Per IRS, Revenue from a Cultural Center’s Gift and Coffee Shops Will Not Be Taxed

On March 10, 2017, the IRS released PLR (private letter ruling) 201710005, which dealt with several activities that a tax-exempt organization was involved in related to a cultural center it built and operated. One issue was whether its operation of gift and coffee shops would be unrelated trade or business. The organization is classified as a private operating foundation under code section 501(c)(3).

Normally, the federal tax code requires that tax-exempt organizations be taxed on income derived from trade or business that is both regularly carried on and not substantially related to the organization’s exempt purpose(s). If revenue is deemed to be from unrelated trade, that revenue is typically taxable.

In this case, the foundation ran a gift shop and a coffee shop located within a cultural center that it built and operated. The center was open to the public and admission was free. The coffee shop was accessible through the Center’s atrium, and did not have an exterior door allowing direct access from the parking lot. Coffee shop signs were posted inside the center, including the shop itself, but there were no such signs outside the center to solicit patronage. It is interesting to note, however, that the coffee shop’s hours of operation were longer (earlier and later) than those of the center in which it was housed.

The foundation’s operating plan specified that the foundation would ensure that its directors and officers, as well as members of the center’s staff or affiliates, or any other persons having personal and private interests in the center’s activities, would have no financial interests in or receive anything of value from the shops or any vendors hired to operate them on behalf of the foundation. Furthermore, all purchases and contracts related to the shops would be negotiated at arm’s length. And, the foundation’s legal counsel would review all contracts, including licensing agreements, to ensure that they conform to market standards and do not impose unreasonable restrictions, costs, and conditions upon the foundation.

The IRS ruled that the shops were not unrelated activities, and therefore all revenue from them was not taxable.

Size and Purpose

In determining whether activities contribute importantly to an exempt purpose, Treas. Reg. § 1.513-1(d)(3) provides that one must consider the size and extent of the activities in relation to the nature and extent of the exempt purpose they purport to serve.

In determining whether trade is related to the tax-exempt purpose of the organization, the IRS typically considers whether is furthers the stated purpose.

In this case, the IRS concluded that the shops generated a small portion of the foundation’s revenue and therefore fit the criteria to be considered a supporting trade.

The IRS said that the coffee shop was integral to the mission of the foundation in so far that it functioned to keep employees and visitors on the premises longer than they otherwise might have stayed if they didn’t have access to the food and beverages that the coffee shop sold.

The IRS also found that the gift shop was a trade carried on as part of the overall activities as they relate to the center’s exempt educational purpose. Thus, so long as it was operated as a functional part of the center’s larger aggregate of other activities which were related to the center’s exempt educational purpose, the gift shop was a functionally related business.