I often make the comment about practicing non-profit law that it is hard to give advice and get people to listen to it when it feels like the regulators are not minding the store. I even wrote a blog about it for my prior firm in the context of exemption applications.

Every once in a while though, the IRS breaks its silence, says ‘no’ to a non-profit, and people like me try to gather the scraps and learn something from it.

To that end, I thought it might be useful or entertaining to start a series on IRS Denial Rulings. They are somewhat rare and so redacted that it is hard to make any sense of them, but they are all that the tax gods are willing to offer us. So, we must make of them what we can and draw overbroad conclusions.

Let’s get started with PLR 202127040 (aka the Case of the Anime Convention That Was Apparently Too Fun).

The Facts (As Far as We Can Tell)

A couple disclaimers about private letter rulings.

• First, they are only binding on the IRS as to the taxpayer who receives it. Other taxpayers/charities can read them and try to learn what the IRS might think if they did the same thing, but that’s all you get out of it: an educated guess at what they might tell you if you did.

• Second, they include sentences like: “you are an X corporation, doing programs for individuals in Y area, charging $Z”. You can try to draw lessons from them, but sometimes a lot turns on the values of Y and Z.

Fortunately, PLR 202127040 is actually relatively readable and clear. X is exempt as a 501(c)(4) social welfare organization and wants to reclassify as a 501(c)(3) charity. X’s primary activity is putting on an anime convention. And the convention sounds mostly like what you’d expect: tickets/badges for entry, presentations on pop culture and the underlying customs, traditions, and media methods and techniques of “V” (I’m going to use context clues and guess V is Japan here), workshops, panels, vendors, and a bunch of interactive events (e.g., “boffer, foam weapon fights”, video games).

Reinforcing the educational/charitable components, the ruling also mentions that X’s ”intention is to include more cultural understanding, discussion, as well as inclusion of not only W-based guests and discussion but also LGBTQ. You have also referenced topics involving mental health and even had professionals on hand for convention participants at past events.”

My Reaction (no precedential value whatsoever):

At this point, I’ll just say that if a client came to me with this fact pattern and asked if we were a charitable organization, I would have said…. “Maybe?”.

After the client rolled their eyes, I would have explained that it depends whether the IRS would be convinced that the “good” facts outweigh the “bad”. An organization with charitable and educational purposes as their dominant activity can tolerate some non-charitable activity (e.g., the occasional foam weapon fight), but that non-charitable activity cannot be a substantial purpose.

It definitely sounds like there could be some educational activities here in terms of the panels and workshops, at least if they are predominately about informing instead of promoting particular products. And the fact that people charge tickets to attend is not a problem in and of itself (my student loan balance informs me that 501(c)(3)’s are absolutely allowed to charge for educational programming). Perhaps some might object that educating about anime to people who can afford tickets to a convention is not as socially valuable as “classic” charitable activities, but….that is not how this whole tax-exempt sector works. Educating the general public about a topic useful to the general public (and let’s just say that there are very few topics off limits here — 1st amendment and all that…) is a 501(c)(3) activity, regardless of who it serves. So an anime convention absolutely can be done by a 501(c)(3) — and there are a number of pop culture conventions that exist in 501(c)(3) form. So, my initial reaction is that we would have an argument here and would be focused on framing the application around our good facts.

The problem (and spoiler alert: the IRS’ conclusion) is that the educational activities do not exactly ‘pop out’ in comparison to the non-exempt activities, i.e. the fun parts of the events or the parts of the events that are about promoting companies. People getting together to talk about anime and have a fun time could be tax-exempt as a 501(c)(7) activity (i.e., a social club), but if that is the primary purpose, it should not obtain exemption as a 501(c)(3). Likewise, anime publishers and video game companies organizing an event to promote their products and uplift the anime industry could be tax-exempt as a 501(c)(6) activity (i.e., a trade association), but having a primary purpose of advancing the interests of industry participants is disqualifying for a 501(c)(3). We do not have a lot of detail of the facts here, but it is fair to assume from what is there that are definitely some events that are primarily about fun and probably some events with an industry-promotion feel.

If this is going to work, then the applicant is going to need to convince the IRS that, taking everything into account, the primary purpose is educating the public about anime and related matters.

The IRS Answer (also no precedential value whatsoever):

Apparently, after reviewing a lot more information than we are able to glean from the ruling, including detailed financial records and projections, the IRS was left unconvinced that the educational purposes were dominant.

The IRS did not provide much explanation, but compared the anime convention to trade association events or recreational events and concluded that the organization was more like those (non-qualifying) organizations than one doing proper educational activity. In their words, “You do not exclusively provide education and instruction to the public as defined in Treas. Reg. Sections 1.501(c)(3)-1(d)(2) and (d)(3)(i). Instead, your annual anime convention offers a variety of entertainment and recreational events for the community. While some of your activities are educational in nature, these are not exclusive. The majority of your activities still serve social and recreational purposes. Therefore, you fail to meet the operational test as described in Treas. Reg. Section 1.501(c)(3)-1(c)(1).”

The IRS compared X’s convention to a non-c3 putting on a festival and said, “Like this organization, the activities at your convention are recreational where the participants play video games, arcade events, foam weapon fights, cosplay and dance.” I cannot help but wonder whether the IRS just thought this convention sounded too fun and that it therefore must not be educational. And maybe that’s the right answer for this organization — we do not have nearly enough facts to know if the IRS is right that the fun events were the dominant part of the convention. But, I am told that people used to have plenty fun at college and at educational conferences in pre-pandemic times (and in some states, throughout the pandemic), and those organizations seem to collect a lot of charitable contributions. “Fun” is not a barrier to c3 status, but being primarily about having fun is.

Interestingly, the IRS also says “Further, your event, while open to the public, requires payment for entry and participation rather than providing education for the general public.” I think this statement is misleading in that it suggests charging for admission is inconsistent with being educational — it is absolutely permissible to charge for admission to a charitable or educational activity. A better way to think about it is that, while charging for admission is not a barrier to 501(c)(3) status, it can still be used against you if the IRS is otherwise dissatisfied. Or that NOT charging for admission (or charging a subsidized amount) can be a useful way to distinguish yourself from a commercial or non-charitable actor. Charging fees should not determine on its own whether an activity is charitable (and I don’t think it did here), but it is clearly a fact that the IRS weighs when making these decisions.

Lessons:

Some stray thoughts on what you might take away from this:

• This is all VERY subjective. Among the many reasons that people dislike lawyers is the frequency with which they are unwilling to give a clear “yes” or “no” answer. I empathize, but unfortunately that is the state of the law in many places, and particularly when it comes to non-profits. My answer was “maybe” above because the answer really is maybe. One reviewer might look at the same convention and see the educational activities as dominant, while another reviewer might see it all as a big party that does not deserve tax-exempt status. The best non-profit lawyers can do sometimes is build up the good facts and minimize the bad facts (both in reality and in the advocacy to the IRS) to increase an organization’s chances and see where the chips fall. They did not fall in the organization’s favor this time around, but there are very many cases where they do. Organizations similar to this anime convention that want to be a charitable organization should put a lot of time and effort into planning their activities and how they are explained in the application. It could make the difference.

• 501(c)(3) is typically the most advantageous tax-exempt status, but the standards are often the highest. This applicant was already tax-exempt as a 501(c)(4) social welfare organization, so it was presumably not paying taxes on its net income from these events (at least the income that was sufficiently related to the purposes). It wanted the additional benefit afforded to 501(c)(3)’s of being able to offer charitable contribution deductions to its donors. To do that, it had to show that its activities not only advanced social welfare, they did so in a way that the primary purpose was one of those listed in 501(c)(3) (i.e. charitable, educational, scientific, etc.). According to the IRS, it could not do that. It still gets to continue as a 501(c)(4), however, and not paying tax on it net income (at least the sufficiently related income), so all is not lost.

• On a related point, not every organization should be a 501(c)(3). For some, it will be preferable to be tax-exempt as a 501(c)(4), (6), or (7) and have more flexibility in terms of how they structure their activities, at least if the prospect of deductible contributions is not a strong enough factor to make it worth giving up that flexibility. This may often be the case for organizations that rely predominately on ‘exempt function income’, like a convention that sells plenty of tickets. I have seen organizations conclude that the changes they would need to make qualify as a 501(c)(3) are just not worth it. Of course, every organization has its own math to do and, if there are interested individual donors or foundations, a 501(c)(3) classification might start to sound more appealing. (A topic for another day: a fiscal sponsor as an alternative to making the whole organization a 501(c)(3)).