Tax Exemption Double Standard? Absolutely.

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Not all tax exemption standards are created equal. Nonprofit organizations recognized as exempt from federal income tax under Internal Revenue Code (IRC) Section 501(c) are often surprised when subsequent state-based applications for exemption from property and sales tax are denied.

Federal Exemption:  The Starting Point

Nonprofits considering such exemptions should understand the significance of these double standards from the onset and plan to demonstrate the organization’s value to the state taxing authority.  At the state level, exemption from federal income tax is usually the starting point of the state’s exemption application process.  Generally, there are additional, sometimes onerous, requirements for state exemption.  Nonprofit leaders should work with experienced legal counsel to understand state-level requirements and submit applications that are carefully drafted to comply with applicable state standards.  Furthermore, nonprofit leaders interested in such state exemptions should evaluate the nature of the organization’s programming and business relationships to ensure that such activities do not jeopardize a possible exemption.

Nonprofit Quarterly recently described how a nonprofit think tank, which had been granted federal tax exemption under IRC 501(c)(3), was denied property tax exemption. According to the organization’s website, the Acton Institute for the Study of Religion and Liberty is a nonprofit that produces “seminars aimed at educating religious leaders of all denominations, business executives, entrepreneurs, university professors, and academic researchers in economics principles, and in the connection that can exist between virtue and economic thinking.”  At first blush, the organization’s stated purposes certainly seem like those that would qualify the organization as exempt under virtually any standard.  All the typical exempt themes are present:  religion, education, and academic research.  But that apparently was not enough to satisfy the higher-lever state standard.

Higher Standard: State-Level Requirements

Despite such extensive philanthropy, the Grand Rapids City Assessor’s Office rejected the application based on its finding that the Acton Institute “does not meet nonprofit charitable requirements according to case law.”  The attorney for the city explained, “Acton does not qualify as a nonprofit educational institution under state property tax law because it’s not part of educational system that’s provided by the state and supported by public funds.”  According to the city’s representatives, even though the Acton Institute was qualified for exemption under the Internal Revenue Code, the organization did not meet the substantially different standard established by the state for property tax exemption.  Having such charitable purposes is not enough.  In addition, the Acton Institute’s educational activities must relieve government-funded educational burdens, but they do not do so.

Such higher thresholds are not unique to Michigan.  In Illinois, for example, it is well established that property tax exemption provisions are strictly construed in favor of taxation, with all debatable facts resolved in favor of taxation.  Furthermore, as stated inProvena v. Department of Revenue, “The burden of establishing entitlement to a tax exemption rests upon the person seeking it. ... The burden is a very heavy one.  The party claiming an exemption must prove by clear and convincing evidence that the property in question falls within both the constitutional authorization and the terms of the statute under which the exemption is claimed.”  236 Ill. 2d at 389-90, 925 N.E.2d at 1144-45.  Armed with such high standards, Illinois judges evaluate exempt organizations to determine whether they meet several highly-specialized criteria for property tax exemption, depending on the organization’s purposes and activities.  In particular, they look for an abundance of “free soup” – i.e., whether, in legal parlance, the organization makes its benefits “widely available to all without undue obstacles,” such as through free tickets, fee waivers and reductions, and other accessibility options.

In the context of the recent economic strain facing municipalities, such scrutiny is heightened.  As the Nonprofit Quarterly article explained, “state and local governments that are hurting financially are starting to look at the denial of property tax exemptions to nonprofits as a new tactic toward meeting budget concerns.”  As reported in the article, according to David Thompson, vice president of the National Council of Nonprofits, "Local government has been turning to nonprofits as a new source of revenue."

The Strategy of a Justifying Narrative

With the deck so seemingly stacked against nonprofits seeking property tax exemption, it is all the more important that such entities work hard to craft narratives justifying their existence and clearly demonstrating their public benefit.  What government burdens are relieved by the organization’s activities?  How is a particular community improved through the nonprofit’s efforts?  An effective application should seek to answer such questions.  Furthermore, consultation with capable legal counsel is crucial throughout the application process.  Given the widely varying standards among states, and among exemption types, such consultation will help frame the organization’s application so that it passes muster under the applicable legal standard

For the full Nonprofit Quarterly article, please click here