The IRS ruled that a foundation formed to provide tuition and
room and board scholarships to members of a local fraternity
chapter is not entitled to exempt status as a
Section 501(c)(3) educational organization. In the past the IRS has
ruled that a fraternity foundation could award
scholarships solely to undergraduate members of a designated
fraternity or fraternity chapter. The facts surrounding the
administration of the scholarship program at issue provide
important guidance as to what activities are exempt, and what
activities are not.
In this case, the IRS took issue with the method by which
scholarship recipients were selected and the potential number of
recipients in relation to the number of applicants. The criteria
for awarding scholarships were financial need, academic excellence,
or both. Scholarship recipients were chosen based on a ranking
system whereby the applicants were ranked based on grade point
average and financial need. The foundation then began at the top of
the list and granted scholarships as far down the list as its
resources allowed. The foundation estimated that between 10 and 14
of the chapter's 31 members received scholarships in a typical
year. The IRS noted however, that in some years, all of the chapter
members could potentially win scholarships if the foundation's
fundraising efforts were particularly successful.
The IRS also took issue with the relationship between the
foundation and the local house corporation owning the chapter
house. In this case, all of the trustees of the foundation were
members of both the fraternity and the local house corporation. The
foundation planned to solicit funds from members of the house
corporation, which, due to its ownership of the chapter house, had
a vested interest in scholarships for room and board
expenses.
Based upon these circumstances, the IRS determined the foundation
was not exempt. The principal reason for the IRS determination was
that the class of beneficiaries was too restricted to confer the
public benefit required by Code Section 501(c)(3). In other words,
the foundation's benefits were overly directed toward a
narrowly designated group.
Moreover, there was an unacceptably high level of pre-selection of
scholarship recipients such that members of the house corporation
donating to the foundation would know, in advance, that their
donations would assist only those applicants from a small
pre-identified pool.
Finally, the fact that some or all of the room and board portion of
the scholarships would be paid to or for the benefit of the house
corporation resulted in a significant private benefit to the house
corporation.
This ruling should not be read as establishing a hard-line rule
precluding exemption for local fraternity foundations that award
scholarships solely to members of the local chapter. The ruling
does, however establish some guidelines.
AVOID:
- the implementation of a ranking system for selection of scholarship recipients;
- a system which results in a possibility of awarding scholarships to all or a high percentage of the chapter members and
- a significant overlap between local house corporation and/or alumni association board members and foundation board members
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.