- 7.25.25 Feeder Organizations
- 220.127.116.11 Introduction
- 18.104.22.168 Purpose of Feeder Provisions
- 22.214.171.124 Statutory Provisions
- 126.96.36.199.1 Meaning of Terms
- 188.8.131.52.2 Trade or Business for Profit
- 184.108.40.206.3 Primary Purpose
- 220.127.116.11.4 Payable
- 18.104.22.168 Activities an Integral Part of the Parent Exempt Organization
- 22.214.171.124 Related Subsidiary Organizations
- 126.96.36.199 Digests of Published Rulings
Part 7. Rulings and Agreements
Chapter 25. Exempt Organizations Determinations Manual
Section 25. Feeder Organizations
IRC 502 does not provide a basis for tax exemption. By providing that an organization operated for the primary purpose of carrying on a trade or business for profit cannot establish exemption on the basis that all its profits are payable to one or more organizations exempt from tax, it limits the type of entity that might otherwise qualify. IRC 502 applies to organizations described under any paragraph of IRC 501(c).
Prior to 1951, organizations whose sole activity was the conduct of a commercial business, "feeder organizations," were considered exempt from Federal income tax under the predecessor to IRC 501(c)(3) because their profits were payable to specified exempt organizations.
The C.F. Mueller Company, a commercial macaroni factory, was recognized as exempt because it turned its profits over to the School of Law of New York University, its exempt parent. C.F. Mueller Company v. Commissioner, 190 F.2d 120 (1951). Although the Service argued against the destination of income theory, the Court noted that the weakness in the statute could only be corrected by legislation.
Congress dealt with this situation in the Revenue Act of 1950. (Revenue Act of 1950, 301b, 64 Stat. 906, 953.) This Act, in a two-pronged attack, attempted to counter the unfair advantage that businesses operated by exempt organizations had over for-profit competitors.
IRC 502 was designed to deny tax exemption to business subsidiaries (such as the macaroni factory) of charitable parents; and
The predecessors to IRC 511–514 were enacted to assure that the income derived by exempt organizations from unrelated business activities they carried on directly would also be taxed.
The Tax Reform Act of 1969 (69 TRA) extended to feeder organizations the exceptions contained in IRC 513(a). Congress imposed no tax on businesses in which substantially all the work was performed without compensation or which sold merchandise substantially all of which was donated. Whether these businesses were run directly, or indirectly through a subsidiary, they were not taxable.
IRC 502 states that an organization operated for the primary purpose of carrying on a trade or business for profit shall not be exempt from taxation under IRC 501 on the ground that all of its profits are payable to one or more organizations exempt from taxation under IRC 501.
For purposes of this section, the term "trade or business" shall not include—
the deriving of rents which would be excluded under IRC 512(b)(3), if IRC 512 applied to the organization;
any trade or business in which substantially all the work in carrying on such trade or business is performed for the organization without compensation; or
any trade or business which is the selling of merchandise, substantially all of which has been received by the organization as gifts or contributions.
A "feeder organization" operates for the primary purpose of carrying on a trade or business for profit, the income from which is to be turned over or "fed" to an organization itself exempt from tax.
If an organization’s principal income-producing activity is the conduct of a trade or business and it has no significant charitable activity other than the required payment of all its profits over to one or more IRC 501(c)(3) organizations, it is operated for the "primary purpose" of carrying on a trade or business for profit within the meaning of IRC 502. See Rev. Rul. 73–164, 1973–1 C.B. 223.
Rev. Rul. 57–52, 1957–1 C.B. 196, holds that an organization whose only activity is a business ordinarily carried on for profit is not exempt under IRC 501(c)(3) merely because all of its profits are payable to a public body or government instrumentality for exclusively public purposes.
Feeder organizations pay all of their profits to one or more IRC 501 organizations. An organization that directs all of its profits to research and dispenses fellowships to individuals rather than institutions is not a feeder. Edward Orton, Jr. Ceramic Foundation, 56 T.C. 147 (1971).
Feeder organizations should not be confused with title holding corporations exempt under IRC 501(c)(2). Title holding corporations are subsidiaries of exempt parents and engage in no activities other than holding title to property, collecting the income therefrom, and turning it over to the parent. They do not engage in the active conduct of any trade or business other than collection of rental income from real property. While feeder organizations may hold title to property, they engage in an active trade or business in utilizing the property beyond the mere rental of real property.
In determining precisely what a feeder organization is, the terms of the statute must be analyzed and interpreted. The key terms are:
trade or business for profit;
primary purpose; and
The term "trade or business" retains the same meaning that it has in Regs. 1.513–1(b). It includes any activity carried on for the production of income from the sale of goods or performance of services and which otherwise possesses the characteristics required by IRC 162. The phrase "for profit" was intended to describe the commercial nature of the activities and not to refer to whether an actual profit is made.
The term "trade or business" does not include passive investment income, but the difference between a trade or business activity and a passive investment is not always clear. IRS initially took the position that an organization that obtained funds to carry on its charitable programs through the acquisition of oil and gas production payments with borrowed money was engaged in a business. The Tax Court disagreed and in Southwest Endowment Corporation v. United States, 58–2 USTC 9577 (CCH), 1 AFTR 2d 1860 (P–H) (1958), ruled that an organization whose funds were produced by the interest equivalent factor (the excess of interest paid in connection with each oil production payment over the interest charged by the lender of the borrowed funds) was exempt under IRC 501(c)(3). IRS accepted this position in Rev. Rul. 66–296, 1966–2 C.B. 215.
The 69 TRA changed the definition of "trade or business" for purposes of IRC 502.
Rental income is excluded if it would be excluded under IRC 512(b)(3).
Businesses in which substantially all the work is performed without compensation or which are selling merchandise, substantially all of which is donated are excluded.
For years prior to the 69 TRA, Rev. Rul. 68–439, 1968–2 C.B. 239, held that a separately incorporated "thrift shop" staffed by volunteer help and selling only donated goods to raise funds for a charity was a trade or business and that IRC 502 precluded exemption. This position was reconsidered and revoked in Rev. Rul. 71–581, 1971–2 C.B. 236, on the basis that the business activity was not the thrift shop’s primary purpose.
There is no specific percentage provided by the regulations as to the meaning of "substantially all" with respect to the donated goods and uncompensated labor exception. "Substantially all" has been interpreted for other sections of the IRC as 85 percent or more. See Rev. Rul. 73–248, 1973–1 C.B. 295, with respect farmers’ cooperatives. Regs. 53.4942(b)–1(c) also refers to the "substantially all" requirement of IRC 4942(j) as meaning 85 percent or more.
With respect to donated goods, neither the Code nor the regulations indicate whether "substantially all" refers to the value or the quantity of the goods. Presumably either would be acceptable.
Although 85 percent is an unofficial guideline, a definite percentage cannot always be applied. A facts and circumstances approach is called for.
In determining the primary purpose of an organization, all the facts and circumstances must be considered, including the size and extent of the trade or business as compared to the exempt activities. See Reg. 1.502–1(a).
If the business activity is not the primary purpose of the organization, IRC 502 does not apply to help resolve the status of the organization for income tax purposes. It is necessary to refer to the exemption provision to determine what effect the incidental business activity might have on the organization’s claim to exempt status. Such business activities may be subject to the tax on unrelated business income.
In a case involving a pre–69 TRA thrift shop operated with substantially all donated goods and where more than half of the work was performed without compensation, the Service held that the organization was not precluded from exemption under IRC 501(c)(3) by IRC 502 because the primary purpose for which the thrift shop was operated was to serve the group of exempt organizations by performing an essential function for them; to solicit contributions of goods on their behalf and to convert the contributed goods to cash for charitable uses with a minimum of expenses by the use of voluntary labor. See Rev. Rul. 71–581, 1971–2 C.B. 236.
An organization may engage in extensive business activity and yet its charitable activity may be regarded as meeting the primary purpose test if its program of charitable contributions and grants is reasonably commensurate with its financial resources.
In Rev. Rul. 64–182, 1964–1 (Part 1) C.B. 186, an organization whose income was derived primarily from the rental of its principal asset, a large commercial office building, was held to meet the primary purpose test of Regs. 1.501(c)(3)–1(e)(1), and therefore was organized and operated exclusively for charitable purposes within IRC 501(c)(3). It was shown to be carrying on, through its contributions and grants, a charitable program commensurate with its financial resources.
b. In Ralph H. Eaton Foundation v. Commissioner, 219 F.2d 527 (1955), a nonprofit corporation was formed to operate several business enterprises (farming, real estate, sports clothes, and construction). Its funds were payable to charitable and religious organizations. During the period in controversy, the foundation earned over $80,000 but made distributions to the charitable and religious beneficiaries in the total amount of $6,550. In this case the business activity was not merely incidental to charitable or religious purposes, it didn’t have the remotest connection to those purposes.
The term "payable" means that the organization is obligated to turn over its profits to one or more designated exempt organizations. If the Board of Directors has any discretion in choosing the charities to which its funds will be distributed, it will not be considered a "feeder."
Rev. Rul. 73–164, 1973–1 C.B. 223, describes a church controlled commercial printing corporation whose business profits are payable to the church, but which has no other significant charitable activity. It acknowledges that in the absence of IRC 502, the organization would qualify under IRC 501(c)(3) because the beneficial use of its assets is dedicated to charitable objectives. However, because its Charter requires that its income be turned over to the church, IRC 502 precludes exemption.
Some organizations are not engaged in a business to make money for designated charitable organizations but are organized and operated to provide services for specific charitable organizations. If an exempt organization creates another organization to furnish it with certain services, the subsidiary organization may also qualify for exemption, even though, as a matter of accounting, the subsidiary’s books reflect a profit. However, the subsidiary will not qualify for exemption if the service provided would constitute the conduct of an unrelated trade or business if conducted directly by the parent. See Reg. 1.502–1(b).
The example given in Reg. 1.502–1(b) is that of a subsidiary that is operated for the sole purpose of furnishing electric power used by its parent, a tax exempt educational organization, in carrying on its educational activities. So long as it provides this essential service to its parent as its primary activity, it will be exempt.
If the subsidiary furnishes electric to consumers other than its parent (and its parent’s tax-exempt subsidiary organizations), it is not exempt since such business would be an unrelated trade or business if regularly carried on by the parent.
A subsidiary that is owned by several unrelated exempt organizations and is operated to furnish electric power to each of them, is not exempt because such business would be unrelated trade or business if regularly carried on by any one of the exempt entities.
A separate subsidiary formed to carry on a function for the benefit and convenience of its exempt parent in furtherance of the parent’s exempt purpose is also not a feeder entity within IRC 502. Rev. Rul. 58–194, 1958–1 C.B. 240, is a good example. It holds that a separately incorporated subsidiary operating a bookstore and cafeteria on a university campus is entitled to exemption as an organization described in IRC 501(c)(3).
An organization formed to furnish services to one or more exempt organizations will not qualify for exemption if the organizations served are not structurally related. The necessary relationship is not established merely because the organizations served hold the same kind of exemption or provide the same kind of service to the community.
Organizations are related if they consist of—
A single parent and one or more of its subsidiaries; or
Subsidiary organizations having a common parent.
This relationship is illustrated in Rev. Rul. 68–26, 1968–1 C.B. 272, where a separately incorporated organization formed to print and sell educational material for a church parochial school system was determined not to be a feeder. Although there was no technical parent-subsidiary relationship between the church and the organization because of the organization’s non-stock character, the relationship was held to exist through control and close supervision of the organization’s affairs by the church. The organization was an integral part of the parent church. Furthermore, since the sole source of the organization’s profits was from sales made to the parochial schools which were components of the parent church, the profits were essentially a matter of accounting among the organizations involved.
Where there is no structural relationship among the parent organizations which the subsidiary is intended to serve, the subsidiary is not exempt by reason of IRC 502. In Rev. Rul. 54–305, 1954–2 C.B. 127, an organization formed to provide centralized purchasing services for a group of unrelated exempt hospitals and other charitable institutions was held nonexempt. Purchasing supplies and performing services for such unrelated charitable organizations are ordinary business activities rather than charitable activities.
Upon similar facts, the Court of Claims held in Hospital Bureau of Standards and Supplies, Inc. v. United States, 158 F. Supp. 560 (1958), that a bureau formed to provide services to a group of unrelated exempt hospitals was exempt. The court concluded that the organization was providing essential services to the hospitals rather than operating a business for profit. The Court also based its finding in part on a conclusion that, because the bureau served only charitable hospitals, the member organizations were "related" within the meaning of the regulations. The regulations have since been amended to clarify that organizations are not "related" merely because they engage in the same type of exempt activities.
IRC 501(e), discussed in a separate IRM Chapter, provides exemption for certain cooperative hospital service organizations for taxable years ending after June 28, 1968. Organizations outside the scope of IRC 501(e), such as those hospital service organizations providing laundry services, are still subject to IRC 502. See, HCSC-Laundry v. United States, 450 U.S. 1, 101 S. Ct. 836 (1981), Ct. D. 2005, 1981–1 C.B. 324.
IRC 502 was determined to preclude exemption in Rev. Rul. 69–528, 1969–2 C.B. 127 because the parent entities were not structurally related. The trust was created to manage the investments of several unrelated IRC 501(c)(3) organizations. Investment management was held to be a trade or business and the organization’s primary activity. The business was regularly carried on and would have been considered unrelated trade or business if conducted by any of the participating exempt organizations.
Rev. Rul. 69–528 was distinguished by Rev. Rul. 71–529, 1971–2 C.B. 234, involving a nonprofit organization providing assistance in the management of participating colleges’ and universities’ endowment or investment funds for a charge substantially below cost. Because the services were provided substantially below cost, the organization’s activities were not considered a regularly carried on trade or business within the purview of IRC 502.
IRC 501(f), discussed in a separate IRM Chapter, provides exemption for certain cooperative investment service organizations organized and controlled by organizations described in either IRC 170(b)(1)(A)(ii) (schools) or IRC 170(b)(1)(A)(iv) (certain organizations that support schools) for the collective investment of their funds in stocks and securities. IRC 501(f) applies only to taxable years ending after December 31, 1973. Cooperative investment organizations may be recognized as exempt for prior years depending on the facts and circumstances of individual cases. See Rev. Rul. 71–529, discussed above.
Purchasing agency— A corporation organized and operated for the primary purpose of maintaining a purchasing agency for the benefit of its otherwise unrelated exempt members, is engaged in business activities which would be unrelated activities if carried on by any one of the tax-exempt organizations served. The corporation is a feeder and not entitled to exemption under section 101(6) of the 1939 Code. See Rev. Rul. 54–305, 1954–2 C.B. 127.
Construction and sale of houses— The construction and sale of houses by an exempt charitable foundation over a period of 18 months for the sole purpose of raising funds for the support of a church constitutes an unrelated trade or business activity. Where such activity is the primary activity of the foundation, it is a feeder and not entitled to exemption. See Rev. Rul. 55–449, 1955–2 C.B. 599.
Home show conductor— A corporation organized for the purpose of promoting and conducting home shows, the net earnings of which are payable to the county recreational board in the form of rent for the use of its premises, is not exempt from tax. See Rev. Rul. 57–52, 1957–1 C.B. 196.
Rental income of office building— A corporation organized exclusively for charitable purposes which derives its income principally from the rental space in a large commercial office building which it owns, maintains, and operates and uses such income to aid other charitable organizations through contributions and grants is entitled to exemption under IRC 501(c)(3) where it is shown to be carrying on, through such contributions and grants, a charitable program commensurate in scope with its financial resources. It’s primary purpose was not considered to be the conduct of a trade or business for profit. See Rev. Rul. 64–182, 1964–1 (part 1) C.B. 186.
Printing and selling educational and religious material— An organization controlled by a church to print and sell educational and religious material to its parochial school system is not a feeder. It is providing a service to its parent and falls within Reg. 1.502–1(b). See Rev. Rul. 68–26 1968–1 C.B. 272.
Thrift Shop— A separately incorporated organization where volunteer workers sell donated goods to raise funds for a charitable organization named in its charter is engaged in a trade or business under IRC 502. See Rev. Rul. 68–439, 1968–2 C.B. 239. Revoked by Rev. Rul. 71–581, 1971–2 C.B. 236.
Investment services— An organization regularly carrying on an investment service that would be unrelated trade or business if carried on by any of the exempt organizations on whose behalf it operates is not exempt under IRC 501(c)(2) or 501(c)(3). See Rev. Rul. 69–528 1969–2 C.B. 127.
Laundry services operated for hospitals— The criteria to be met in determining the tax consequences of operating laundry services for hospitals are outlined in Rev. Rul. 69–633, 1969–2 C.B. 121.
Investment management services for colleges and universities— A nonprofit organization that provides assistance in the management of participating colleges’ and universities’ endowment or investment funds for a fee substantially below the cost of providing such service is not engaged in a trade or business and qualifies for exemption. Rev. Rul. 69–528 distinguished. See Rev. Rul. 71–529, 1971–2 C.B. 234.
Thrift Shop— Operation of a separately incorporated thrift shop to raise funds for a group of specified exempt organizations may qualify for exemption under section 501(c)(3) of the Code. See Rev. Rul. 71–581, 1971–2 C.B. 236.
Investment management services— An organization formed to provide managerial and consulting services at cost to unrelated exempt organizations does not qualify for exemption under IRC 501(c)(3). Rev. Rul. 71–529 distinguished. See Rev. Rul. 72–369, 1972–2 C.B. 245.
Commercial printing corporation— A church-controlled commercial printing corporation whose business earnings are periodically paid to the church, but which has no other significant charitable activity, is a feeder organization and does not qualify for exemption. See Rev. Rul. 73–164, 1973–1 C.B. 223.
Thrift Shop— Organization that operates a thrift shop substantially all of the work of which is performed without compensation is not a feeder. The sale of items on consignment does not result in prohibited inurement. See Rev. Rul. 80–106, 1980–1 C.B. 113.