may be met if the purposes stated in the articles of organization are limited in some way by reference to §501(c)(3). In addition, assets of an organization must be permanently dedicated to an exempt purpose. This means that should an organization dissolve, its assets must be distributed for an exempt purpose described in this chapter, or to the federal government or to a state or local government for a public purpose. To establish that an organization's assets will be permanently dedicated to an exempt purpose, the articles of organization should contain a provision insuring their distribution for an exempt purpose in the event of dissolution. Although reliance may be placed upon state law to establish permanent dedication of assets for exempt purposes, an organization's application can be processed by the IRS more rapidly if its articles of organization include a provision insuring permanent dedication of assets for exempt purposes.

An organization will be regarded as "operated exclusively" for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of the exempt purposes specified in §501(c)(3). An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.

The organization must not be organized or operated for the benefit of private interests, such as the creator or the creator's family, shareholders of the organization, other designated individuals, or persons controlled directly or indirectly by such private interests. No part of the net earnings of a §501(c)(3) organization may inure to the benefit of any private shareholder or individual. A private shareholder or individual is a person having a personal and private interest in the activities of the organization. If the organization engages in an excess benefit transaction with a person having substantial influence over the organization, an excise tax may be imposed on the person and any managers agreeing to the transaction.

A §501(c)(3) organization may not engage in carrying on propaganda, or otherwise attempting, to influence legislation as a substantial part of its activities. Whether an organization has attempted to influence legislation as a substantial part of its activities is determined based upon all relevant facts and circumstances. However, most §501(c)(3) organizations may use Form 5768, Election/Revocation of Election by an Eligible Section 501(c)(3) Organization to Make Expenditures to Influence Legislation, to make an election under §501(h) to be subject to an objectively measured expenditure test with respect to lobbying activities rather than the less precise "substantial activity" test. Electing organizations are subject to tax on lobbying activities that exceed a specified percentage of their exempt function expenditures.

For purposes of §501(c)(3), legislative activities and political activities are two different things, and are subject to two different sets of rules. The latter is an absolute bar. A §501(c)(3) organization may not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office. Whether an organization is engaging in prohibited political campaign activity depends upon all the facts and circumstances in each case. For example, organizations may sponsor debates or forums to educate voters. But if the forum or debate shows a preference for or against a certain candidate, it becomes a prohibited activity. The motivation of an organization is not relevant in determining whether the political campaign prohibition has been violated. Activities that encourage people to vote for or against a particular candidate, even on the basis of non-partisan criteria, violate the political campaign prohibition of §501(c)(3).