Several commentators have called attention to the statement of the IRS in Revenue Procedure 2018-5, just reiterated in Rev. Proc. 2019-1, that it will not issue a determination letter recognizing exemption from income tax for “an organization whose purpose is directed to the improvement of business conditions of one or more lines of business relating to an activity involving controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law regardless of its legality under the law of the state in which such activity is conducted.”
These commentators suggest that this position could constitute impermissible viewpoint discrimination in violation of the First Amendment. I do not view the IRS announcement in this way. Instead, I see it as an application of the long-standing principle denying exemption to entities with an illegal purpose or engage primarily in illegal activities.
The illegality doctrine has long prevented exemption under section 501(c)(3), the category that encompasses what we generally call charities. In the words of Section 101(c) of the ALI Draft Restatement of the Law of Charitable Nonprofit Organizations, “[a] purpose is not charitable if it is not lawful, its performance requires the commission of criminal or tortious activity, or it is otherwise contrary to fundamental public policy.”
Bob Jones University v. United States, 461 U.S. 574 (1983), acknowledged that the law of charitable trusts undergirds the law of tax exemption. Justice Rehnquist dissented from Justice Burger’s opinion for the Court that a school discriminating on the basis on race could not qualify for exemption under section 501(c)(3) because it violated fundamental public policy. Nonetheless, both Justice Burger and Justice Rehnquist, borrowing from Judge Leventhal in Green v. Connally, 330 F.Supp.1150, 1160 (DC), summarily aff’d sub nom. Coit v. Green, 404 U.S. 997 (1971), agreed that Fagin’s School for Pickpockets would not be entitled to exemption under section 501(c)(3). That is, although Justice Rehnquist rejected a broad public policy doctrine as a basis for denial of exemption, he accepted illegality as a basis for denial.
I see an analogy here. Like a school for pickpockets, an organization dedicated to improving business conditions for marijuana sales would support enterprises engaged in illegal activity.
Revenue Ruling 75-384 offers important guidance regarding illegality and exemption. It involved an organization formed to educate the public on the principles of pacifism and nonviolent action, including civil disobedience. The ruling explains that no section 501(c)(3) organization can have an illegal purpose. The ruling’s analysis, however, emphasized the group’s primary activity of undertaking protest demonstrations and nonviolent actions, including deliberately blocking traffic, disrupting the work of government and preventing the movement of supplies, all breaches of the peace in violation of local ordinances. The ruling concluded that the organization’s activities “demonstrate an illegal purpose which is inconsistent with charitable ends.” The Tax Court in Church of Scientology of California v. California, 83 T.C. 381 (1984), similarly concluded that pervasive illegal activities, including a number of felony convictions, constituted an illegal purpose and that the organization did not qualify for exemption under the illegality doctrine. Applying the illegality doctrine, a 2016 private letter ruling denied exemption under section 501(c)(3) to an unincorporated association with a mission to “collectively and cooperatively cultivate and distribute medical marijuana for medical purposes to qualified patients and primary caregivers.”
The illegality doctrine prevents exemption under other subsections of section 501(c) as well as Professor Philip Hackney has explained. As he describes, a 2013 IRS private letter ruling addressed exempt status as a “crop-financing organizations” under section 501(c)(16) for members involved in marijuana cultivation or use for medical purposes, The IRS denied exemption. It reasoned that ‘[t]he general principle that tax deductions and exemptions are not applicable to activities that are illegal is well established, and the courts and the IRS have consistently applied this general principle to organizations seeking exemption.” Similarly, organizations intending to improve business conditions for marijuana dealers could not qualify as a business league under section 501(c)(6) or a social welfare organization under section 501(c)(4).
Section 501(c)(4) organizations, however, have freedom to lobby without limit to change the law. See Revenue Ruling 71-530. I do not see the statement in Revenue Procedure 2018-5 as in any way suggesting that an organization formed to change the federal law treating marijuana as a controlled substance would be denied exemption under section 501(c)(4). That is, the statement in Revenue Procedures 2018-5 and 2019-1 rests on the illegality of marijuana under federal law. While legalizing marijuana would indirectly improve business conditions for marijuana dealers, it would do so only after use of the drug had become legal. Lobbying for legality is distinct from engaging in or supporting illegal activities.
The Surly Subgroup 