Should Nonprofits Pay Tax?

The executive director of Wilder Research, Paul Mattessich, asked this question on his blog last summer: Should nonprofits pay taxes?

You might say no, but what if you knew that the National Football League is a nonprofit organization, or that some nonprofit CEOs earn more than many local business executives? A recent, front page article in the New York Times, citing a new Minnesota court ruling, described the increasing number of challenges across the nation regarding the tax exempt status of nonprofits, and it raised the issue of how to define “nonprofit”.

Mattessich argued that there are some very good reasons why nonprofits should be taxed: among them, the fact that nonprofits, like other businesses, consume public goods provided by government--fire and police protection, transportation infrastructure, etc. In this sense, from a benefit-received perspective, it seems appropriate to levy some form of nonprofit business tax.

Mattessich also noted several counter-arguments to taxation. Among the most compelling is that the activities of many nonprofits are substantially funded by government. In these cases, it makes little sense to tax government-supported activities. As the line between the public and para-public sectors grows increasingly blurry, I suspect that this "tax or no tax" question will be more difficult to settle. As governments enter into collaborations and partnerships with parapublic and private institutions in an effort to maximize efficiency and stimulate competition, who can know to which entity the "value added" or "profit" should be assigned?

Other cash-strapped jurisdictions (who isn't these days?) have proposed levying taxes upon activities unrelated to a nonprofit organization's exempt purpose. The city of Philadelphia recently proposed an expansion to its tax regulation:

...the proposed changes were broad enough to permit the city to tax universities for dorm fees, performing-arts theaters for concession-stand sales, and small community groups for fund-raising dinners.

This unrelated business income tax for nonprofits is hardly new, but in practice has been only loosely enforced--if only because of the inherent difficulty in judging an income-producing activity's relationship to the organization's exempt purpose. At the margin, the answer is rarely cut and dried.