Nonprofit organizations have to pass the organizational and operational tests to be recognized as tax-exempt by the IRS. Due to the requirements of the organizational test, most nonprofit organizations are formed as non-stock nonprofit corporations. This is because boards of directors of corporations with stock are required to maximize shareholder return instead of focusing on the exempt purposes of the organization. In addition, allowing board members to have shareholder interest could result in private inurement.
The Cato Institute, a libertarian think tank, has people across the country scratching their heads. The organization was formed as a Kansas nonprofit corporation, but unlike most other nonprofit organizations, Cato has shareholders.
Advocacy group Common Cause recently filed a complaint with the IRS alleging that some of Cato’s shareholders are trying to take advantage of the organization’s corporate structure by using their voting power to transform the entity into a partisan organization instead of a charitable one.
A handful of states actually do let nonprofits have shareholders. However, they are treated the same as members of other nonprofit organizations. As in the case of Cato, the shareholders don’t actually receive any financial benefits. Rather, the structure is just a means by which to control the organization.
The IRS will now investigate whether the corporate structure jeopardizes Cato’s tax-exemption. The IRS will also determine whether the directors of Cato breached their fiduciary duties to the organization when they created the shareholder structure.