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...variety issues and ills the era. These types of voluntary organizations have continued to thrive in the United States for centuries. In 1831, during his historic visit to the United States, Alexis de Tocqueville observed:
"Americans of all ages, conditions, and dispositions constantly unite together. Not only do they have commercial and industrial associations to which all belong but also a thousand other kinds, religious, moral, serious, futile...Americans group together to hold fetes, found seminaries, build inns, construct churches, distribute books...They establish prisons, schools by the same method ... I have frequently admired the endless skill with which the inhabitants of the United States manage to set a common aim to the efforts of a great number of men and to persuade them to pursue it voluntarily." (1)
Voluntary associations comprised two distinct types of organizations--public-serving and member-serving. (2,3) Early public-serving, or charitable, organizations included schools, churches, and other voluntary organizations designed to provide services to the public. The popularity of voluntary charitable organizations in the United States, even in the midst of strengthening State and Federal governments, suggests that perhaps these organizations, with their well-established structures and programs, were able to fill a gap in social welfare programs where the young Government's efforts proved insufficient. Another suggestion is that many early Americans embraced charitable organizations over Government programs because they feared "the rebirth of monarchy, or bureaucracy." (4)
By the end of the 19th century, private philanthropy, as typified by the modern private foundation, had joined voluntary associations as an important component of the public-serving charitable sector of the United States. The foundation originated from the charitable trust, a tool for giving that became widely used in this period. (5) In the early 20th century, a number of American industrialists, wishing to direct their newly acquired wealth toward a broad range of altruistic endeavors, created private foundations that remain prominent today. Unlike other early charitable organizations, private foundations generally were controlled and funded by a single source, such as an individual, corporation, or family. Andrew Carnegie articulated the vision of these early philanthropists in his essay, "The Gospel of Wealth," where he argued that a wealthy individual should "consider all surplus revenues which come to him simply as trust funds, which he is called upon to administer, and strictly bound as a matter of duty to administer in the manner which, in his judgment, is best calculated to produce the most beneficial results for the community ..." (6)
Member-serving associations, including fraternal societies, were also popular among early Americans. The Freemasons, for example, have roots in 17th century England and count a number of this Nation's founding fathers as members. By the 19th century, mutual benefit associations, serving members in areas such as banking and insurance, began to flourish. Additionally, labor and agricultural organizations, established to promote the interests of their members, started to take root across the Nation around this time.
Voluntary associations and philanthropic vehicles continue to coexist and forge a relationship with Government that remains into the 21st century. A significant component of this relationship is Government's recognition of the importance of the charitable and voluntary sector, and the support of its organizations in the form of an exemption from income and certain other taxes. This article explores the legislative history of tax exemption and presents historical data that highlight recent financial trends among tax-exempt organizations.
Legislative History of the Tax-Exempt Sector
The structure of tax exemption granted to the charitable and voluntary sector outlined in the United States Tax Code was developed through legislation enacted between 1894 and 1969. Over that 75-year period, Congress established the basic principles and requirements of tax exemption, identified business activities of tax-exempt organizations that were subject to taxation, and defined and regulated private foundations as a subset of tax-exempt organizations. Figure A shows a timeline of major legislative actions relevant to tax-exempt organizations, while a more complete history can be found in Appendix B at the end of this article.
Figure A Major Exempt Organization Legislation, 1894-Present --1894 Tariff Act of 1894--Earliest statutory reference to tax exemption for certain organizations. --Revenue Act of 1909--Introduced language prohibiting private inurement, --Revenue Act of 1913--Established income tax system with tax exemption for certain organizations. --Revenue Act of 1917--Introduced individual income tax deduction for charitable donations. --Revenue Act of 1918--Estate tax deduction for charitable bequests added. --Revenue Act of 1934--Set limits on lobbying activities by charitable organizations. --Revenue Act of 1936--Introduced corporate tax deduction for charitable contributions. --Revenue Act of 1943--Required first Forms 990 to be filed. --Revenue Act of 1950--Established unrelated business income tax. --Revenue Act of 1954- Modern tax code established, including section 501(c) for exempt organizations. Also, limits on political activities established. --Revenue Act of 1964--Raised the limitation on deduction for donations to public charities to 30 percent of adjusted gross income (AGI). --Tax Reform Act of 1969--Established private foundation rules, including a minimum charitable payout requirement and a 4-percent excise tax on net investment income, and raised the limitation on the deduction for donations to operating private foundations and public charities to 50 percent of AGI. --Revenue Act of 1978--Reduced the net investment income excise tax for private foundations to 2 percent. --Deficit Reduction Act of 1984--Raised the limitation on the deduction for donations to nonoperating private foundations to 30 percent of AGI and introduced other more favorable rules for donors to these organizations. Also, exempted certain operating foundations from the net investment income tax and reduced the tax to I percent for foundations meeting other requirements. --Revenue Reconciliation Act of 1993--Imposed a proxy tax on certain lobbying and political expenditures made by membership organizations. --Tax Payer Bill of Rights 2 (1996)--Introduced intermediate sanction rules for excess benefit transactions. --Tax Payer Relief Act of 1997--Revoked tax exemption of certain organizations providing commercial-type insurance. Pension Protection Act of 2006--Required section 501(c)(3) organizations to make their Forms 990-T available for public inspection. NOTE For more extensive information see Appendix B
Early Legislation, 1894-1936
The privileged tax treatment that the Government grants to charitable and member-serving organizations can be traced to the earliest versions of United States tax law. Early tax-exemption regulations developed around three major principles. First, organizations that operated for charitable purposes were granted exemption from the Federal income tax. Second, charitable organizations were required to be free of private inurement--that is, a charitable organization's income could not be used to benefit an individual related to the organization. Finally, an income tax deduction for contributions, designed to encourage charitable giving, was developed.
The Wilson-Gorman Tariff Act of 1894, one of the earliest statutory references to the tax-exempt status enjoyed by charitable organizations, established the requirement that tax-exempt, charitable organizations operate for charitable purposes. While establishing a flat 2-percent tax on corporate income, the act stated "nothing herein contained shall apply to ... corporations, companies, or associations organized and conducted solely for charitable, religious, or educational purposes, including fraternal beneficiary associations." Though the law was declared unconstitutional by the Supreme Court in 1895, the exemption language contained in the act would provide the cornerstone for tax legislation involving charitable organizations for the next century.
The Revenue Act of 1909 mirrored and expanded the language from the 1894 act. Under this statute, tax exemption was granted to "any corporation or association organized and operated exclusively for religious, charitable, or educational purposes, no part of the net income of which inures to the benefit of any private stockholder or individual." This important addition set forth the idea that tax-exempt charitable organizations should be free of private inurement--in other words, nonprofit.
Ratification of the Sixteenth Amendment granted Congress the power to levy income tax. The subsequent Revenue Act of 1913 established the modern Federal income tax system. For charitable organizations, the act used identical language as that found in the Tariff Acts of 1894 and 1909 with regard to charitable purpose and private inurement.
The Revenue Act of 1917 established, for the first time, an individual income tax deduction for contributions made to tax-exempt charitable organizations. This deduction was conceived as a way to encourage charitable contributions at a time when income tax rates were rising in order to fund World War I. One year later, the Revenue Act of 1918 provided that charitable bequests were entitled to a similar deduction on estate tax returns. Finally, corporations were able to claim the charitable deduction beginning in 1936.
The Revenue Act of 1950
Before the 1950s, tax-exempt organizations could earn tax-free income from both mission-related activities and commercial business activities that were unrelated to the purpose for which they were exempt, as long as they used the net profits for exempt purposes. However, in the 1940s, concerns grew in Congress over the perception that tax-exempt organizations were permitted an unfair competitive advantage over taxable entities. As a result, Congress established the "unrelated business income tax" (UBIT) as part of the Revenue Act of 1950. For tax years beginning after December 31, 1950, UBIT was imposed on the "unrelated business income" (UBI) of charitable organizations (except churches); labor and agricultural organizations; chambers of commerce, business leagues, and real estate boards; certain trusts; and certain title holding companies. (7)
Income was considered UBI if it was produced from an activity deemed a "trade or business" that was "regularly carried on" and was not "substantially related" to the organization's exempt purpose(s), regardless of whether or not the profits from the unrelated trade or business were used solely for exempt purposes. Passive income and certain gains and losses from the disposition of property were not subject to tax.
The Revenue Act of 1950 addressed several other issues regarding the unrelated activities of tax-exempt organizations. Tax exemption was no longer permitted to "feeder" organizations, which did not conduct any charitable activities, but rather operated commercial enterprises from which they passed income to a charitable organization. In addition, income from debt-financed real estate sale-lease-back activities was subject to UBIT. In these cases, tax-exempt organizations purchased real estate with borrowed funds, leased the property back to the owner, and used the tax-free rental income to pay off the debt. (8)
The Revenue Act of 1950, and additional changes made under the Tax Reform Act of 1969, discussed in the following section, formed the contemporary structure for the unrelated business taxation of tax-exempt organizations.
Tax Reform Act of 1969
By the 1960s, there was a growing perception among lawmakers that private foundations, with their small networks of financers and administrators, were less accountable to the public than traditional charities. These concerns were addressed with the Tax Reform Act of 1969 (TRA69), which introduced sweeping reforms to the charitable sector. TRA69 also significantly expanded the rules governing unrelated business income taxation of tax-exempt entities.
The first explicit definition of private foundations, for tax purposes, was included in TRA69. This legislation defined a foundation as a charitable organization that did not engage in inherently public activities, test for public safety, receive substantial support from a wide array of public sources, or operate in support of any organization that met any of these three requirements. (9) Further, the legislation created two subclasses of private foundations--nonoperating and operating. Nonoperating foundations, which represented the majority of all private foundations, were defined as primarily grantmaking organizations. Conversely, operating foundations were those that operated charitable programs in a manner similar to that of punic charities.
TRA69 established an array of more stringent requirements specific to private foundations. These "private foundation rules" outlined two annual requirements and a variety of "prohibited activities" that were considered to be contrary to the public interest. First, TRA69 established an annual excise tax on investment income. This provision was intended to compel private foundations to "share some of the burden of paying the cost of government," particularly the enforcement of regulations related to the tax-exempt sector. (10) Second, nonoperating foundations were required to distribute a minimum amount for charitable purposes each year. Further, private foundations that failed to meet the minimum charitable distribution requirement or engaged in certain prohibited activities were subject to taxes and Other sanctions.
TRA69 also increased the existing charitable deduction limits for individual donors and sharpened the definitions of the organizations to which contributions were deductible. Under the Revenue Act of 1964, individuals could deduct contributions made to public charities up to 30 percent of adjusted gross income (AGI). The new regulations enacted under TRA69 increased the maximum deduction limitation for cash and ordinary income contributions to 50 percent for public charities and operating foundations. Most nonoperating private foundations remained subject to a lower 20-percent limitation. (11)
TRA69 also expanded the tax on unrelated business income, extending the tax to all tax-exempt organizations described in IRC sections 501(c) and 401(a) (except United States instrumentalities), and including churches for the first time. Additionally, TRA69 expanded the taxation of debt-financed income to include forms of income other than rents from real estate sale-leaseback arrangements. (12) Since 1969, Congress has made a number of changes to the UBIT statutes. However, the rules on unrelated business taxation of tax-exempt organizations established by the Revenue Act of 1950 and TRA69 have remained largely intact.
Other Legislation, 1970-2007
While the underlying structure of tax exemption for the charitable and voluntary sector has changed little since the passage of TRA69, subsequent legislation has introduced a number of modifications. These include adjustments to the private foundation net investment income tax rates and to the excise tax rates on charitable organizations that engage in prohibited activities. Further changes have provided new exceptions to UBIT taxation for specified activities, tightened the rules pertaining to the taxation of payments received from subsidiaries, and required unrelated business income tax returns filed by IRC section 501(c)(3) organizations to be made publicly available.
Overview of the Statistics of Income Exempt Organization Program
The Internal Revenue Service provides, by Congressional mandate, statistics and microdata derived from information and tax returns filed with IRS. To fulfill this requirement, the Statistics of Income (SOI) division has conducted annual studies of organizations exempt under IRC section 501(c)(3) for every tax year since 1985. (13) Currently, SOI collects information from stratified random samples of Forms 990, 990-PF, 990-T, and the population of Forms 4720.
Tax-exempt organizations, other than private foundations, file Form 990, Return of Organization Exempt from Income Tax; private foundations file Form 990-PF, Return of Private Foundation or Section 4947(a)(1) Nonexempt Charitable Trust Treated as a Private Foundation. Forms 990 and 990-PF are used by these organizations to report standard financial information, as well as information regarding compliance with the regulations that govern their tax-exemption. Charitable and other types of tax-exempt organizations report any unrelated business income and taxes on Form 990-T, Exempt Organization Business Income Tax Return. Private foundations, public charities, and split-interest and charitable trusts use Form 4720, Return of Certain Excise Taxes on Charities and Other Persons under Chapters 41 and 42 of the Internal Revenue Code, to calculate and pay taxes on prohibited activities and, for private foundations, failure to meet the minimum annual distribution requirement. SOI produces a variety of statistical tables and articles annually for all of the tax-exempt organization programs. Also annually, microdata files that include all information collected from the Form 990 and Form 990-PF samples are made available to the public on the IRS Web site, www.irs. gov/taxstats. Microdata derived from Forms 4720...
NOTE: All illustrations and photos
have been removed from this article.
More articles from Statistics of Income. SOI Bulletin
Ninety years of individual income and tax statistics, 1916-2005., January 01, 2008
SOI sampling methodology and data limitations., January 01, 2008
SOI projects and contacts., January 01, 2008
Individual public-use microdata files.(Individual Income Tax Returns), January 01, 2008
ZIP code area data.(Individual Income Tax Returns), January 01, 2008
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