A Brief Recap of the Impact of Illegal Activities on Tax-Exempt Organizations in Light of Dobbs

• August 19, 2022

• Albert Lin , Husch Blackwell LLP

Over the decades since Roe v. Wade[1] was decided in 1973, Texas enacted restrictions on abortion procedures. Many other states have responded similarly.[2] In response to these state legislative restrictions, which led to the closure of clinics offering the procedures, nonprofit, tax-exempt organizations were formed in Texas to provide funding to pregnant people seeking abortions who faced financial obstacles. These funds have recently paused their assistance[3] due to the United States Supreme Court’s decision in Dobbs v. Jackson Women’s Health Organization,[4] which overturned Roe v. Wade, and Planned Parenthood of Southeastern Pa. v. Casey.[5]

Given Dobbs, timely and critical legal questions are arising as to any potential threat to abortion funds’ tax-exempt status if they continue to provide funding for travel assistance to states that still permit abortions. This article seeks to recap existing law on the impact of illegality and public policy considerations on tax-exempt organizations.

Background

A longtime principle is that a tax-exempt organization should not qualify as tax exempt under Section 501(c)(3) of the Internal Revenue Code of 1986, as amended (Code), if an organization engages in an activity that is illegal or that violates fundamental public policy.[6] Clearly, if an exempt organization’s purpose is illegal, the organization should not qualify as tax-exempt.

In addition, the activities should not be illegal as well. The argument is that the activities frustrate a fundamental charitable purpose, which is the relief from the burdens of government.[7] Yet, purposes and activities are often not blatantly illegal—most tax-exempt health care organizations that previously provided abortion assistance attempt to serve the broader permitted purpose of providing for, and improving, community health. The situation for tax-exempt organizations following Dobbs, in considering whether to offer travel benefits for patients to states that permit abortion, can create a juxtaposition of one side arguing for an exempt organization’s promotion of public health, versus one side arguing illegality as a bar to exemption.

The most instructive statement of current Internal Revenue Service (IRS) policy appears in GCM 34631 (1971). This GCM did not expressly rule for or against a particular taxpayer in question, which was a New York nonprofit that conducted picketing activities in connection with its charitable purpose (such charitable purpose was not identified in the authority but generally related to community safety). In the GCM, the issue was whether demonstrations, including picketing against both governmental entities and private businesses, would result in a denial of tax exemption. The IRS stated that in the course of evaluating the question, “If an organization carries on substantial illegal activities, it cannot qualify for exemption under section 501(c)(3) of the Code.”

But what is “substantial”? The IRS stated that just looking the ratio of illegality acts to the overall activities of a tax-exemption would not be enough.

The quality of such acts are as important as their quantity. A great many violations of local pollution regulations relating to a sizable percentage of an organization's operations would be required to disqualify it from 501(c)(3) exemption. Yet, if only.01% of its activities were directed to robbing banks, it would not be exempt. This is an example of an act having a substantial non-exempt quality, while lacking substantiality of amount. A very little planned violence or terrorism would constitute “substantial” activities not in furtherance of exempt purposes.

The rules for tax-exempt organizations that provide funding for out of state abortions, then, will go to whether the activity is illegal, and then, whether the activity is substantial. Moreover, the question will go to whether the illegal activity should be akin to violations of local pollution regulations, as opposed to robbing banks. Thus, evaluation of tax-exemption risk requires a highly factual and legal analysis and evaluation of all local laws and policies.

Illegality Rulings—Illegal Purpose & Enforcement Activities

Until the IRS provides further guidance on abortion travel activities, the IRS position on exempt organizations related to medical marijuana may be instructive (whereby the IRS denied exemption to an organization organized to distribute medical cannabis to qualified patients). In PLR 20194008 (Oct. 4, 2019), the IRS ruled against a Section 501(c)(3) organization with the goal of fundraising, educating, advocating for, and disseminating funds to patients that have been approved to receive medicinal marijuana in a state that permitted it. The patients were required to demonstrate financial need. If approved, the recipients would receive assistance of the supply of product directly from the dispensary.

The IRS held that the organization did not qualify under Section 501(c)(3) because federal law permitted the use of marijuana and cannabis only in limited circumstances, of which medicinal purposes was not one of them. “Because you advocate and engage in activities that contravene federal law, you serve a substantial nonexempt purpose.” Even though such use was permitted in the specific state in question (not identified), the activity was still illegal under federal law.

Yet the IRS has held that mere illegality under local law does not bar exemption, at least, in a case and a revenue ruling dealing with social clubs tax-exempt under Section 501(c)(7). In Rev. Rul. 69-68,[8] the IRS ruled in favor of a tax-exempt social club, the purpose of which was operating social and recreational facilities for members and guests. Where the club operated gaming devices that were illegal under local law, the IRS found such operation did not bar exemption. It cited a 1954 Tax Court case involving a private tax-exempt club at the Broadmoor in Colorado, which also operated slot machines.[9] “There were virtually no private clubs in the Denver area where slot machines were not operated during 1949 and part of 1950. Although illegal, such operation was with full knowledge and acquiescence of the law enforcement officials.” The Tax Court held that the club was still tax-exempt based on overall facts, including, presumably, the non-enforcement policy of local law enforcement. Clearly the lesson here is that local laws and policies will need to factor heavily into the analysis of a tax-exempt organization considering any financial assistance implicating Dobbs.

Coordination with Policy on Abortion-Related Travel Benefits

Dobbs created a quandary of issues where employers, both for-profit and nonprofit, consider offering benefits for travel for employees trying to obtain reproductive health care. Solutions have ranged from expanding the scope of travel benefits to cover any out-of-state care required, to creation of one-time only bonus plans for travel and procedure costs. The key issue is whether the provision of benefits violates local “aiding and abetting” statutes. If so, the charitable purpose/activity impact on provision of such benefits by tax-exempt organizations must be considered. These topics will be covered in greater detail in a later publication from the AHLA Tax & Finance Practice Group.

Conclusion

Tax-exempt health care organizations that have provided abortion assistance, whether directly or indirectly, should be advised to consider the impact on their tax-exempt status as well as the possibility of civil and criminal penalties. The IRS will look to state and local laws, as well as enforcement policies, when balancing whether or not tax-exempt status will be approved or revoked.

* The author gratefully acknowledges the excellent research assistance provided by Allison Fink, J.D. Candidate, the University of Texas at Austin, May 2023. In addition, any opinions, express or implied, in this article are solely of the author and not attributed to either the American Health Lawyers Association or Husch Blackwell LLP.

ARTICLE TAGS

• Tax and Finance Practice Group
• Reproductive Health Law Hub
• Tax and Nonprofit