Operating a 501(c)(3) Charity Requires the Right Type of Purpose

To qualify as exempt under section 501(c)(3), an organization needs to be organized and operated for qualifying purposes. These purposes can be charitable, educational, scientific, religious, and more—and a wide range of organizations fit under this section.

One question that comes up often at our firm, though, is whether an organization can qualify under 501(c)(3) purely on the basis of donating business profits to charity. The answer—which is routinely disappointing to the asker—is no. The U.S. Court of Appeals recently upheld a Tax Court ruling on this point, in Zagfly, Inc. v. Commissioner. This case held that a business operating an online flower store, which sold flowers at market price and then donated profits to charitable organizations, wasn’t eligible to be exempt itself under 501(c)(3).

While it may seem counterintuitive at first, this reasoning does make sense. Allowing a flower shop to be exempt from taxation purely because it donates some or all profits to charities would allow that shop to compete unfairly with other flower shops. And operating a flower shop in itself is not accomplishing a charitable or exempt purpose—as opposed to operating an animal shelter, a school or an emergency assistance organization, to name a few.

To be sure, there are plenty of examples in the marketplace of businesses donating profits to charity. One well-known one is Newman’s Own, maker of salad dressings and other food products, which donates all of its after-tax profits to the Newman’s Own Foundation. But it’s important to remember that while this business model can be a great way of directing money to charitable causes, it does not qualify itself as a charitable activity.

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