T.C. Memo. 1996-247
UNITED STATES TAX COURT
BOB JONES UNIVERSITY MUSEUM AND GALLERY, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 717-95X. Filed May 29, 1996.
John C. Stophel, Richard W. Bethea, Jr., and Stephen S.
Duggins, for petitioner.
Charles B. Burnett and Monice Rosenbaum, for respondent.
MEMORANDUM OPINION
FOLEY, Judge: Petitioner seeks a declaratory judgment under
section 7428(a) that it is exempt from Federal income taxation
under section 501(a) as an organization meeting the requirements
of section 501(c)(3). Pursuant to Rule 122, this case was
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submitted for decision based on the stipulated administrative
record as defined in Rule 210(b)(10). Petitioner has exhausted
its administrative remedies within the Internal Revenue Service
as required by section 7428(b)(2) and Rule 210(c)(4), received a
final adverse ruling dated December 2, 1994, and invoked the
jurisdiction of this Court by a petition filed on January 12,
1995.
Unless otherwise indicated, all section references are to
the Internal Revenue Code of 1986, and all Rule references are to
the Tax Court Rules of Practice and Procedure.
Background
Petitioner was incorporated as a nonprofit corporation under
the laws of South Carolina on June 2, 1992. Petitioner is a
museum and art gallery located on the campus of Bob Jones
University (the University) in Greenville, South Carolina.
The University first opened an art gallery in 1951, and
prior to petitioner's incorporation, the art gallery was a part
of the University. The museum and art gallery have been housed
in their present location since 1965. Petitioner represents that
the museum contains “one of the greatest collections of religious
paintings and works of art in the western hemisphere.”
At one time, the University was a tax-exempt organization.
The University's exempt status was revoked, however, as a result
of a 1983 Supreme Court decision. See Bob Jones Univ. v. United
States, 461 U.S. 574 (1983). The University maintains a policy
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that prohibits students from engaging in interracial dating and
marriage, and the Supreme Court found that policy to be contrary
to public policy.
Petitioner's charter states that petitioner was organized
for the following reasons:
To operate a museum and art gallery which will be open
to the public with the hope that it will contribute
substantially to the need of the Southeastern United
States for cultural and artistic opportunities akin to
that of other regions long recognized for their
outstanding art galleries which enrich the lives of
their people.
To solicit, collect, receive, accumulate, administer
and disburse funds and property in such a manner as
will, in the sole discretion of the board of directors,
most effectively operate to further religious,
charitable, scientific, literary, or educational
purposes, either directly or by contributions to any
organization described in Section 501(c)(3) of the
Internal Revenue Code, with the exception of
organizations testing for public safety.
In essence, petitioner is taking over all of the operations
of the museum previously managed by the University. At the
outset, the museum operated by petitioner will display the same
artwork, retain the same employees, and be housed in the same
building (the Building) as the museum operated by the University.
Unlike the University, however, petitioner does not prohibit
interracial dating or marriage.
Petitioner and the University entered into a 3-year lease
agreement beginning January 1, 1993, under which petitioner is
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renting the Building.1 Under the terms of the lease agreement,
petitioner is to pay the University a total of $105,600 per year.
The Building contains 35,200 square feet of floor space. The
rent charged thus equals $3 per square foot, an amount
substantially below the Building’s fair market rental value of
$10-$12 per square foot. The lease agreement states "that all
works of art, furniture, fixtures, and other items of personal
property located on or in the Leased Premises" are owned by the
University and are being lent to petitioner free of charge for
the 3-year term of the lease. The artwork initially to be
displayed by petitioner consists exclusively of artwork on loan
from the University, but petitioner over time intends to acquire
additional artwork to display.
In addition, the lease agreement states that the University
is responsible for the payment of taxes and repair and utility
costs as well as for the maintenance of personal injury and
property damage liability insurance relating to the Building.
Petitioner, however, must provide routine maintenance and care
for all artwork it borrows. To the extent that petitioner’s
employees perform any restoration services on artwork owned by
1
The lease agreement provides that petitioner “shall have
the option to extend the term of this Lease for additional terms
of three (3) years each at a rental rate to be determined after
consideration of all of the facts and circumstances at the time
of renewal.” The original 3-year term ended on Dec. 31, 1995.
The administrative record does not indicate whether the lease
agreement has been extended.
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the University, petitioner will insist on reasonable
remuneration.
According to its bylaws, petitioner is governed by a board
of directors that must consist of at least three members and that
is self-perpetuating. The board appoints officers for 1-year
terms. Both the directors and the officers serve without
compensation from petitioner.
Petitioner's board of directors currently consists of five
persons: Bob Jones, chancellor of the University and the son of
the University’s founder; Bob Jones III, president and a member
of the board of the University and the son of Bob Jones; John
Brausch, an accountant; Terry E. Haskins, an attorney; and R.
Dana Sullivan, a businessman.
Petitioner's officers are as follows: Bob Jones III,
president; Bob Wood, vice president (Mr. Wood is also a vice
president of the University); Roger Syrja, treasurer; and Roy A.
Barton, Jr., secretary (Mr. Barton is also the executive director
of financial affairs for the University).
In recent years, the number of visitors to the museum has
exceeded 20,000 annually. Approximately 80 percent of the
visitors have no connection with the University. The museum is
open to the public free of charge. Petitioner anticipates that
substantially all of its revenue will come from contributions.
The balance of its revenue will come from sales of artwork
reproductions in a gift shop.
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Discussion
I. In General
Section 501(a) exempts organizations described in section
501(c)(3) from Federal income tax. Section 501(c)(3) includes:
Corporations * * * organized and operated exclusively
for religious, charitable, * * * or educational
purposes, * * * no part of the net earnings of which
inures to the benefit of any private shareholder or
individual, no substantial part of the activities of
which is carrying on propaganda, or otherwise
attempting, to influence legislation * * * and which
does not participate in, or intervene in, * * * any
political campaign * * *.
The requirement that a corporation be organized exclusively for
permitted purposes is referred to as the “organizational” test.
The requirement that a corporation be operated exclusively for
permitted purposes is referred to as the “operational” test.
Only the operational test is at issue in this case.
Section 1.501(c)(3)-1(c), Income Tax Regs., provides that an
organization will be regarded as “operated exclusively” for one
or more exempt purposes only if three requirements are satisfied:
(1) The organization engages primarily in activities that
accomplish exempt purposes, and no more than an insubstantial
part of its activities is in furtherance of a nonexempt purpose;
(2) the net earnings of the organization do not inure in whole or
in part to the benefit of private shareholders or individuals;
and (3) the organization is not an “action” organization that
attempts to influence legislation by propaganda or otherwise.
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Section 1.501(c)(3)-1(d)(3), Income Tax Regs., expressly
includes museums within the scope of section 501(c)(3). Museums,
of course, must also satisfy all other requirements of section
501(c)(3) to qualify for exemption. In her final adverse ruling,
respondent provided the following explanation for denying
petitioner’s application for exempt status:
This ruling is made for the following reasons. You are
not operated exclusively for exempt purposes. Your
operation results in substantial private benefit to Bob
Jones University, which is not exempt from income tax
under § 501(c)(3) of the Code because of its racially
discriminatory policies. Your earnings inure to
private shareholders or individuals. Furthermore, you
are operated for a substantial non-exempt purpose.
This explanation appears to set forth four separate
justifications for denying petitioner’s application for
exemption. In substance, however, it sets forth a single
justification. Respondent contends that the University derives
an impermissible benefit from petitioner’s operation and that
petitioner, by providing such benefit, furthers a substantial
nonexempt purpose. Respondent argues that the University
receives an impermissible benefit based on: (1) Petitioner’s
payment of rent to the University; (2) petitioner’s payment of
salaries to employees formerly employed by the University;
(3) petitioner’s exhibition of artwork on loan from the
University; (4) the University’s influence on petitioner’s board;
(5) petitioner's location on the campus of the University; and
(6) the reputational benefit that the University will derive from
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its association with petitioner. Even if none of these factors
alone is found to be disqualifying, respondent maintains that
their cumulative effect precludes petitioner’s qualification for
exempt status.
As a preliminary matter, we address respondent’s contention
that petitioner has conceded that it furthers a substantial
nonexempt purpose. Respondent emphasizes that petitioner’s
application for tax-exempt status contained the following
statement: “One of the purposes behind the establishment of the
organization is to allow for gifts to be made to the museum and
art gallery as charitable contributions, whereas no such
deduction would be allowed for such contributions if they were
given to the University.” (Emphasis added.) We do not agree
with respondent that this statement constitutes a disqualifying
admission of a nonexempt purpose. The “purpose” of allowing
donors to deduct contributions, which presumably induces a larger
number and greater amount of contributions to an organization,
motivates virtually every organization’s decision to seek exempt
status. If that objective precluded an organization from
qualifying for tax exemption, few if any organizations would ever
satisfy the section 501(c)(3) requirements. More importantly,
the sentence in petitioner's application immediately following
the one quoted above states: “Contributions to the organization
will be used solely for the operation of the museum and art
gallery and for acquisition of additional art as available funds
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permit.” Petitioner’s stated purposes thus are consistent with
those of any museum.
Respondent contends that, notwithstanding petitioner’s
stated purposes, one of petitioner’s actual purposes is to funnel
tax-deductible contributions to the University. For support,
respondent quotes Christian Manner Intl., Inc. v. Commissioner,
71 T.C. 661, 668 (1979), which states: “It has been recognized
* * * that an organization engaged in a single activity may have
more than one purpose in conducting the activity. So we must be
concerned with both the actual as well as the stated purposes for
the existence of the organization and the activities it engages
in to accomplish those purposes.” We reject respondent’s
contention that petitioner's actual purpose is to funnel tax-
deductible contributions to the University. We see nothing
improper about an educational organization's having as one of its
purposes the receipt of tax-deductible contributions and the use
of those contributions to pay ordinary and necessary business
expenses. In addition, we find Christian Manner International
readily distinguishable from the present case. In Christian
Manner International, the founder of a nonprofit corporation
wrote books that advanced a purportedly religious message and
received proceeds from the sale of the books. The Court
concluded that the corporation’s activities resembled ordinary
commercial publishing practices and that the corporation’s
principal purpose was commercial in nature. In the present case,
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there is no doubt that petitioner is a bona fide museum that
furthers educational purposes.
II. Private Benefit Factors
We now turn our attention to the specific factors cited by
respondent as the basis for her final adverse determination.
A. Petitioner’s Payment of Rent to the University
Respondent contends that petitioner’s payment of rent to the
University confers on the University an impermissible private
benefit. Respondent states:
This [fundraising by the museum] will result in
direct economic benefit to Bob Jones University because
tax-deductible contributions made to Petitioner will be
used to reimburse Bob Jones University for rental of
the building on the University campus where the art
collection is housed. This will relieve Bob Jones
University of the cost of operating the museum itself,
and will allow Bob Jones University to have the benefit
of the museum on its campus financed by tax-deductible
contributions.
The principal inquiry in determining whether rental
arrangements create private benefit or inurement is whether the
rental payments are excessive. See B.H.W. Anesthesia Found. v.
Commissioner, 72 T.C. 681, 686 (1979) (focusing on “whether
comparable services would cost as much if obtained from an
outside source in an arm’s-length transaction”). In the present
case, petitioner is to pay the University $105,600 per year,
which is substantially less than the Building's fair market
value. Respondent contends that payments for less than fair
market value can create private inurement. For support,
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respondent quotes Founding Church of Scientology v. United
States, 188 Ct. Cl. 490, 412 F.2d 1197 (1969), which states:
“That the benefit conveyed may be relatively small does not
change the basic fact of inurement.” Id. at 497, 412 F.2d at
1200. This quotation, however, is taken out of context. The
same case concludes that an organization may “incur ordinary and
necessary expenditures in the course of its operations without
losing its tax-exempt status.” Id. at 496, 412 F.2d at 1200.
We conclude that petitioner's payment of below-market rent
constitutes an “ordinary and necessary” expenditure and does not
confer an impermissible private benefit on the University.
B. Petitioner’s Payment of Employees’ Salaries
Respondent states that petitioner has retained the same
museum employees that the University had employed. Because the
burden of paying the employees’ salaries has shifted from the
University to petitioner, respondent maintains, the University is
receiving a private benefit.
We reject respondent's argument. Petitioner is an
independent organization that conducts its own operations.
Petitioner pays its employees to perform services for the museum.
Although petitioner's employees previously worked for the
University, they do not currently provide any services to the
University in exchange for their salaries. Therefore, we
conclude that petitioner's payment of its employees' salaries
does not confer a private benefit on the University.
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C. Petitioner’s Use of Artwork Lent by the University
The lease agreement between petitioner and the University
restricts to the Building the use of all leased artwork,
furniture, and fixtures. Respondent contends that this
restriction unduly limits petitioner’s operations.
We disagree. The terms of the lease agreement are somewhat
restricting, but the lease agreement expires after 3 years.
Moreover, respondent concedes that displaying artwork on loan is
a common practice of museums. Respondent further concedes that
petitioner is not paying the University an excessive amount for
its use of the artwork. In fact, petitioner is not paying the
University anything for its use of the artwork. Based on these
facts, we conclude that the lease agreement does not confer an
impermissible private benefit on the University.
D. Excessive Control
Respondent contends that persons on petitioner’s board of
directors who are affiliated with the University will manage
petitioner for the purpose of benefiting the University. There
are no bright-line standards that address the effect on exempt
status, if any, of overlapping boards of directors. In Rev. Rul.
66-358, 1966-2 C.B. 218, the Commissioner concluded that a
nonprofit organization spun off from a taxable corporation was
tax exempt even though the nonprofit organization’s directors
consisted of the taxable corporation’s officers. Thus, the
Commissioner has recognized that overlapping boards of directors
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do not automatically prevent an organization from qualifying for
exempt status.
Two factors in the present case weigh in petitioner’s favor.
First, the University controls less than 50 percent of the votes
on petitioner’s board of directors. Only two of petitioner’s
five directors, Bob Jones and Bob Jones III, are employed by the
University. Second, we agree with petitioner that the issue of
control would be relevant only if petitioner and the University
were to engage in transactions in which petitioner paid the
University unreasonable amounts for goods or services. See
Bubbling Well Church v. Commissioner, 74 T.C. 531, 537 (1980)
(“If members of the Harberts family [which made up the entire
board of directors] were actually engaged in performing
employment services, compensating them in reasonable amounts for
those services would not disqualify petitioners for exemption.”),
affd. 670 F.2d 104 (9th Cir. 1981). Given that University
officials do not control a majority of petitioner’s board of
directors and that the record does not lead us to believe that
petitioner will make unreasonable payments to the University, we
conclude that the current composition of the board does not
preclude petitioner from satisfying the requirements of section
501(c)(3).
E. Location
Respondent contends that petitioner’s location on the
University’s campus confers a private benefit on the University.
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In particular, respondent emphasizes that the University requires
all of its students to visit the museum as part of a required
freshman course and as part of several elective courses.
Petitioner contends that the University’s requirement that
students visit the museum is not problematic. Petitioner
emphasizes that other schools may require students to visit
museums as part of their academic curricula and that whether
those museums are located on or off campus does not affect the
tax-exempt status of the schools imposing the requirement.
We conclude that any benefit the University derives from
petitioner’s location is merely incidental. See Kentucky Bar
Found., Inc. v. Commissioner, 78 T.C. 921, 926 (1982).
Respondent has not cited, nor have we found, any cases that
suggest that the location of an organization may affect its
eligibility for exempt status. Moreover, approximately 80
percent of all visitors to the museum are not affiliated with the
University. Evidently, the location does not deter public
visitors.
F. Enhancement to Reputation
Respondent contends that petitioner’s name and location
serve to “enhance the University’s educational and spiritual
reputation” and thus confer a private benefit on the University.
While we agree that the University receives an intangible benefit
from petitioner’s name and location, we conclude that the benefit
is minimal and incidental. See id.
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Respondent is especially concerned about preventing the
University from circumventing the Supreme Court’s 1983 decision
in Bob Jones Univ. v. United States, 461 U.S. 574 (1983).
Respondent contends that, if petitioner prevails, “Bob Jones
University will be able effectively to achieve the tax exempt
status which was denied to it by the Supreme Court.” By spinning
off component parts, respondent states, the University “may
achieve an aura of tax-exempt status itself by being associated
with various tax-exempt spin-offs.” Respondent further contends
that a decision for petitioner would create a “slippery slope”.
She believes that if the University is allowed to spin off its
museum, it may next attempt to spin off other component parts,
such as its library, cafeteria, and bookstore.
Respondent’s concerns about spinoffs are misplaced for
several reasons. First, as petitioner aptly points out,
respondent does not cite any cases to support her “aura”
argument, nor does she clearly define this exempt status-
defeating “aura”. Second, libraries, cafeterias, and bookstores
are essential parts of a university, while most universities do
not maintain art museums. Third, a cafeteria or bookstore spun
off from a taxable corporation might not independently qualify
for exempt status. Finally, while additional concerns may arise
if a university were to attempt to spin off one of its essential
parts, those concerns are not implicated here.
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We find problematic and reject the notion that enhancement
of another entity’s “educational and spiritual reputation” may
preclude exempt status. Respondent has not cited, nor have we
found, any cases supporting her position.
G. Cumulative Effect of These Factors
Ultimately, respondent concedes that “most of the individual
factors * * * may not appear to result in more than incidental
private benefit” but contends that the “cumulative effect” of
these factors creates a private benefit. We disagree. Based on
our review of the record, we conclude that petitioner satisfies
the requirements of section 501(c)(3) in substance as well as in
form. Petitioner is a museum, open to the public free of charge,
that displays what petitioner claims is one of the greatest
collections of religious art in the Western Hemisphere.
Respondent has not challenged this claim. With respect to all
financial dealings between petitioner and the University,
respondent has conceded that petitioner is paying the University
fair market value or less. While there is no doubt that the
University receives certain benefits from petitioner's existence,
these benefits are merely incidental.
III. Conclusion
Respondent’s arguments ultimately lead to the conclusion
that a taxable corporation could never spin off a tax-exempt
organization and conduct subsequent financial dealings with it.
Because funds raised by a tax-exempt organization generally come
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from tax-deductible donations, respondent’s position implies that
any transfer by an exempt organization to a taxable corporation
would create a private benefit or inurement problem. We reject
this position. Accordingly, we hold that petitioner’s operation
does not result in an impermissible private benefit to the
University and that petitioner’s net earnings do not inure to the
University.
To reflect the foregoing,
Decision will be entered
for petitioner.