Using Nonprofits to Serve Charitable Goals of Social Businesses in the United States: Circumventing the Lack of Recognition of the Social Business Model in the Federal Tax Code

Pace Law Review Volume 32 Issue 1 Winter 2012 Article 7 January 2012 Using Nonprofits to Serve Charitable Goals of Social Businesses in the United States: Circumventing the Lack of Recognition of the Social Business Model in the Federal Tax Code Gautam Jagannath Northeastern University School of Law Follow this and additional works at: https://digitalcommons.pace.edu/plr Part of the Business Organizations Law Commons, and the Organizations Law Commons Recommended Citation Gautam Jagannath, Using Nonprofits to Serve Charitable Goals of Social Businesses in the United States: Circumventing the Lack of Recognition of the Social Business Model in the Federal Tax Code, 32 Pace L. Rev. 239 (2012) Available at: https://digitalcommons.pace.edu/plr/vol32/iss1/7 This Article is brought to you for free and open access by the School of Law at DigitalCommons@Pace. It has been accepted for inclusion in Pace Law Review by an authorized administrator of DigitalCommons@Pace. For more information, please contact . JAGANNATH_Formatted_Finalv2 4/11/2012 7:39 PM Using Nonprofits to Serve Charitable Goals of Social Businesses in the United States: Circumventing the Lack of Recognition of the Social Business Model in the Federal Tax Code Gautam Jagannath* I. Introduction Is the pursuit of profit always contrary to the public good?1 Social businesses are for-profit businesses focused on pursuing their charitable goal rather than maximizing profits.2 Often, they cater solely to their social mission. These social enterprises opt to maximize their social benefit while nevertheless producing a profit.3 One area in which social businesses have garnered attention is microfinance. In 2005, the New York Times reported that there were less than three hundred Americanbased microfinance companies offering microloans.4 Today, the ubiquity of microfinance is evidenced by the measure of social concern for the socalled “indigent third-world.”5 However, the burgeoning excitement * J.D. Candidate, Northeastern University School of Law (2012). The Author would like to thank his mother for starting Amba, a social business, his partner Emily Abraham for her tireless editing and concern for this Article, and Professor Beth Elliott for her feedback. 1. Darryll K. Jones, Restating the Private Benefit Doctrine for A Brave New World, 1 NW. J. TECH. & INTELL. PROP. 1, 4 (2003). 2. See Muhammad Yunus, Founder, Grameen Bank, 2006 Nobel Peace Prize Lecture (Dec. 10, 2006), available at http://www.nobelprize.org/nobel_prizes/peace/laure ates/2006/yunus-lecture-en.html#. 3. What Is Social Enterprise?, SOC. ENTERPRISE ALLIANCE, https://sealliance.org/what-is-social-enterprise (last visited Nov. 23, 2011). This form of business is quite old—predating capitalism—and has origins in the natural economy vis-à-vis bartering. 4. Amy Zipkin, For Some, a Little Loan Goes a Long Way, N.Y. TIMES, Dec. 22, 2005, at C5. 5. See Kentaro Toyama, Lies, Hype and Profit: The Truth About Microfinance, ATLANTIC (Jan. 28, 2011, 11:07 AM), http://www.theatlantic.com/business/archive/2011/ 01/lies-hype-and-profit-the-truth-about-microfinance/70405/. 239 1 JAGANNATH_Formatted_Finalv2 240 PACE LAW REVIEW 4/11/2012 7:39 PM [Vol. 32:1 about microfinance raised an issue in American law: is the industry charitable and should it be considered tax-exempt?6 In considering the value of these organizations, it should be noted that, while microlending organizations represent a form of social business, they are certainly not the final solution to poverty.7 As states only recently begin to recognize social enterprise, the United States federal government is still stuck with traditional notions of charitable entities.8 Social enterprise is older than microfinance and is ubiquitous albeit unrecognized.9 Literally hundreds of companies are operated as social businesses in America.10 Nobel Laureate Muhammad Yunus of the Grameen Bank contributed to, but did not “create,” the social enterprise business model.11 Examples from recent times are varied and diverse, including diners, rural clinics, start-ups, and public corporations.12 There is a strong potential for these companies to do good, and even perhaps change the face of capitalism.13 While this may be the case, the legal separation between nonprofits and for-profits continues to enforce the stale notion that they cannot be interrelated.14 Legislators have fixed notions about what a nonprofit should do, and do not see for-profit values as being an essential part of a nonprofit business model. As a 6. Kiva, for example, is an American based microfinance corporation that is wholly based upon individual contributions and does not itself earn any interest. See About Us, KIVA, http://www.kiva.org/about (last visited Nov. 23, 2011). 7. See Rashmi Dyal-Chand, Reflection in a Distant Mirror: Why the West Has Misperceived the Grameen Bank’s Vision of Microcredit, 41 STAN. J. INT’L L. 217 (2005). 8. Stephanie Strom, A Quest for Hybrid Companies that Profit, but Can Tap Charity, N.Y. TIMES, Oct. 12, 2011, at B1. 9. Julia Taylor Kennedy, A Conversation with Microfinance Pioneer Susan Davis, POL’Y INNOVATIONS (Jul. 5, 2011), http://www.policyinnovations.org/ideas/audio/data/00 0615. 10. John Tozzi, America’s Most Promising Social Entrepreneurs 2011, BUS. WK. (Jun. 22, 2011, 2:24 PM), http://www.businessweek.com/smallbiz/content/jun2011/sb201 10621_158462.htm. 11. This is not to diminish the fact that Yunus is a key actor in modern microfinance. See Yunus, supra note 2. 12. See DENNIS R. YOUNG, SOCIAL ENTERPRISE IN THE UNITED STATES: ALTERNATE IDENTITIES AND FORMS (2001), available at http://www.communitywealth.org/_pdfs/articles-publications/social/paper-young.pdf. Apparently, even Ben & Jerry’s Homemade, Inc. was at one time a social business. Id. at 5. 13. Muhammad Yunus et al., Building Social Business Models: Lessons from the Grameen Experience 22 (HEC Paris, Working Paper No. 913, 2009). 14. See e.g., P.L.L. Scholarship Fund v. Comm’r, 82 T.C. 196, 200 (1984); I.R.S. Priv. Ltr. Rul. 201115026 (Jan. 19, 2011). https://digitalcommons.pace.edu/plr/vol32/iss1/7 2 JAGANNATH_Formatted_Finalv2 4/11/2012 7:39 PM 2012] USING NONPROFITS TO SERVE CHARITABLE GOALS 241 result, social businesses live on the fringe of American corporate law.15 Social businesses are organized as traditional for-profit organizations, such as corporations. This is the reality because limitations would befall them if they were organized as tax-exempt organizations.16 One such problem recognized by social business owners is that exempt organizations are limited by their operating budgets. 17 Unlike social businesses, nonprofits tend to be dependent on charitable donations for a large percentage of their work.18 The social business is not constrained in this manner through the Internal Revenue Code (IRC) because it is legally indistinguishable from any other for-profit.19 While this provides great freedom for the social business, (...truncated)