Forgiving Our Debtors May Jeopardize Tax-Exempt Status
What a church should know before forgiving its debtors.

Background. Churches and other organizations that are exempt from federal income taxes must comply with several requirements in order to maintain their exempt status. One of these requirements is that none of the exempt organization's resources "inures" to the benefit of a private individual—other than as reasonable compensation for services rendered or in direct furtherance of the organization's exempt functions. Does an exempt organization's forgiveness of a bad debt constitute prohibited "inurement"? That was the issue presented to a federal court in a recent case. While the case involved a non-religious charity, it has implications for churches and other religious organizations.

Facts. The founder of a tax-exempt charity also created a for-profit corporation. The for-profit corporation leased property from the charity, but did not pay rent in a timely manner and eventually accumulated hundreds of thousands of dollars in rental debt. The charity also "forgave" nearly $34,000 in interest owed by the for-profit corporation. The charity claimed that the interest was "forgiven" "because of the unlikelihood of repayment." The IRS audited the charity and revoked its tax-exempt status. It concluded that the charity's forgiveness of interest and failure to collect back rent from the for-profit corporation controlled by the charity's founder amounted to prohibited "inurement" of the charity's resources to the benefit of the founder. The charity appealed this ruling.

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Posted: August 1, 1995
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