Tax Insider

Charities Must Operate Exclusively for Charitable Purposes

Upholding the IRS’s denial of a tax exemption, the Tax Court found the organization at issue, created to provide gaming activities in a “sober” environment, was not operated exclusively for charitable purposes.
By Stephen D. Kirkland, CPA/CFF

The U.S. Tax Court recently issued an opinion focusing on the requirements for an organization to qualify for a tax exemption under Sec. 501(c)(3), emphasizing that an organization must strictly comply with those requirements.

In GameHearts, T.C. Memo. 2015-218, the Tax Court held in a declaratory judgment proceeding that the IRS was justified in denying the nonprofit organization GameHearts a tax exemption. The organization claimed in its bylaws that it would promote “adult sobriety and the general welfare of the citizens of the State of Montana.”

In its Form 1023, Application for Recognition of Exemption Under Section 501(c)(3), GameHearts said it was committed to “providing alternative forms of entertainment” including “free and low cost tabletop gaming activities in a supervised non-alcoholic, sober environment …” GameHearts also stated that it was working toward the betterment of the region by attracting participants to its activities “during evening hours, as opposed to frequenting bars and casinos in the area, as well as to inspire decision making and problem solving abilities by teaching and promoting educational and strategic games and activities ...” On its Form 1023, GameHearts also said it depended on donations from the gaming community and was largely a “mobile tutorial program.”

To encourage adult sobriety, GameHearts offered tutorials on how to play card games and miniature games and offered “organized play.” Many of the games were similar to those offered in nearby for-profit casinos. GameHearts claimed that another purpose for its programs was to teach participants how to develop relationships with retailers and game manufacturers and teach important life skills and work ethics.  

Its stated purpose for providing free services was to appeal to the poor, distressed citizens in the community. However, GameHearts also claimed that it would help “boost the overall market shares of the industry by introducing new and motivated players into the environment.”

The IRS concluded that GameHearts was not organized or operated exclusively for exempt purposes because (1) GameHearts failed to establish that it benefited a charitable class; (2) GameHearts’ nonexempt activities were more substantial than its exempt activities; and (3) GameHearts did not meet the exempt purpose requirements of Regs. Sec. 1.501(c)(3)-1(d) since it did not limit its activities to addicts with low incomes.

The requirements for exempt status

In its opinion, the court included two important reminders. First, the organization bears the burden of proving that it meets the requirements under Sec. 501(c)(3). Second, a statute creating an exemption “must be strictly construed.”

The exemption under Sec. 501(c)(3) is available to the following organizations:

Corporations … organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition …, or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual …

Although an organization must be both organized and operated exclusively for tax-exempt purposes, the court focused primarily on whether GameHearts was operated for charitable purposes.

The court explained that the term “charitable” is used in Sec. 501(c)(3) in its generally accepted legal sense. According to Regs. Sec. 501(c)(3)-1(d)(2), the term includes, but is not limited to:

[r]elief of the poor and distressed or of the underprivileged; … lessening of the burdens of Government; and promotion of social welfare by organizations designed to accomplish any of the above purposes, or (i) to lessen neighborhood tensions; … or (iv) to combat community deterioration and juvenile delinquency.

The Tax Court had previously held that the term “charitable” could include “any benevolent or philanthropic objective not prohibited by law or public policy which tends to advance the well-doing and well-being of man” (Hutchinson Baseball Enters., Inc., 73 T.C. 144, 152 (1979), aff’d, 696 F.2d 757 (10th Cir. 1982) (quoting Peters, 21 T.C. 55, 59 (1953))).

Operating exclusively for charitable purposes

According to Regs. Sec. 501(c)(3)-1(c)(1), an organization will be regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities that accomplish one or more of the exempt purposes specified in Sec. 501(c)(3).

The IRS’s primary issue with GameHearts was that it was not operated exclusively for charitable purposes because of the way it promoted sobriety and the general welfare of the people of Montana. A single, substantial nonexempt purpose will disqualify an organization despite the importance of its exempt purpose. Also, if an organization serves private rather than public interests, it will not qualify.

GameHearts claimed that it was in fact operating for charitable purposes because it provided relief for the poor, distressed, or underprivileged and promoted general welfare by encouraging community-minded sobriety. The IRS argued that more than an insubstantial part of GameHearts’ activities furthered “nonexempt social and recreational interests” because GameHearts offered gaming to anyone who was over 18 years old and sober.

The IRS’s positions were that (1) gaming is recreational, and (2) GameHearts did not limit its services to a charitable class. GameHearts countered, and the court agreed, that the specific type or nature of recreation is not relevant.

GameHearts also argued that it served a charitable class because its programs did not compete with the for-profit gaming industry.

The court focused on how an organization that offers a recreational activity to achieve a charitable purpose can qualify as a charitable organization. A single activity can have more than one purpose. The purpose of the activity, not the nature of it, is determinative. Therefore, the Court focused on whether GameHearts’ primary purpose for engaging in its sole activity (gaming) was an exempt purpose or whether there was another substantial nonexempt purpose (recreation).

Prior case law

In its analysis, the court considered earlier cases on this point.

B.S.W. Group, Inc., 70 T.C. 352 (1978), involved an organization that provided consulting services to not-for-profit, limited-resource organizations that were engaged in various rural-related activities. The court did not find that B.S.W. Group was not exempt because its activities might be a trade or business, but it did conclude that its activities were commercial rather than charitable. The organization failed to show that it did not compete with commercial consulting businesses. Also, B.S.W. Group charged fees for its services, which produced a net profit, and also did not get any public support besides the fees. B.S.W. Group also failed to limit its clientele to other organizations that were exempt under Sec. 501(c)(3). As a result, B.S.W. Group did not qualify for exemption because the primary purpose for its sole activity (consulting) was commercial rather than educational, scientific, or charitable.

In Schoger Foundation, 76 T.C. 380 (1981), a religious retreat facility in Colorado was not operated primarily for an exempt religious purpose. Although wholesome family recreation and contemplating nature might provide a religious or uplifting experience, Schoger Foundation failed to show how its religious retreat experience differed from experiences available at any other quiet inn or lodge in Colorado.

Hutchinson Baseball Enters., Inc., 73 T.C. 144 (1979), involved an organization that primarily promoted baseball in the surrounding community by maintaining a baseball field for the public, providing coaches and instruction for children, and sponsoring a baseball camp. As a result, the organization was operating for an exempt purpose.

However, in Wayne Baseball, Inc., T.C. Memo. 1999-304, the organization’s nonexempt social and recreational activities were substantial in comparison to the organization’s promotion of baseball in the community. The sole activity sponsored by the organization was the operation of an adult amateur baseball team, and the primary beneficiaries were the individual team participants. Allowing spectators to watch the baseball games without charge was incidental to the purpose of providing enjoyment, recreation, and social interaction for the team participants.

In Peters, 21 T.C. 55 (1953), a foundation qualified for exempt status since it was organized to promote social welfare by furnishing public swimming facilities to all residents of a school district, especially those who did not have access to private facilities.

In Columbia Park & Recreation Ass’n, 88 T.C. 1 (1987), aff’d, 838 F.2d 465 (4th Cir. 1988), the association, which was organized to provide recreational facilities for residents of a planned community, did not qualify for exemption because it benefited only residents of the planned community, limited access to them, and obtained funding only from those residents rather than by voluntary contributions from the public. The key difference between Peters and Columbia Park & Recreation was not whether the activities themselves were charitable, but whether the organizations were organized for charitable purposes.


The GameHearts court recognized that recreational therapy could be a way to achieve a charitable purpose. Nonetheless, GameHearts did not show that it was “operated exclusively” for one or more exempt purposes. The organization was denied tax-exempt status because there was a single, substantial nonexempt purpose, despite the importance of the exempt purpose. Although promoting sober recreation may benefit the community, the form of recreation GameHearts offered was also offered by for-profit entities. Even though GameHearts did not profit from the recreation that it offered and it could not offer recreational gaming that competed with for-profit casinos, tax-exempt status was denied. Recreation was found to be a significant purpose, in addition to the therapy provided, because of the inherently commercial nature of the recreation and the ties to the for-profit gaming industry.

As a final note, the court mentioned that the IRS had encouraged GameHearts to apply for exemption as a social welfare organization under Sec. 501(c)(4) instead of trying to qualify as a charity under Sec. 501(c)(3), but GameHearts had declined.

Stephen D. Kirkland, CPA/CFF, serves as an expert witness in U.S. Tax Court cases involving (un)reasonable compensation issues. He is an active member of the AICPA Forensic and Valuation Services Section.

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