Key point. The operation of a coffee shop as a church outreach to the community will not constitute a basis for tax-exempt status if the operation of the coffee shop is overly commercialized to the extent that the religious purpose is minimal.
The IRS ruled that a "coffee shop" founded by the pastor of a church for personal evangelism in an urban area did not qualify for tax-exempt status since it was indistinguishable in operation from secular, for-profit coffee shops.
A nonprofit corporation (the "Corporation") was formed for the following four purposes:
- Proclaim earnestly the gospel message and to urge its personal acceptance.
- Promote prayer, Bible study, missions, Christian fellowship, evangelism, Christian service and encouraging, in every possible way, a lifetime commitment to Christ.
- Provide a forum in which the Gospel of Jesus Christ can be discussed with non-believers outside of a formal church setting.
- Generously extend the grace of God by giving away 100% of all profits (except those retained for capital expenditures) to community ministries, other local, national or international nonprofits or organizations, or those in financial need.
The founder of the Corporation came up with the vision to form a coffee shop where believers could interact with nonbelievers in a safe and friendly environment to convey the gospel in a nonconfrontational manner in word and deed. The founder served as pastor of a local church, but he elected to form the Corporation as a separate entity from his church in order to encourage other Christian churches and organizations to participate in his vision. The founder's church granted funding for the Corporation's start up, and the Corporation's bylaws specified that a majority of its board members had to be members of the church.
The Corporation applied to the IRS for recognition of tax-exempt status as a ministry organized and operated exclusively for religious purposes. Its application for exemption described it purposes and activities as follows:
- Once formed, the Corporation opened a coffee shop and obtained trade name protection for its name.
- It sold coffee locally and planned to eventually sell it online as well.
- The Corporation's coffee shop was open Monday through Friday from 6 a.m. to 8 p.m. and Saturday from 7 a.m. to 8 p.m.
- It had free WiFi and power outlets for customer use. It used coffee that was sourced directly from coffee farmers. The Corporation believed that its coffee benefited coffee farmers 50 percent to 100 percent over the price paid for ""Fair Trade" coffee. Its drink selection included coffee, tea, smoothies, frappes, soft drinks, and juices. Food items included baked goods, soups, sandwiches, salads, and desserts.
- The coffee shop provided a location for both formal and informal Bible study, church group meetings, and meetings for other organizations. The coffee shop was used for a Women's Bible Study, a Men's Bible Ministry, meetings of the church's elders, book signings, birthday parties, baby and bridal showers, community business meetings, game nights, live music, and similar events.
- The Corporation stated that its promotion of the gospel of Jesus Christ was subtle and indirect. Several times a year the gospel was promoted through a program consisting of a donor paying for a certain amount of coffee in advance. Then, when a customer came in they were told by the staff that the coffee had already been paid for and, "that the coffee is not free but that the price has already been paid, just like Jesus already paid the price for all of our sins by dying on the cross for us."
- The Corporation had a "Monthly Mission" in which it partnered with other ministries, missionaries, and nonprofit organizations by highlighting their activities to help raise funds, supplies, and recognition for them. The Corporation selected a "partner" and provided information about the person or organization to customers. It also collected donations for the partner.
- The Corporation gave away meals and drinks to the homeless and helped connect them with local ministries for lodging and jobs.
- The Corporation took part in a training program that helped train underserved youth by placing them in a local business for a six-week internship so they could gain firsthand experience.
- The coffee shop's activities are run by compensated staff as well as volunteers.
- Almost all of the coffee shop's revenue was from the sale of food items. Its largest expense was for salaries and wages. It also had occupancy expenses and expenses for cost of goods sold, advertising, licenses and permits, insurance, supplies, payroll, and repairs and maintenance.
- The coffee shop had not earned profits that would have allowed it to give away any substantial amount of money, but it hoped to be able to do so in the future.
In rejecting the Corporation's application for tax-exempt status, the IRS noted that one of the requirements for exemption enumerated in section 501(c)(3) of the tax code is that the organization seeking exempt status must be "organized and operated exclusively for charitable, religious or educational purposes, no part of the net earnings of which inures to the benefit of any private shareholder or individual." This essential requirement was not met in this case, the IRS concluded:
You are not described in Section 501(c)(3) of the Code … because you fail the operational test. Specifically, the facts show you are not operated exclusively for Section 501(c)(3) purposes because a substantial portion of your activities consists of the operation of a coffee shop in a commercial manner.
While donating funds to other nonprofit community organizations is charitable … your main focus is the operation of a coffee shop. Additionally, while some of the activities that take place in the coffee shop … advance religion, more than an insubstantial portion of your activities serve a commercial purpose… . You are not regarded as "operated exclusively" for one or more exempt purposes because you do not engage primarily in activities which accomplish one or more of such exempt purposes specified in section 501(c)(3) of the Code. Your primary activity is the operation of a coffee shop in a commercial manner. You are open to the public Monday through Friday from 6 a.m. to 8 p.m. and Saturday from 7 a.m. to 8 p.m. You have free Wi-Fi and power outlets throughout for customer use. You have space that can be used for gatherings such as meetings and parties. You have a selection of food and beverage items that can be purchased at the coffee shop… . You believe the location of the coffee house is ideal because there are no other similar businesses downtown. Therefore, the operation of your coffee shop to raise funds is a commercial activity, not a charitable activity ….
The operation of the coffee shop and your programs to further the Gospel of Jesus Christ, partner with other organizations, and participate in community activities are separate and distinct activities. Since the operation of the coffee shop is a substantial part of your activities and is not a recognized charitable purpose, you are not organized and operated exclusively for 501(c)(3) purposes ….
You are operating a coffee shop that is open to the public six days a week in competition with other commercial markets. This is indicative of a business. Your primary sources of revenues are from coffee shop sales. Your expenses are mainly for salaries, cost of goods sold, and occupancy expenses to support the operation of the coffee shop. Taking in totality, the operation of your coffee shop constitutes a significant non-exempt commercial activity.
The IRS concluded: "You do not qualify for recognition of exemption from federal income tax as an organization described in Section 501(c)(3) of the Code. Your coffee shop activities are indistinguishable from similar activities of an ordinary commercial enterprise."
What this means for churches
This case is instructive for any church that is considering the creation of a commercial venture in furtherance of its religious mission. A predominantly commercial enterprise will not qualify for tax-exempt status if its principal activities are indistinguishable from competing for-profit entities, even if it engages in occasional or insignificant activities in furtherance of its religious mission.
Churches that operate coffee shops on or off of church premises should be aware of the following legal and tax considerations:
- Income tax exemption for separate facilities. A church cannot assume that a coffee shop will be exempt from federal income taxes, even if it has a religious purpose, if its commercial functions and purposes are significant. In such cases, the facility may fail the "operational test" of tax-exempt status described in section 501(c)(3) of the Internal Revenue Code.
- The federal unrelated business income tax, which subjects tax-exempt entities to the corporate income tax. There are exceptions, including facilities that are operated by volunteer labor.
- The potential impact on a church's property tax exemption.
- The potential impact of an applicable state sales tax law.
- Compliance with local zoning laws.
- Compliance with health department regulations.
- Liability issues for injuries occurring at the facility.
The least regulatory burden will apply to church-operated coffee facilities that:
- Are located on church property.
- Are operated solely for the convenience of members.
- Are operated by volunteers.
- Are not advertised to the general public by exterior signage, newspaper ads, etc.
- Are open only during (or immediately before and after) church services.
- Do not charge a fee for coffee or snacks.
IRS Private Letter Ruling 201645017 (2017).