What Is a Charity?

Key lawmakers ask fundamental questions about the types of organizations that deserve tax exemptions

One of the most powerful lawmakers on Capitol Hill last week opened a wide-ranging inquiry into nonprofit organizations, raising fundamental questions about what constitutes a charity and why some groups should receive tax-exempt status — and promising to examine problems he sees in the nonprofit world.

“Despite the significant size, scope, and economic impact of tax-exempt organizations, there has been no comprehensive oversight by Congress in nearly two decades,” said Rep. William M. Thomas, the California Republican who chairs the Ways and Means Committee.

The House action comes after the Senate Finance Committee has spent more than a year reviewing nonprofit groups, and increases the likelihood that Congress will debate new legislation to alter how charities, foundations, and donors operate.

The Senate committee has been focusing on whether nonprofit groups and donors have been abusing tax laws, and its staff members have floated more than 200 specific proposals to overhaul charity operations.

Senators have raised questions such as whether donors exaggerate the amount they write off on their tax returns for noncash gifts and whether some nonprofit groups are participating in tax shelters, and suggested that charities need to do a better job of proving that they are accomplishing social goals.

The contrast between the big-picture questions being asked by the House and the more specific ideas under consideration in the Senate has left charity officials and observers confused about what bill might ultimately result: a sweeping overhaul of the laws regarding nonprofit groups, a measure that aims only to prevent abuses of tax laws, much narrower legislation aimed at specific types of charities such as hospitals, or something altogether different.

In addition, some observers wonder whether the different approaches could be a sign that the House and Senate are unlikely to agree anytime soon on what legislation, if any, is needed.

Whatever the outcome, Paul C. Light, a professor of public service at New York University and a senior fellow at the Brookings Institution, a Washington think tank, said one message is clear: Lawmakers do not plan to give up their focus on charities.

“Congress is going to continue investigating,” he said. “Anyone who thinks it’s going to go away is just whistling past the graveyard.”

Nonprofit Hospitals

Over the past several years, Mr. Thomas has frequently questioned why nonprofit hospitals should enjoy a special tax status when, in his view, they provide services that are virtually identical to those at for-profit hospitals.

And last week he made clear that the hospitals continue to be a large focus of his attention, and a big part of his motivation for asking questions about whether too many organizations have tax exemptions. The situation with hospitals, he said, “raises a fundamental question of what makes these organizations unique and hence deserving of a tax-exempt status.”

But legal scholars at the hearing urged Mr. Thomas to look closely at other organizations as they define what types of groups deserve tax subsidies.

“Financially, it’s pretty clear that hospitals and health-care providers are the 1,000-pound gorilla,” said John Colombo, a professor at the University of Illinois College of Law. But, he added, it would be difficult to single out hospitals without also regulating other charitable groups.

“One of the core problems with tax exemptions for charities has been that exemptions more or less just happened without a great deal of thought regarding why we hand out tax exemptions,” he told lawmakers. “As a result, while we have this vague notion that we grant exemptions to charities because they do good things for society, there has never been a specifically articulated rationale that allows us to tie down exactly what good behavior should be rewarded.”

Mr. Colombo proposed a system in which only organizations that are “substantially dependent on donations for their operating revenues” would be granted tax exemptions.

“Donations are the signal that people believe an organization is doing something worthwhile, and is not otherwise being sufficiently funded by the private market or the government,” he said. “In contrast, organizations that do not get significant donations either aren’t doing anything the public thinks is worthwhile, or the public sees that they have ample resources without donations. In either case, such organizations do not need tax exemptions.”

A different approach was put forward by Frances R. Hill, a professor at the University of Miami School of Law. To qualify for tax exemptions, she said, organizations should be required to demonstrate that they are “providing a public benefit to a defined category of beneficiaries.”

A fundamental problem with current law and its enforcement by government regulators is that the focus has been more on ensuring that no individuals receive undue financial gains from a nonprofit organization’s operations. While that concern is justifiable, Ms. Hill said, “the mere absence of a private benefit does not provide a rationale for exemption.”

Bruce Hopkins, a lawyer in Kansas City, Mo., and the author of numerous legal guides for nonprofit organizations, said that the current language of the tax code stating that groups organized for charitable, educational, or scientific purposes qualify for tax exemptions needs to be better defined.

“Many aspects of today’s law of tax-exempt organizations are unclear,” he said. “As the sector has grown, this situation has fostered or facilitated misunderstandings and abuses by certain tax-exempt organizations and tax-law planners.”

He urged the panel to close gaps in the law by making it clearer when nonprofit groups are acting too much like businesses or getting too heavily involved in political activities. For example, he said, Congress should explain when it is acceptable for a charity to operate for-profit subsidiaries or to run a joint venture with a business.

Now, he said, the Internal Revenue Service and the courts are essentially drafting their own definitions of what types of business activities are acceptable. As an example, he said the IRS recently ruled that a tax-exempt group that has a Web site could be acting too much like a business, while courts have questioned whether some advertising by charities is too commercial.

He also said the federal government needs to enact a law governing fund raising by nonprofit groups. Now, fund raising is regulated by the states, but that has led to a patchwork of laws that overlap and conflict — a big challenge in an era where technology has made it easy for even the smallest group to operate nationally or internationally.

Potential Harm

While lawmakers in both the House and Senate have been asking hard questions about nonprofit groups over the past year, some members of Congress worry that new legislation could harm charities and foundations.

As the hearing in the House opened last week, Rep. Charles Rangel, the senior Democrat on the Ways and Means Committee, said: “At a time when there are severe cutbacks in federal programs, and more and more people rely on charitable organizations, I would hope that the testimony we hear today will help show how we can more effectively support these organizations that provide services for poor people that the for-profits don’t have as a priority.”

Sheldon S. Cohen, a Washington lawyer and former commissioner of the Internal Revenue Service, said that the kinds of questions lawmakers asked were serious — and demanded strenuous deliberations.

He recommended that to develop legislation clarifying the law on tax-exempt organizations, Congress should appoint a commission made up of experts and legislative staff members to spend a year studying the issues involved.

Mr. Thomas, however, said that was unlikely to happen. “You just outlined a timeline which the VH1 generation can’t focus on,” Mr. Thomas said.