Dateline: January 4, 2007, Chicago
The ongoing battle between nonprofits and the state taxing authorities over property tax exemptions has the Great Trail Girl Scout Council doing battle with J. Patrick McAndrew, the Tax Commissioner of Ohio. McAndrew won the first fight, but the Ohio Board of Tax Appeals ruled in favor of the Girl Scouts in round 2. Yes, those little girls...
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bloodied Commissioner McAndrew. The matter is currently before the Ohio Supreme Court, with a decision expected to be rendered any day.
If this were Junior Achievement, the kids would be commended for earning a profit. But business success doesn’t equate with tax success in the world of property taxes. Tax Commissioner McAndrew claims that the Girl Scouts can’t earn a profit and still qualify for tax exemption. At first, we were very concerned because we thought the case might involve Girl Scout cookies. Could a government official really argue that the Girl Scouts shouldn’t profit from their delicious thin mints? Maybe, but that question will go unanswered for the time being. The profit in question involved the sale of the certain products through a store that occupied 3% (16 feet by 16 feet) of the space in a 12,000 square foot office building owned and used by the Great Trails Council.
The sales that were so troubling included the sale of items that reflect a girl’s membership in the Girl Scouts (e.g., uniforms, badges, patches, pins, and handbooks) and clothing with the Girl Scout logo (e.g., polo shirts, tee shirts, and sweatshirts). The first set of items (referred to by the Board of Tax Appeals as “category 1 items”) accounted for 85% to 90% of sales and were considered to be an integral part of the Girl Scout program. These items were sold strictly as an accommodation to the Girl Scout members. For eleven years the sale of these items didn’t generate a profit, but in 2003, the Girl Scouts earned $2,363 in profit on sales of all items.
The prices charged by the Girl Scouts included a 20% to 25% markup. However, the prices were set to just cover the cost of goods sold, and the direct and indirect costs of operating the store. The Girl Scouts were required to purchase the category 1 items from National Equipment Services (NES). These items could only be sold through a Girl Scout store and were sold at prices set by NES. The Great Trails Council purchased items in the second category from vendors licensed through by the national Girl Scouts umbrella organization.
The Board of Tax Appeals noted that to qualify for tax exemption, the Great Trails Council had to satisfy a two-prong test. First, it had to establish that it was a charitable organization. Nobody seemed to dispute that fact. Second, it had to establish that the property was being used “exclusively for charitable purposes.” In addition, Great Trails had to establish that the store was not used with a view toward profit and was not used in competition with commercial enterprises. The board states these additional requirements as separate tests, but both appear to be part of the second prong of the basic test.
After reviewing the facts and distinguishing the Great Trails Council facts from those in Seven Hills Schools v. Kinney, 28 Ohio St.3d 186 (1986), the Board ruled in favor the Great Trails Council. It viewed the following facts as supporting its decision: (i) the goods were sold only to those connected with girl scouting, (ii) the merchandise related only to scouting, (iii) there was not an alternative source for the merchandise (with the exception of the Web site operated by the national girl scout umbrella organization, which sold some of the goods at the same price); and (iv) the goods were sold with the intent of covering costs rather than making a profit.
We view this as the right decision. It holds several important lessons for all nonprofits seeking to claim exemptions from property taxes. First, notice that even had the Great Trails Council lost the case, it would still have been permitted to claim an exemption for the other 97% of its building. In some jurisdictions, disqualification of the 3% portion from exemption would have also disqualified the remainder of the building. Any organization that decides to take an aggressive position with respect to an activity conducted in only part of an otherwise exempt facility should first assess whether the law permits bifurcation of the building or applies an “all or nothing” rule.
Second, the property tax exemption statute in this case required that the property be used exclusively for charitable purposes. Under federal tax law, a Section 501(c)(3) organization must also be operated exclusively for charitable purposes to qualify under Section 501(c)(3) for tax exemption. However, exclusive does not mean 100%, as confusing and illogical as that may sound. Many state property tax regimes are not as lenient. Exclusive means exclusive. Boards should ask the financial people whether there is any activity that could jeopardize the organization’s exemption. As always cash hungry organizations look for new sources of revenue, they should first consider the implications of conducting new revenue generating activities on their property tax-exemption.
While unrelated business income is not per se fatal to federal tax exemption, it must be reported on Form 990-T (unless gross income from unrelated activities is under $1,000--gross income = gross receipts - cost of goods sold). We are unwilling to say that the conduct of an unrelated business on property always precludes a claim that the property qualifies for a property tax exemption. Before that conclusion can be drawn, it is necessary to look at governing law. However, as a general matter, unrelated business income probably isn’t helpful and in many cases will be fatal to a claim that the related property qualifies for property tax exemption. Consequently, organizations must balance the revenue gained from unrelated business income against its possible adverse impact on their property tax exemptions.
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