Charities and Property Taxes: A Dilemma For Local Officials
New Hampshire’s low crime rate, quality of life and favorable tax climate attracts hundreds of new residents to the state every year. As the population of our towns and cities grow the need for new schools, police and fire equipment, recreational activities and other municipal services presents funding challenges for elected and appointed officials tasked with setting priorities and allocating scarce financial resources in the community.
The reduction in federal assistance to local governments and an increase in property taxes have compelled public officials to search for additional sources of revenue and many municipalities are now revisiting the tax exemptions historically granted to nonprofit charitable organizations located within their borders. When towns or cities undertake this task the evaluation process can be perplexing and difficult for municipal officials who may lack the expertise to gauge whether the public benefit provided by a particular charity is legally sufficient to justify the exemption. More importantly, the judgments made by public officials are sometimes subject to judicial review and a basic understanding of the nonprofit sector and public benefit requirement is therefore key to the decision making process.
What Does the Term ‘Nonprofit’ Mean?
There are 28 categories of “nonprofit" activities recognized by the Internal Revenue Service (IRS) under section 501(c) of the Internal Revenue Code. However, only those entities recognized as meeting the requirements of section 501(c)(3) are eligible to apply for the real estate tax exemption. Nonprofit charitable organizations can and should raise funds to carry out their mission and they are not required to expend all of their money each year. The term “nonprofit" as defined by the Internal Revenue Code means any funds raised by a charity are not taxed by the federal government and therefore are not defined as a “profit" for federal tax purposes.
What Is a Charity?
“Tax exemptions are matters of legislative grace and taxpayers have the burden to establish their entitlement to exemptions." Christian Echoes National Ministry, Inc. v. U.S. 470 F.2d 849 (1972).
Charitable nonprofit status is granted by the Internal Revenue Service to organizations whose mission and purpose qualify as “charitable" under Internal Revenue Code section 501(c)(3). Those organizations granted charitable status by the federal government have a unique legal benefit and are required to serve a public purpose consistent with the terms of their mission statement. Entities seeking 501(c)(3) status must therefore prove their mission and purpose fits within one or more of the following categories listed in the Internal Revenue Code: “charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, or the prevention of cruelty to children or animals." Because charities are mission-driven all funds raised by the organization must be used to carry out the public purpose or purposes set forth in the organization’s governing documents.
Qualifying for Exemption
The primary purpose of a charitable organization is to serve a public and not a private purpose. The Internal Revenue Code states: “No part of the net earnings of a section 501(c)(3) organization may inure to the benefit of any private shareholder or individual. A private shareholder or individual is a person having a personal and private interest in the activities of the organization." Similarly, RSA 72:23-l requires the organization to “perform some service of public good or welfare ... with no pecuniary profit or benefit to its officers or members, or any restrictions which confine its benefits or services to such officers or members, or those of any related organization."
In New Hampshire, charitable organizations are governed by duly elected boards of directors that have legally enforceable fiduciary responsibilities, including the duty of loyalty and the duty of care. These duties require board members to act in the best interest of the organization rather than in the furtherance of personal interests or the interests of third parties. Boards are required to adopt conflict of interest policies and, under RSA 7:19-a, II(c), “Every New Hampshire charitable nonprofit organization must file a conflict of interest statement with the Attorney General on an annual basis." The activities of charitable organizations are regulated by the Internal Revenue Service and the state Attorney General.
New Hampshire has a long tradition of supporting charitable activities within its borders as reflected in our State Constitution, which urges legislators “to countenance and inculcate the principles of humanity and general benevolence, public and private charity" N.H. CONST. Part 2, art. 83. The real estate tax exemption for charities was codified in 1895 when the New Hampshire legislature passed the first law specifically exempting the real estate owned by charities from taxation stating “all public cemeteries, and … so much of the real estate and personal property of charitable associations, corporations, and societies as is devoted exclusively to the uses and purposes of the public charity [is] exempted from taxation." (Municipal Law and Taxation, Peter Loughlin, page 333.)
Although the laws regarding real estate tax exemption have been amended several times since 1895, the standards necessary to qualify for the exemption remain essentially the same. Under the New Hampshire RSAs and in the recent case, Eldertrust of Florida, Inc. v. Town of Epsom, decided by the New Hampshire Supreme Court on January 18, 2007, the granting or denial of an exemption is based on certain specific criteria: the definition of “charitable" in accordance with RSA 72:23-l and the four standards in RSA 72:23, V: “(1) the institution or organization must be established and administered for a charitable purpose; (2) it must be demonstrated that an obligation exists to perform the organization’s stated purpose for the benefit of the public rather than simply for members of the organization; (3) the land, in addition to being owned by the organization, is occupied by it and used directly for the stated charitable purposes; and (4) it must be determined whether the organization’s income or profits are used for any purpose other than the purpose for which the organization was established." (See ElderTrust, 154 N.H. 10 and the March 2007 issue of New Hampshire Town and City.)
The recognition of 501(c)(3) charitable status by the IRS is not enough to make an organization eligible for the property tax exemption. RSA 72:23-l states: “The fact that an organization’s activities are not conducted for profit shall not in itself be sufficient to render the organization ‘charitable’ for purposes of this chapter, nor shall the organization’s treatment under the United States Internal Revenue Code of 1986, as amended."
The Application Process
Charitable organizations seeking favorable tax status must make application to the town or city in which the real estate is located and every charitable organization is required under RSA 72:23-c, to file annually, on or before April 1, a list of all real estate and personal property owned by the organization within a municipality for which they seek a property tax exemption. The form provided by the New Hampshire Board of Tax and Land Appeals (BTLA) for this purpose is the BTLA Form A-9. In addition, all charitable organizations are required under RSA 72:23, VI, to file annually on or before June 1, a statement of its financial condition for the preceding year utilizing BTLA Form A-12. Failure to file either one of these forms may be cause for the municipality to deny the exemption sought.
Under RSA 72:23-m, exemptions are granted to charitable organizations on the basis that the property meets all the requirements of the statute under which the exemption is claimed and the burden of demonstrating the applicability of any exemption is on the charitable organization. Should the municipality refuse to grant the exemption requested, the charitable organization has several remedies including the right under RSA 72:34-a to appeal in writing on or before September 1 following the date of notice of tax under RSA 72:1-d, to the Board of Tax and Land Appeals or Superior Court.
Sound decisions rely on complete and accurate information and, while the BTLA Form A-9 and Form A-12 ask the organization applying for the exemption specific questions prescribed by statute, under RSA 72:23-c, II local officials may request additional documentation from the charity to assist them in the decision making process.
“City assessors, boards of selectmen, and other officials having power to act under the provisions of this chapter to grant or deny tax exemptions to religious, educational, and charitable organizations shall have the authority to request such materials concerning the organization seeking exemption including its organizational documents, nature of membership, functions, property and the nature of that property, and such other information as shall be reasonably required to make determinations of exemption of property under this chapter. Such information shall be provided within 30 days of a written request. Failure to provide information requested under this section shall result in a denial of exemption unless it is found that such requests were unreasonable." (Emphasis added)
There are a number of documents, including those listed below, which provide detailed information on the mission, activities and financial transactions of the charitable organization applying for the exemption.
Internal Revenue Service Letter of Determination. This is the document issued by the IRS to an organization that has been recognized as a 501(c)(3) tax-exempt entity for federal tax purposes, not property tax purposes. It provides official documentation that the organization has been classified as a charity by the IRS and may therefore be eligible for charitable exemption if it also meets the requirements of RSA 72:23-l.
Governing Documents. Governing documents include the organization’s articles of incorporation, bylaws or constitution. The articles of incorporation and/or the constitution define the mission and purpose of the charity while the bylaws explain the procedure by which the organization carries out its mission.
Mission Statement. Perhaps the most important document is the mission statement. The mission statement defines the core purpose of the organization and why it exists. The mission should be clearly stated and have an underlying public purpose. If the mission statement is vague or confusing public officials may want to ask the charitable organization for further clarification of its exempt purpose.
The letter of determination, mission statement, governing documents and bylaws help to answer the question “is the organization established and administered for a charitable purpose?"
Conflict of Interest Policy. Under the provisions of RSA 7:19-a all charitable organizations incorporated in New Hampshire are required to adopt a conflict of interest policy. The law also specifies that no charity shall lend money or property to its directors, officers or trustees. This document helps to answer the question “is the organization engaging in any activities that promote private benefit or private inurement?"
IRS Form 990. The form 990 is the “tax return" filed with the Internal Revenue Service by charitable organizations earning more than $25,000 per year. It is a public document and contains detailed financial information on the charity’s activities during its fiscal year. The sections of the return most useful to municipal officials in determining eligibility for tax exemption are: Part II Statement of Functional Expenses: Where did the organization spend its money during the year? Part II requires each expense reported be allocated into one or more of three specific categories: Program Services, Management and General and Fundraising. Program Services are further defined in Part III Statement of Program Service Accomplishments, which requires that “all organizations must describe their exempt purpose achievements in a clear and concise manner. State the number of clients served, publications issued … and discuss achievements that are not measurable." Because, in order to qualify for the real estate tax exemption, an organization must demonstrate it is carrying out its stated charitable purpose, Part II and Part III can provide municipal officials with a detailed description of the organization’s charitable accomplishments as well as its management and fundraising costs. Copies of the form 990 may also be found on the Internet at www.guidestar.org.
Attorney General’s Form NHCT-2A. The NHCT-2A is the annual financial report filed with the Attorney General by charitable organizations earning less than $25,000 per year. It is a public document and contains the same basic financial information found in Part II of the IRS Form 990.
IRS Form 990T. Question 78a and 78b of Part VI of the Form 990 ask for information concerning any taxable activities that may have been conducted by the nonprofit organization during the reporting year. The form 990T is the tax return filed with the IRS by charitable organizations operating a for-profit business not directly related to its charitable mission and which produce annual gross income of $1,000 or more. This activity is known as unrelated business income or UBI. An example of UBI is an art museum recognized as a 501(c)(3) charitable entity that also owns and operates a coffee shop. While the display of art and other educational activities of the museum are directly related to the charitable mission, the sale of coffee and sandwiches to the public is not and may be subject to federal taxation. The form 990T has now been classified as a public document (see the federal Pension Protection Act of 2006 §1225) and may help determine what percentage of the real estate owned by the charity was used to generate taxable income.
IRS Form 1023. The form 1023 is the Application for Recognition of Exemption under section 501(c)(3) of the Internal Revenue Code. This document explains why an entity believes it is entitled to the federal tax exemption under section 501(c)(3) and provides detailed information on the mission and public purpose of the organization. Please note, however, prior to July 15, 1987 organizations were not required to provide a copy of the form 1023 to the public and organizations in existence prior to that date may not have retained a copy of their form 1023.
Other Sources of Information
All healthcare charitable trusts as defined by RSA 7:32-d are required to file an additional report with the Attorney General known as the Community Benefits Report (CBR). The purpose of the report is stated in RSA 7:32-c: “to ensure that health care charitable trusts provide the communities they serve with benefits in keeping with the charitable purposes for which the trusts were established and in recognition of the advantages the trusts enjoy." CBRs are public documents and explain in detail the public benefits provided by a healthcare charitable trust to the community, service area, or specific patient population it served during the year. Please note, however, preparing a CBR does not guarantee real estate tax exemption: RSA 7:32-k states “Compliance with this subdivision shall not establish eligibility for a property tax exemption under RSA 72:23, V, but may be considered if relevant to the criteria established in and at common law."
While this article provides an overview of the form and substance of charitable organizations, additional questions may arise and towns and cities are encouraged to seek specific information for their situations. In the words of the New Hampshire Local Government Center it is important for municipal officials to “know the territory" in order to make the best possible decisions for their communities and the citizens they serve.
Terry Knowles is the Assistant Director of Charitable Trusts in the Office of the Attorney General. Robert Boley is the Property Tax Advisor for the Property Appraisal Division of the New Hampshire Department of Revenue Administration.