When an exempt nonprofit organization's single-minded pursuit of funding for its mission threatens to damage the broader common good, many in the larger community will question the tax advantages that enable that organization to thrive while others suffer. And so they should.
Recently, this tension was underscored by a situation in our nation's capital, where tax-exempt American University's activities as a commercial real estate developer have led to the loss of local businesses much valued in (and beyond) adjacent neighborhoods — and raised additional concerns about the sometimes-harmful practices of "charitable" entities. While local residents around the country have been doing what they can to maintain the increasingly fragile business mix that reflects the often-historic and unique character of their neighborhoods, too many exempt organizations ignore such concerns and go about their business with a blatant disregard for the consequences of their actions on others.
We've all become familiar with the egregious practices of commercial real estate owners who double, triple, or quadruple a small business owner's rent when a lease expires, forcing the business to vacate the space and leaving it empty for years in hopes that, at some point down the road, it can be combined with adjacent properties to create an attractive parcel for luxury development or perhaps a national chain tenant, even as the surrounding neighborhood retail ecosystem withers and dies.
And when ostensibly nonprofit organizations get into the game, it adds more than insult to injury. Indeed, in the recent case involving American University, which is taking steps to force out a popular family-owned garden center from one of the commercial properties it owns, it heightens the scrutiny on all exempt organizations.
Our current tax code allows exempt nonprofit organizations and institutions to maximize the revenue they generate by mimicking the often-rapacious behavior of commercial real estate developers. While some defenders of exempt organizations’ commercial real estate ventures believe that income from such activities are subject to Unrelated Business Income Tax (UBIT), they are wrong.
For all "charitable" organizations, federal — and, in most cases, local — income taxes are not applied to "passive income" derived from commercial rental properties that aren't debt-financed — although, in most locales, property taxes do apply. Astoundingly, however, educational institutions benefit from a special provision in the tax code that allows them to also avoid income taxes on profitable mortgage-encumbered properties. In fact, educational and other nonprofit institutions can use their tax-advantaged status to establish for-profit corporations (e.g., a "single-member LLC") to manage their real estate developments as a "disregarded entity" and completely avoid income taxes on those properties.
Even in cases where the exception doesn't apply, all exempt organizations can extend their tax-deductibility to donors of debt-free commercial property; can use tax-deductible cash and other donated financial instruments to purchase commercial property outright; and many — such as universities — can even use government-issued tax-exempt bonds to finance the mission-related acquisition of property, thereby freeing up fungible dollars to buy other properties for commercial development.
Some may applaud these organizations and institutions for using any and all available means to generate every last dollar to advance their missions, but too often such behavior has a deleterious effect on the common good. As prevailing wisdom would have it, the common good "[i]s much more than the aggregate of individual goods and accomplishments" — more, for instance, than the sum total of the benefits that accrue to a university’s graduates. "Rather, it reflects both the morality and enlightened self-interest that allows institutions across society to operate so that all might enjoy a life of justly and humanely distributed resources, rewards, responsibilities and obligations."
When exempt organizations and institutions operate to the detriment of the common good, when they serve a narrower constituency — even if a portion of that constituency has pressing needs — at a real cost to the quality of life to others in the community (and to the broader public interest), it focuses our attention on their overall contribution to society and begs the question of their tax advantages and other privileges.
Commercial real estate development that destroys the character of a neighborhood and squeezes already hard-pressed local businesses to the point of extinction might not seem to be an assault on the common good. But for those who live and work in and around affected communities, for those who value retail and business diversity, for those whose livelihoods are destroyed, and for those who believe that all tax-exempt organization should serve the larger public interest, it is. And it raises a host of serious and related questions.
For instance, should a charity's or educational institution's investment portfolio include stock in companies whose activities harm the environment and/or the quality of life in a community or region? (It's worth noting that many such organizations and institutions exclude commercial property and other investment holdings, as American University did, when self-rating their performance on "do-good" indexes like that compiled by the Association for the Advancement of Sustainability in Higher Education.)
Should a charity or educational institution hold stock or bonds issued by companies whose activities cause health problems in humans or involve experiments on animals? What about businesses that actively lobby to roll back public safeguards, government protections, and commonsense regulations designed to protect the public against toxic pollution or dangerous manufacturing practices?
While many organizations have socially-responsible investment committees and policies in place, too often they are toothless or simply provide a patina of respectability to what is otherwise business as usual. (In other cases, the recommendations forwarded by such bodies are rejected by boards as being too costly.)
Should charities and educational institutions seek the highest possible returns in their portfolios by investing in corporations that lobby for self-serving tax cuts and/or to reduce government spending on safety-net, public-benefit, and entitlement programs like Social Security and Medicare? What about businesses that have poor track records with respect to employment equity and diversity hiring?
What about their our own supply chains? Should charities and educational institutions favor low-cost suppliers even when they’ve been known to exploit low-income labor or compel employees to work in unsafe conditions? Many organizations publish lofty statements about the social responsibility they require of their "business partners," but there are woefully few examples of those policies ever being enforced.
And what about charities or educational institutions that fail to pay their own workforce a living wage or fail to offer a benefits package that allows employees to achieve a reasonable standard of living? Should we expect them to try to save on labor costs by pushing people into part-time positions or to fight any attempt to unionize their workers? Or should we limit their tax privileges when they do?
Should nonprofit institutions contract-out to for-profit corporations to provide and oversee workers or to offer other services when the charities know that particular businesses have faced repeated protests and litigation in support of the rights of such workers and the unions that represent them?
Too many exempt organizations operate in ways that too narrowly serve their own purposes while ignoring the adverse consequences their actions have on others. That not only harms people and communities, it also muddies the water for other organizations working hard against long odds and with limited resources to make the world a better place.
And so the question stands: Should exempt organizations benefit from self-serving tax-advantaged commercial and other activities that harm the common good. We’d love to hear from you in the comments section below.
Mark Rosenman is a professor emeritus at the Union Institute & University. To read more of Rosenman's commentary, click here.