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Flower Retailer's Plan to Donate Profits Failed "Operational Test" for 501(c)(3) Status

(Parker Tax Publishing June 2, 2015)

Affirming a Tax Court decision denying a request for declaratory judgment granting tax-exempt status to a nonprofit corporation, the Ninth Circuit Court found the company's plan to donate profits from online sales of flowers to charitable organizations did not meet the "operated exclusively for a charitable purpose" test under Code Sec. 501(c)(3). Zagfly, Inc. v. Comm'r, 2015 PTC 159 (9th Cir. 2015).


Zagfly, Inc. was organized as a California nonprofit corporation in 2010, but delayed commencing operations pending a final determination of its exempt status. Zagfly planned to engage in an Internet-based business, initially selling flowers as part of an established network of florists. As a flower broker, Zagfly expected to sell flowers at market rates and anticipated earning a sales commission of approximately 10 to 20 percent of the purchase price. When customers purchase flowers from the corporation, they would have the opportunity to designate a charity to receive all of the profit arising from the transaction from a list of tax-exempt organizations approved by Zagfly.

Zagfly also planned to suggest to its users that they allocate a small percentage (1 to 2 percent) of the price of their flower purchase to go to supporting Zagfly. If the users were not inclined to voluntarily elect to allocate funds to the corporation, Zagfly indicated it may need to include its operating expenses in determining the profit' that would go to charitable causes.

Zagfly requested a declaratory judgment from the Tax Court granting it tax-exempt status. The court denied the request, holding that under the "operational test" of Reg. Sec. 1.501(c)(3)-1(c)(1), Zagfly would not be operated exclusively for one or more exempt purposes, and thus was not an exempt organization.


To qualify as an exempt organization under Code Sec. 501(c)(3), a corporation generally must demonstrate:

(1) it is organized and will operate exclusively for religious, charitable, scientific, educational, or other specified exempt purposes;

(2) no part of its net earnings will inure to the benefit of a private shareholder or individual;

(3) no part of its activities constitutes intervention or participation in any political campaign on behalf of any candidate for public office; and

(4) no substantial part of its activities consists of political or lobbying activities.

Reg. Sec. 1.501(c)(3)-1(c)(1) provides that an organization will be regarded as "operated exclusively" for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of the exempt purposes specified in Code Sec. 501(c)(3), and will not be so regarded if more than an insubstantial part of its activities is in furtherance of a non-exempt purpose.

Before the Tax Court, Zagfly argued that although it would fulfill its purpose by engaging in activities that others engage in for commercial gain, its primary motivation was charitable. Zagfly claimed it would not realize a profit since it would donate all operational revenue. The tax court noted an organization may operate a trade or business as a substantial part of its activities and still meet the requirements of section 501(c)(3) so long as the business is not an "unrelated trade or business" as defined in Code Sec. 513(a).

The tax court found that Zagfly intended to sell flowers in direct competition with commercial flower brokers, on a regular and continuous basis with the ultimate aim of maximizing its profits in the form of commissions paid on each completed sale and this business was not substantially related to an exempt purpose under Code Sec. 501(c)(3), except insofar as it provided Zagfly with funds to distribute to charitable organizations. Thus, the tax court held that Zagfly was not "operated exclusively" for an exempt purpose.

On appeal, the Ninth Circuit Court reviewed the Tax Court's denial of Zagfly's application for recognition of tax-exempt status under Code Sec. 501(c)(3) for error. The ninth circuit found that although Zagfly planned to donate its business profits to charitable organizations, the tax court did not err in concluding the donation of business profits was not an exempt purpose. The circuit court adopted the reasoning of the tax court and found that the tax court had properly applied the operational test under Reg. Sec. 1.501(c)(3)-(c)(1).

Because Zagfly would not be operated exclusively for an exempt purpose, the Ninth Circuit Court affirmed the Tax Court's denial of Zagfly's request for status as an exempt organization under Code Sec. 501(c)(3).

For a discussion of 501(c)(3) organizations, including organizational requirements, see Parker Tax ¶60,502. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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