May 2010 Vol. 108 No. 7 THE REVIEW

The Attack on Nonprofit Status: A Charitable Assessment

James R. Hines Jr., Jill R. Horwitz & Austin Nichols

American nonprofit organizations receive favorable tax treatment, including tax exemptions and tax-deductibility of contributions, in return for their devotion to charitable purposes and restrictions not to distribute profits. Recent efforts to extend some or all of these tax benefits to for-profit companies making social investments, including the creation of the new hybrid nonprofit/for-profit company form known as the Low-Profit Limited Liability Company, threaten to undermine the vitality of the nonprofit sector and the integrity of the tax system.

Reform advocates maintain that the ability to compensate executives based on performance and to distribute profits when attractive investment opportunities are scarce makes for-profit entities more efficient than nonprofit counterparts. Offering more favorable tax treatment to for-profits engaging in charity would encourage greater charitable entrepreneurship, the argument goes, and provide worthwhile competition for the nonprofit sector. As matters stand, however, nonprofits can and occasionally do reward executives with performance-based compensation, and their nondistribution rules impose no obligation to make subpar investments. The existing nonprofit sector is extremely competitive, and the charitable activities of for-profits already receive favorable tax treatment. Going further and offering socially active for-profits the tax benefits equivalent to those available currently to nonprofits would create opportunities for tax arbitrage by providing tax deductions to high-bracket donors and taxable income for lightly taxed recipients. The difficulty of policing lines between nonprofit and for-profit activities of the same business entities would entail significant administrative complexity and is unlikely ultimately to succeed. And even should it succeed, the costs of offering new tax benefits to for-profit charities include not only foregone tax revenues, but also spillover effects on the charitable activities of nonprofits.

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