Update 15 June 09: Rich Schmalbeck (who is on the Duke law faculty, btw) emailed me his comments on my post re MoJo v. IRS. With his okay, here’s what he said:
The Technical Advice Memorandum that turned the tide in your case has almost certainly been published, though I didn’t look to verify that. These are documents prepared by the IRS Chief Counsel’s Office, at the request of either a taxpayer or a field office of the IRS, in the context of an audit that raises difficult legal questions. They had long been completely private, but a Freedom of Information Act suit sometime in the 1970s compelled their disclosure, but with information that might identify the taxpayer redacted. They are typically not reviewed at the highest levels of the IRS or Treasury, and so are specifically not intended to establish precedent, but are merely supposed to resolve the issues with respect to a particular taxpayer. But now that they are routinely published, lawyers do consult them, and do sometimes cite them, though with the understanding that a court may not accord them much weight.
A few days ago, I said I would come back to one specific item from the Duke conference a while back on non profit media, so here goes. It’s triggered by an issue raised in a paper prepped for the conference by Rich Schmalbeck, “Financing the American Newspaper in the Twenty-First Century.” Turns out that a battle royale Mother Jones went through with the Reagan-era IRS has some relevance today. It might point to a way to deal w/the IRS for newspapers and other publications looking to convert to non profit status.
First, Schmalbeck’s paper.
Schmalbeck begins with the assumption that the standard corporate model for daily metro newspapers isn’t sustainable any more, and then asks, what would work better? With that, we’re off on a lawyerly survey of the pros and cons of different variants of non profit corporate structure. In the end (and his argument is compelling) Schmalbeck argues that an emerging non profit corporate form – the Low Profit Limited Liability Corporation (“L3C”) – probably would work best, mainly because it offers the greatest flexibility in terms of attracting different kinds of capital: low interest money from, say, foundations pursuing a social mission, plus market rate interest from investors seeking to maximize their return. But that’s not what caught my attention.
The problem Schmalbeck surfaces turns out not to be about a specific corporate structure, but whether the Internal Revenue Service would recognize ANY non profit newspaper under Section 501c3 of the tax code.
That’s the section of the code that most of us in the non profit world operate under, with “religious, charitable [which means, here, alleviation of poverty], scientific, literary or educational” purposes. Even with a healthy dose of Britney, horoscope, and the comics, a newspaper probably could make the case that its primary purpose is educational.
The question, though, is what the IRS thinks about organizations – say, like newspapers or some magazines – that get a major chunk of their revenue from “commercial” activities like advertising or renting their mailing lists? Is this considered “unrelated business” that has no relationship to the primary non profit “educational” purpose of the publication? As Schmalbeck asks, would “the conduct of a newspaper” be
… too tainted by commerciality to pass muster as an entity organized and operated exclusively for exempt purposes?
Based on the cases Schmalbeck discusses in his paper, he’s forced to come to the conclusion that as far as the IRS is concerned, the answer is yes: if it looks like a commercial operation, if it walks like a commercial operation, if it sells advertising like a commercial operation, then it is a commercial operation. That’s a big no-no for the green eyeshades at the IRS.
In which case he’s right to say that it “means in all likelihood a newspaper seeking such status would have to litigate the issue with the IRS, under circumstances where victory was far from certain.” While it turns out that the courts have taken a more flexible approach to this “commerciality” question, it still means a non profit would have to pour substantial time and money into making their case. And who needs that headache when you’ve got a newspaper to put out?
So if that’s all true, it could be a major deal-breaker for converting (or creating) non profit newspapers that have a mix of earned revenue plus contributions.
Now, onto the Mother Jones angle.
Mother Jones started life in March, 1975, as a project of a non profit entity called the Foundation for National Progress (FNP). Headed up by Adam Hochschild, direct marketing pro Bill Dodd, business wiz (and now Harvard professor) Richard Parker, and anti-nuke activist Paul Jacobs, the magazine flourished, growing rapidly (it had the largest circulation of any progressive magazine of the time) and being recognized with awards for its pathbreaking mix of investigative journalism and progressive culture coverage. Mark Dowie‘s piece on the exploding Ford Pinto pretty much ensured no advertising from the auto companies (the mag didn’t take another ad from Ford until 2006), and its special report on tobacco industry lobbying inside the Beltway put the kibosh on that revenue source, too.
Soon after starting, the IRS told the organization that it would probably qualify as a non profit tax exempt charitable organization, which it confirmed in a May, 1980, letter. The organization felt it had no reason to worry when it learned, in the waning days of the Carter administration (March, 1980), that the San Francisco office of the IRS was conducting a “routine” field audit of Mother Jones and the Foundation for National Progress.
That changed with the election of Ronald Reagan in late 1980. In the spring of 1981, the IRS told Mother Jones that it had decided to revoke the non profit status of the Foundation for National Progress, because it had decided that its main activity – publication of Mother Jones – was a commercial profit making operation, hence inconsistent with the charitable and eduational goals of the FNP. And a year after that, in August 1982, the IRS responded to MoJo’s challenge to its initial determination, by shifting emphasis: the FNP, it wrote to the organization, was a tax exempt organization and could keep its 501c3 status, but Mother Jones magazine was a purely commercial enterprise and therefore not permitted to function under the FNP’s non profit umbrella.
The IRS figured that MoJo owed the feds about $390,000 in back taxes; the way the books looked on the MoJo side of things, the magazine had been operating at a loss from day one – to the tune of as much as $500,000 a year. The IRS decision, if upheld, pretty much guaranteed that Mother Jones would have to close down. As then executive editor Deidre English put it in a January 1982 article in the magazine, “In today’s economy, it is almost impossible for non-commercial magazines to exist unless they have non-profit status.” (I suppose it’s some measure of how things have changed that these days that’s true for non-commercial AND commercial magazines….)
And plenty of people were asking why Mother Jones was being singled out for this punitive action. After all, there were lots of other magazines that functioned as non profits – National Geographic, Harpers, Smithsonian, Commentary, and National Review. How come they weren’t being audited? “With mounting dismay,” editor English wrote, “we watched the once-innocuous audit become increasingly repressive under the Reagan administration.” Suspicions were that this was part of a larger campaign to “defund the Left,” especially since other left magazines, like NACLA’s Report on the Americas, Big Mama Rag out of Denver, Oakland’s People’s Translation Service, and The [New York] Guardian, were also targets of IRS action around the same time.
Okay, granted, when you publish articles with titles like “Investigating Reagan’s Brain and Other Dark Regions of the Right,” chances are if someone’s looking for a target, you’ll probably show up on their screen. But the other thing going on at the time was that the courts had pretty thoroughly undermined the legal reasoning the IRS used to figure out what qualified as “educational” and what did not. In 1980, the D.C. Court of Appeals reversed a lower court ruling, ruled in favor of Big Mama Rag, a feminist monthly, and found the IRS’ definition of ‘educational’ “unconstitutionally vague” and “in violation of the First Amendment.” The IRS, said the court, was making its evaluation “solely on the basis of one’s subjective notion of what is ‘controversial.'”
At worst, that left the IRS open to manipulation by Reagan-era political operatives; at best, it left the decision as to which organization would be considered tax exempt and which not up to IRS field staff, who clearly had no idea what they were dealing with.
The Mother Jones case became something of a cause celebre. The story got picked up by newspapers around the country – USA Today, the Los Angeles Times, the Washington Post, the San Jose Mercury News, San Francisco Chronicle, Houston Post, Philadelphia Inquirer, Des Moines Register, Hartford Courant, and others. Representative Benjamin Rosenthal convened a congressional inquiry into the matter before the commerce, consumer, and monetary affairs subscommittee of the House Committee on Government Operations (which sadly was cut short by Rosenthal’s death).
Finally, after three and a half years, and some $100,000 in legal expenses, the IRS reversed itself. In a “technical memorandum” in mid-1983, the IRS agreed that Mother Jones was carried out “in a manner consonant with” the Foundation for National Progress’ charitable, tax exempt purpose.
The essential issue, the IRS now said, was “whether the distribution of a journal or a magazine is accomplished in a manner distinguishable from ordinary commercial publishing practices” (for you lawyers out there, this is referring to criteria in IRS Rev. Rule 67-4, 1967-1, C.B. 121). It continues:
Relevant facts would thus include . . . whether the publication was intended to generate a profit, the existence or accumulation of large profits, and whether the materials were published exclusively for sale or not.
“Large profits?” Not happening:
. . . the journal has never made a profit and, in fact, is subsidized by the organization with funds derived from other sources including contributions. . .incidents involving articles critical of the automobile and cigarette industries with the resulting loss of advertising revenues from two industries that customarily use print media for advertising supports a conclusion that profit is not a prime motivator in publishing the journal.
Got that right.
So, the IRS at long last concluded that “‘commercial’ is not an appropriate description of the organization’s journal but, rather, that its publication is carried out in a manner consonant with the organization’s exempt purpose.”
As publisher Robin Wolander put it in MoJo’s news release announcing the victory, “They’ve finally accepted what we’ve said all along. That the magazine is published not to make a profit, but to make a point.”
However, this IRS decision was never published. The IRS instructed its staff and interested attorneys that the decision “may not be used or cited as precedent.” Nonetheless, my layperson’s reading of the decision says that this has direct relevance to the question that Rich Schmalbeck raised about how newspapers can thread the IRS needle without wasting thousands of dollars and hours of effort in unproductive litigation. The fact is: the IRS did decide that non profit organizations can earn revenues from advertising and other “commercial” activities – without jeopardizing their non profit tax exempt status.
And that’s a lesson worth remembering as we head into the new era of non profit journalism.