Economic development may not immediately come to mind as an activity that furthers a charitable purpose, but it doesn’t take long to think of circumstances where helping a depressed community in its economic development can help in the relief of poverty and distress, and in the combat of community deterioration, all of which are regarded as charitable purposes. Accordingly, it is possible for a 501(c)(3) organization to provide funds and other resources to for-profit businesses to advance the purposes of economic development consistent with its charitable purpose. However, such support is limited by the 501(c)(3) restrictions against private inurement, prohibited private benefit, substantial lobbying, and political campaign intervention. For private foundations, additional rules and restrictions apply with respect to self-dealing, excess business holdings, jeopardizing investments, and taxable expenditures.
Economic Development Corporations and Incubators
Public charities that focus on charitable economic development are sometimes referred to as economic development organizations or incubators. According to a 1990 EO CPE Text (Economic Development Corporations: Charity Through the Back Door) published by the IRS:
Economic development corporations generally are established to assist existing and new businesses located in a particular geographic area through a variety of activities including grants, loans, provision of information and expertise, or creation of industrial parks. Incubators are a type of economic development corporation generally formed to provide assistance to induce new businesses to locate in communities whose economies are depressed or deteriorating, or to provide assistance to existing, emerging businesses so that they may remain in such communities. Incubators provide low-interest loans, facilities and equipment to new and emerging businesses as well as clerical and technical services in an effort to encourage such businesses to locate in the depressed areas. The services provided to the new businesses are offered by the incubator at reduced rates or even free of charge. Incubators may be set-up and/or sponsored by local and state governments, they may be affiliated with universities, or they may be an offshoot of an existing tax-exempt organization. In many cases, incubator organizations operate a “technology center” where businesses can be assisted (nurtured) through provision of business expertise, lower rental rates or pooled or shared services.
Serving a Public Interest
In addition to having a stated charitable purpose and consistent activities, a 501(c)(3) economic development organization or incubator must serve a public rather than an private interest. Any private benefit conferred upon an individual or for-profit business that is more than incidental, quantitatively and qualitatively, to the furthering of its exempt purposes is prohibited. Grants of funds or other resources to for-profit businesses must be justified as incidental to advancing the 501(c)(3) organization’s charitable purposes, which may include relief of the poor and distressed and combat of community deterioration.
The 1990 EO CPE Text stated that the following factors “are necessary” for an agent to conclude that an economic development corporation is primarily accomplishing charitable purposes despite the element of private benefit present.
Assistance is targeted (1) to aid an economically depressed or blighted area; (2) to benefit a disadvantaged group, such as minorities, the unemployed or underemployed; and (3) to aid businesses that have actually experienced difficulty in obtaining conventional financing (a) because of the deteriorated nature of the area in which they were or would be located or (b) because of their minority composition, or to aid businesses that would locate or remain in the economically depressed or blighted area and provide jobs and training to the unemployed or underemployed from such area only if the economic development corporation’s assistance was available.
It’s been more than 25 years since the above guidance was released, and additional guidance, including a more definitive test and/or examples of acceptable charitable activities that reflect the current needs and economic climate in many communities, has recently been requested by the Council of Michigan Foundations (CMF):
CMF urges Treasury to consider updating previous guidance regarding economic development as a charitable activity by providing a more definitive test and/or examples of acceptable charitable activities that reflect the current needs and economic climate in many communities. Here are two examples encountered by CMF foundation members that illustrate the requests for foundation support.
• The Chamber of Commerce is sponsoring an initiative to encourage small businesses to locate in a deteriorating section of downtown and ask the local community foundation about collecting charitable contributions from individuals and businesses. The community foundation will then make grants to assist individuals with expenses associated with establishing new small businesses provided they agree to locate in this particular area.
• A rural municipality in the Upper Peninsula desires to expand internet services to its citizens and wants to collect charitable donations to build infrastructure through a fund at the local community foundation.
Lessening the Burdens of Government
It’s possible for an economic development organization to be exempt under 501(c)(3) based on the charitable purpose of lessening the burdens of government. This involves a two part test:
- There is an objective manifestation by a governmental unit that it considers the activities of the organization to be its burden; and
- The organization’s activities actually lessen such burden of the government.
The 1990 EO CPE Text lists 7 factors that favor a lessening of governmental burdens rationale for an economic development corporation (but also states that extreme caution should be exercised before employing a lessening the burdens rationale ):
(1) There is a state statute specifically authorizing government funding of an economic development corporation to operate by assisting fledgling businesses within the state as a means to help alleviate severe unemployment.
(2) The economic development corporation was established to specifically qualify under the statute and was funded under the statute.
(3) The state statute provides that the funding is more than a mere grant but provides the state with approval authority over projects to be financed by the corporation and approval must be obtained from the state on an ongoing basis.
(4) As part of its assistance, the economic development corporation operates in conjunction with a state university. (5) The specific cities which will be the corporation’s primary beneficiaries provide officials who sit on the corporation’s board of directors in their official capacity.
(6) The commissioner of the state’s Department of Economic Development utilizes the corporation as an extension to carry out services formally conducted by the Department. The Department was unable to continue such services because of budgetary constraints and is not otherwise prohibited from providing such services.
(7) The corporation is required to provide annual reports of its activities and finances to the state government.
Obtaining 501(c)(3) Status for Economic Development Organizations (Community Economic Development Law Project)
Economic Development Organizations, Trickle Down Charity and the Private Benefit Doctrine (American Bar Association)