All’s well that ends well – at least according to Shakespeare and now Aegis for Dreams Foundation and its journey toward Section 501(c)(3) tax-exempt recognition. The Foundation is a self-described educational nonprofit that is producing an historically accurate film about the United States’ founding fathers. Last January, W&O blogged about the IRS’s denial of tax-exempt status, based on the IRS’ misplaced reliance on private benefit and commerciality tax doctrines.[1] While these tax doctrines bear much relevance for nonprofits that rely on strategic relationships with private parties or engage in innovative business-like methods, they can derail a tax-exempt application and result in denial.
That happened for the Foundation, at least in its initial application to the IRS. On appeal, the U.S. Tax Court approved a favorable settlement: the IRS has now recognized the Foundation as exempt under Section 501(c)(3).[2] A happy ending indeed! Chiming in, Forbes contributor Peter J. Reilly has named the Aegis decision “the best tax news of the year”![3] This blog builds on Reilly’s enthusiasm and our prior article, particularly in light of these often elusive, subjective, and difficult tax doctrines.
The Foundation’s Proposed Educational Activity: Aegis Screenplay
The Foundation holds licensing rights to a highly accurate screenplay, Aegis for Dreams, that dramatizes the relationship between Alexander Hamilton and George Washington during the Revolutionary War. Unlike other Hollywood films, Aegis for Dreams doesn’t sacrifice historicity for dramatic effect. More than forty percent of the dialogue is drawn directly from primary sources and the entire production is rooted in founder and screenwriter Matthew Ryan’s meticulous research.
Ryan is seeking to raise $30 million through the Foundation to produce the film and, eventually, exhibit it in educational settings like schools. The Foundation will donate all proceeds from screenings to charities serving children and soldiers.
IRS Denial
The IRS initially denied the Foundation’s application for recognition of exemption on several grounds. First, the IRS determined that the Foundation provided a private benefit to its founder, Ryan. Ryan retained the copyright in the Aegis screenplay, as well as certain merchandising rights.
Second, the IRS determined that the Foundation’s purposes were too commercial to qualify for Section 501(c)(3) tax-exempt status. Because the Foundation planned to produce and promote the film similarly to a for-profit commercial entity, the IRS reasoned that the Foundation was not operating exclusively for tax-exempt educational purposes. Instead, the IRS viewed the Foundation as competing with commercial producers of historical films.
As we highlighted in our prior W&O blog, the IRS’s reasoning contained serious flaws with significant tax implications for “educational” qualification under Section 501(c)(3). This case was thus closely watched by tax practitioners and commentators. Did the IRS reach the wrong result? Or was this denial simply a reflection of bad facts mixed with the IRS’s somewhat subjective ability to construe Section 501(c)(3) more narrowly than some would prefer? While the term “educational” for tax purposes can prove challenging in certain contexts, especially when a commercial overlay is involved such as through ticket sales, the Aegis screenplay fits squarely into the Treasury Regulation definition of educational activity: it “instruct[s] the public on subjects useful to the individual and beneficial to the community” by educating the public on an important era of American history.
The IRS took a dimmer view. Applying the “commerciality doctrine,” the IRS scrutinized how the Foundation planned to market and exhibit the film.[4] In doing so, the IRS ignored the film’s important educational purposes, historical accuracy, and lack of commercial viability (such as through its heavy reliance on original sources and hefty historical research). Stated differently, in applying the commerciality doctrine, the IRS gave too much weight to the means of the film’s production and distribution than how the film would promote educational ends that have long been recognized as Section 501(c)(3) compliant within the genre of documentary films.
Barring a successful appeal or other tax correction, the IRS’s adverse Aegis determination could have sounded a death knell for other educational nonprofits hoping to fill in cultural, historical, and other important gaps by producing educational and artistic works lacking commercial viability. Such projects inherently rely on tax-deductible charitable contributions to make them possible. In the wake of much criticism over the IRS’ rejection of 501(c)(3) charitable qualifications, the Foundation petitioned the Tax Court to reverse the IRS denial in November 2021.[5] Thankfully, this tax story has ended well.
Victory for Aegis and for “Educational” Tax-Exempt Status
Following the Foundation’s appeal, and perhaps in light of such extensive criticism, the IRS was willing to settle and approve tax-exempt status. Given the IRS’s flawed reasoning and potential implications (as an indicator of how the IRS would view other “educational” nonprofits, both as applicants and through their Form 990 reporting), the Tax Court’s order is a huge win for the Foundation and for other educational charities.
Notably, the Foundation appears to have resolved the IRS’s private benefit concerns before the parties reached their settlement (as we addressed in more detail through our prior blog). In particular, Ryan granted the Foundation perpetual rights to the screenplay and significantly expanded the terms of the original license, both to better reflect charitable attributes instead of favoring his own financial interests. Consequently, the only outstanding legal issue prior to settlement was the film’s methods of production, commerciality, and educational purposes.
The IRS’s willingness to grant Section 501(c)(3) tax-exempt status after all suggests its recognition that the Aegis for Dreams film will not commercially compete with other historical films. The IRS thus finally accepted, however grudgingly, Ryan’s position that no commercial market exists for historically accurate Revolutionary War films – at least not sufficiently to defeat the Foundation’s charitable status. Without a favorable tax-exempt result, this important screenplay likely would go unmade. The Aegis outcome thus should protect availability of tax-exempt status for organizations that employ commercially oriented methods to produce important but non-commercial educational materials.
What’s next? Now we can move on from this tax saga and on to the main film feature!
[1] Please see our law firm’s January 2022 blog article here.
[2] The U.S. Tax Court decision can be found here.
[3] Please see Peter J. Reilly’s Forbes article here.
[4] Please see our law firm’s blog article on commerciality here.
[5] Aegis for Dreams Foundation’s petition can be found on Taxnotes, here.
