501(3)(c), charity, nonprofit, history

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The Health of the Republic Relies on Nonprofits

A brief history and why it matters. 

"Not only does the charitable sector represent a large swath of our economy, it’s also what makes us uniquely American."

Most nonprofit leaders know little about the history of philanthropy, how it evolved, and what makes it unique. Why should we care?

According to the National Center for Charitable Statistics, there are approximately 1.6 million nonprofit organizations in the United States. 380 thousand of these are churches. Nonprofits contribute over one trillion dollars to the U.S. economy each year, or 5.6 percent of the country’s gross domestic product. Moreover, this sector employs about 10 percent of the American workforce, or 11.4 million jobs. Another 65 million Americans — more than 25 percent of the adult population — volunteer for nonprofit organizations each year.

Not only does the charitable sector represent a large swath of our economy, it’s also what makes us uniquely American. Peter Drucker concluded more than 30 years ago that nonprofit organizations are “human-change agents” and the country’s “most distinguishing feature.” Some observers understand American nonprofits to be so unique that they predict their flourishing at the expense of other sectors. Economic and social theorist Jeremy Rifkin prognosticated in his 1995 book, The End of Work, that for-profit and governmental spheres would play diminishing roles in human labor around the world. In his view, the void will “be taken up either by the growth of an increasing outlaw subculture or by greater participation in the third sector,” the charitable segment of the economy. To look forward and begin to make sense of the philanthropic sector’s future, it’s important to look back.

Understanding our philanthropic past

From the Puritans founding of Harvard College in 1636, the origins of the nonprofit sector precede the founding of our country. As settlers migrated west, they created charitable organizations and voluntary associations to fill gaps that the government didn’t provide. During his 1831 visit to the U.S. — chronicled in Democracy in America — French diplomat, philosopher, and historian, Alexis de Tocqueville, observed the following about American voluntary associations:

Americans of all ages, all conditions, all minds constantly unite. Not only do they have commercial and industrial associations in which all take part, but they also have a thousand other kinds: religious, moral, grave, futile, very general, and very particular, immense and very small; Americans use associations to give fêtes, to found seminaries, to build inns, to raise churches, to distribute books, to send missionaries to the antipodes; in this manner they create hospitals, prisons, schools. Finally, if it is a question of bringing to light a truth or developing a sentiment with the support of a great example, they associate. Everywhere that, at the head of a new undertaking, you see the government in France and a great lord in England, count on it that you will perceive an association in the United States.

Later in the century, a new base of philanthropy — the millionaire class — emerged as the U.S economy industrialized. According to historian Olivier Zunz, in the 1870s there were 100 millionaires in the United States. By 1892 the number had grown to 4,047, and by 1916 totaled 40,000. During this same period, private foundations began to emerge, fueled by the success of American industrialists including Andrew Carnegie, Henry Ford, J.P. Morgan, and Henry D. Rockefeller. Carnegie’s 1889 essay, Gospel of Wealth, advocated for intentional philanthropic stewardship during a benefactor’s lifetime as a duty to society. “The only point required by the Gospel of Wealth is that the surplus which accrues from time to time in the hands of a man should be administered by him in his own lifetime for that purpose which is seen by him, as trustee, for the good of the people.”

During the first decades of the 20th century and with the rise of disposable income among the middle class, philanthropic organizations began to systematize and mass-market their fundraising appeals in order to combat disease, cure social ills, prepare for war, or heal in its aftermath. According to Zunz, “By the 1950s, mass philanthropy was so well integrated into everyday life in the United States that one could identify the season by the door-to-door collection in progress—winter and spring for health agencies and the Red Cross, fall for community chests.”

The shaping role of tax law

American capitalism and its penchant for charitable associations and altruism have played vital roles in shaping the third sector, but so too has government through tax law. Nonprofit organizations are excluded from paying income, sales, and property taxes under local and state laws. Additionally, nonprofits are relieved from tax obligations under federal law. The types of organizations exempt under the Internal Revenue Code Section 501(c) are both public- and member-serving in orientation. Public-serving nonprofits include schools, churches, hospitals, and other similar entities. Member-serving organizations include fraternal associations, chambers of commerce, credit unions, labor and agricultural associations, and other mutual benefit associations. In all, there are nearly 30 different 501(c) designations allowing for federal tax-exempt status. 501(c)(3) public charities, the most prevalent classification, include religious organizations, educational institutions, hospitals, and qualified medical research organizations.

Tax exemption for nonprofit organizations came into effect over a 75-year period from 1894 to 1969 with little structural change thereafter. The Wilson-Gorman Tariff Act of 1894 established a 2 percent flat tax for corporate income but exempted entities “organized and conducted solely for charitable, religious, or educational purposes, including fraternal beneficiary associations.” A year later the Supreme Court declared the new tax law unconstitutional; however, the language exempting charitable organizations from corporate income remained intact, shaping ongoing legal policy and legislation.

The Revenue Act of 1909 closely emulated the 1894 Wilson-Gorman language. It exempted charitable organizations from tax obligations while introducing restrictions on private inurement, which prohibited benefits from tax exemption accruing to private stockholders or individuals associated with the organization. Four years later, in 1913, the 16th Amendment to the Constitution was ratified, granting Congress the authority to levy and collect income tax “from whatever source derived.” This was codified in the Revenue Act of 1913, which established the modern-day federal income tax system. To encourage charitable giving, the Revenue Act of 1917 allowed individuals to deduct charitable contributions made to tax-exempt organizations. Corporations were similarly allowed to offset income through charitable contributions through the Revenue Act of 1936.

Prior to 1950, nonprofit organizations were exempt from paying taxes on income generated from business activities unrelated to the organization’s mission. This shifted with the Revenue Act of 1950, which allowed the federal government to tax nonprofits — excluding churches — for business income unrelated to mission. There was growing anxiety in the 1960s about the accountability of 501(c)(3) private foundations. The Tax Reform Act of 1969 (TRA69) attempted to provide more stringent delineations. Defining private foundations as entities receiving more than one-third of their funding from gross investment income, TRA69 created two sub-classes of 501(c)(3) private foundations: operating and non-operating. The non-operating, or grantmaking foundations, were required by law to distribute a percentage of their income each year (currently five percent).

Why history matters

This brief overview outlines the evolution of nonprofits in America. But why should you care?

First, because history and cultural context matter. T.S. Eliot wrote, “If one can really penetrate the life of another age, one is penetrating the life of one’s own.” Where we better understand the cultural background and historical roots that enliven our third sector, we’re better equipped to navigate the larger institutional ecosystem. And it follows that the more fluent we become in the language of nonprofits, the more agile and resilient we will be when moving within and across this sector.

A second reason for knowing this history, particularly for non-profit leaders and participants, centers on mission control. When we’re on mission, we’re more likely to be out of danger. Nonprofits must follow specific rules and procedures — beginning with their articles of incorporation and bylaws, and ending with their dissolution. Once operational, 501(c)(3)s must abide by laws and regulations so they don’t lose their tax-exempt status, which is bestowed to them to serve the public good. These guiding principles embedded in the tax code are especially important:

  • No private benefit: Nonprofit organizations cannot use their income or assets to directly or indirectly privilege an individual who has a close association with the nonprofit. Stated differently, nonprofits are disallowed by the IRS from directing profits or benefits to anyone who has power over the organization.
  • No political campaigning: A 501(c)(3) may neither oppose nor endorse nor financially support through any form a candidate for political office at local, state, or federal levels. Sadly, many churches and nonprofits violate this law. Doing so could and should threaten their tax-exempt status.
  • Operate in agreement with stated purposes: Nonprofits must function in accordance with their articles of incorporation and bylaws; if not, they can lose your tax-exempt status. When encountering mission drift, nonprofits should move back within the lines or amend their founding documents.

A third reason for better understanding philanthropic history is to help preserve the Republic. As Alex Reid observes in The Almanac of American Philanthropy, nonprofits create a “locus of power” that is distinct from government agencies. “The civil society we build through our nonprofit institutions is not just some sweetener of our quality of life. It is fundamental to our democracy, a replenishing source of nourishment to individual freedom.”

In the future, charitable deductions may become even more contested among politicians, lobbyists, nonprofit executives, and taxpaying citizens. One rising conflict between the business and nonprofit sectors involves the significant growth of medical and higher education organizations. As the Nonprofit Quarterly notes: 

For much of the general public, these prosperous institutions do not look like charity cases marked by modest salaries, nondescript buildings, and substantial grassroots fundraising. … When the property tax exemptions were written into most state constitutions (in the 1800s), the colleges and hospitals were just getting started—usually with religious roots, certainly of modest size. 

Today many dominate their industries with market scale and tax immunity.

Another rising conflict involves the status of the charitable deduction for income tax purposes. In 2017 Congress made a momentous tax change by nearly doubling the standard deduction, which now stands at $12,400 for single filers and $24,800 for married couples filing jointly. For most taxpayers who give little to charitable causes this was a boon, but for taxpayers who plan their giving more intentionally and itemize their deductions, it became a disincentive to give. Eliminating or modifying the charitable deduction will not stop charitable giving, but it will change the power dynamics. According to Alex Reid, 

We shield private donations from the brunt of taxation in order to limit government interference with our personal choices on how best to further the public interest. The charitable deduction is a mechanism for ensuring that the government does not lay claim to ... private gifts devoted to the good of the people. 

Eliminating or changing the calculus behind the charitable deduction changes patterns by which the public makes decisions about how best to serve the common good.

As Zunz reflects, there is an inherent tension between politics and the third sector, whereby the government wants to simultaneously encourage and control it. More specifically, “The government is less at ease with philanthropy’s entry into the realm of policymaking, and has proven most hostile to its efforts at advocacy, seeing its own prerogatives challenged directly.” Religious nonprofits’ defense of the unborn and traditional views of marriage are two examples.

The three-legged stool

The nonprofit sector in America has a dynamic past. Ignoring our history limits our ability to see into the future. Predating the founding of our Republic, charitable associations have been an integral part of our social fabric. They heal, entertain, educate, organize, protect, discover, defend, and nourish. By better understanding their particular roots, nonprofit leaders, advocates, and board members, ensure their future. Rifkin observes that we best re-imagine work when we think of our society not as a continuum of the marketplace on one end and government on the other, but rather 

as a three-legged stool made up of the market sector, the government sector, and the civil sector. The first leg creates market capital, the second leg creates public capital, and the third leg creates social capital. Of the three legs, the oldest and most important, but least acknowledged, is the Third Sector. 

Let’s work to raise the visibility of our vital third sector, and lead faithfully within it for the health of our Republic and care of our common good.

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