A Brief History: Part II
What is the proper mode of administering wealth after the laws upon which civilization is founded have thrown it into the hands of the few?
As introduced last time, the Industrial Revolution created crises of poverty, housing, and deadly working conditions. It also gave a handful of enterprising individuals access to more personal wealth than the world had ever seen. Among them was Andrew Carnegie, who publicly posed the above question: if society enables one person to amass more money than they could possibly spend in a lifetime, what should that person do with it? His answer: put it back into the community.
Congress first officially recognized the public role of nonprofits in 1894. The Wilson–Gorman Tariff Act of 1894included language exempting charitable organizations from Federal income tax—listing them immediately after states, counties, and municipalities. This placement implicitly confirmed that Congress viewed charitable organizations as performing services akin to those of government. Just as governments would not pay taxes, neither would associations carrying out government-like functions.
The idea of tax exemption for public-serving organizations was codified again in the Revenue Act of 1909 (after the Wilson–Gorman Act was struck down on other grounds). That law also introduced the no-private-inurement rule, which prohibits nonprofit funds from creating personal profit. That language was carried into the Revenue Act of 1913, from which the modern tax code is a direct descendant. In 1917, Congress added another key provision: contributions to nonprofits became tax-deductible to encourage private giving in light of increased taxes to fund World War I. Again, Congress implicitly recognized the public value of nonprofits, effectively declaring that directing money to government-like entities was nearly as beneficial to society as paying taxes to fund government services.
After several decades of experience regulating nonprofits, Congress added two more major provisions. Concerned that tax exempt organizations might gain an unfair competitive advantage over for-profit businesses, the Revenue Act of 1950 established the Unrelated Business Income Tax, which imposed tax on income from activities unrelated to the organization’s exempt purpose, even if the proceeds supported its mission. Then, worried about the lack of public accountability for foundations controlled by small groups of wealthy individuals, the Tax Reform Act of 1969 created a formal definition of “private foundation”, imposed strict requirements (such as an annual excise tax on investment income and minimum distributions for charitable purposes), and prohibited certain activities contrary to the public interest. Still, Congress affirmed the value of private foundations by raising the ceiling for individual donor deductions from 30% to 50%.
Meanwhile, nonprofits’ role in society continued to evolve. The dual crises of the Great Depression and World War II, along with the New Deal’s governmental reorganization, transformed nonprofits from mere charitable actors into partners of government. Exempt organizations distributed food, medical and psychological care, and international aid in response to global crises. By the 1960s, the Federal government was contracting with nonprofits to deliver services directly. Nonprofits also expanded their missions, joining movements for social justice and civil rights (for example, the NAACP and Amnesty International). Their methods diversified as well, encompassing lobbying, public education, and grassroots mobilization. In the weeks ahead, we will dive deep into the rules governing these and other activities.
This legislative and political history reveals three core principles of U.S. nonprofit law—
because they serve the public good, organizations operating for charitable purposes are exempt from Federal income tax;
because they pursue missions above self-interest, their income cannot benefit any insider (the rule against private inurement); and
because society benefits from charitable work, contributions to these organizations are tax-deductible to encourage giving.
Carnegie’s answer to his own question set the moral and legal framework for these principles:
The best means of benefiting the community is to place within its reach the ladders upon which the aspiring can rise—parks and means of recreation, by which men are helped in body and mind; works of art, certain to give pleasure and improve the public taste; and public institutions of various kinds, which will improve the general condition of the people—thus returning their surplus wealth to the mass of their fellows in the forms best calculated to do them lasting good.
Thus, we can take away from this brief history of nonprofit law that citizens not only have the right and duty to associate to solve problems large and small, but capitalism’s winners have a duty to fund those endeavors—and Congress passed laws to encourage it all.
This article is for general informational purposes only and does not constitute legal advice. Reading this article does not create an attorney-client relationship. For advice specific to your organization's situation, contact Commonlight Legal LLP.