Philanthropy Tax E-Letter

Beauty Pageant: Exemption Revoked and Scholarships Taxable

For information about Conrad Teitell’s publications and lectures visit: taxwisegiving.com. For information about Cummings & Lockwood visit: cl-law.com.

While beauty may be in the eye of the judges, a beauty pageant’s qualification as an Internal Revenue Code Section 501(c)(3) charity is in the eye of the Internal Revenue Service.

Although the name of the pageant has been redacted, I smell saltwater taffy—and can hear redacted singing: “There she is, Miss [redacted]. There she is, your ideal. The dream of a million girls who are more than pretty can come true in [redacted] City.”

The IRS paraded these facts down its exemption runway and revoked a pageant’s exemption:

Contract of the winner. “If I am selected as ‘Miss * * *’ at the competition, I will serve as ‘Miss * * *’ during the Year of Service and until my successor is selected or appointed. The duties and obligations of my service as ‘Miss * * *’ have been described to me and I understand and accept them. I agree that I will dedicate my  entire time, efforts and energy during my Year of Service to the fulfillment of these duties and obligations, and that I will engage in no other business or other activities that will in any way interfere with the duties and obligations of my Year of Service. However, school academic activities take precedence." [This is just one provision of a much longer contract.]

Contract if selected as Runner-Up. “If I am selected at the competition as a runner-up for the title of ‘Miss * * *’, I agree to remain available to assume all of the rights, obligations and commitments of the Year of Service, as described in Section 5 of this Application and Contract, in the event that the Miss * * * Organization appoints me to do so by reason of the inability or ineligibility, during the Year of Service, of any Contestant who was selected as Miss * * * or as another runner-up." [Sort of like rules of U.S. Presidential succession: Vice President; Speaker of the House; President Pro Tempore of the Senate; Secretary of State; Secretary of the Treasury; Secretary of Defense; Attorney General; Secretary of the Interior; Secretary of Commerce. The list goes on, naming other cabinet offices.]

The law according to the IRS:

Exempt purposes qualifying for exemption under Section 501(c)(3) include religious, charitable, scientific, testing for public safety, educational, amateur sports competition or prevention of cruelty to children or animals. Contests or pageants are not described under this section or in the corresponding tax regulations.

In Miss Georgia Scholarship Fund, Inc. v. Commissioner, 72 T.C. 267 (1979) regarding a scholarship granting entity independent of pageant organizations,  the organization was found to be not exempt under Section 501(c)(3) due to contractual obligations placed on the scholarship winners. The contractual obligations included performance in the Miss Georgia pageant and CO-1 pageant. These obligations placed upon scholarship recipients were found not to be exclusively 501(c)(3) purposes.

In Bingler v. Johnson, 394 US 741, 751 (1969), the Supreme Court stated that to be excluded from gross income under IRC Section 117, scholarships must be relatively disinterested, "no strings" educational grants, with no requirements of any substantial quid pro quo from the recipients.

Reg 44.4421-1 Defines beauty pageants as "contests." ". . .(3) Contest. -- A contest includes any type of contest involving speed, skill, endurance, popularity, politics, strength, appearances, etc., such as a general or primary election, the outcome of a nominating convention, a dance marathon, a log-rolling, wood-chopping, weight-lifting, corn-husking*, beauty contest, etc."

Reg 1.117-4(c)(1) provides that "any amount paid, or allowed to, or on behalf of an individual to enable him or her to pursue studies shall not be considered to be an amount received as a scholarship if the amount represents either compensation for past, present, or future employment services or represents payment for services that are subject to the direction or supervision of the grantor."

For an organization to qualify for tax exemption under Section 501(c)(3), its activities must be exclusively Section 501(c)(3) activities. The vast majority of the pageant activities involve organizing and conducting beauty pageants and supporting [National Organization], neither of which is a Section 501(c)(3) activity.

While the pageant uses the term "scholarships" for marketing purposes, and used this term on their application for exemption, these monetary awards aren't qualified scholarships per Section 117. In Revenue Ruling 68-20, 1968-1 CB 55, the IRS held that under Section 117 a scholarship is includable in the gross income of a beauty pageant winner as compensation for participating in the contest, playing a leading role in the televised pageant and for performing subsequent services for, or at the direction of, the sponsoring corporation.

For a 501(c)(3) organization to be based on providing scholarships, the awards must be consistent with true scholarships as defined in Section 117. This code section defines scholarships as being free from obligations, as was made clear in the Bingler v. Johnson case. In contrast, the awards provided by the pageant have significant contractual obligations attached. Contestants are required to attend pageant rehearsals, attend and perform in the pageants themselves and agree not to participate in any competing pageant activities. 

Contestants must agree to give up all rights to intangible assets associated with the pageant, such as photographs, and copyright claims. They must agree to the pageant using the contestant's name, likeness and/or physical depiction for any purpose in perpetuity. Additionally, contestants are required to meet predefined fundraising goals as defined by the contract. [emphasis supplied.] No contestant may participate in a pageant without first signing the contract, legally binding themselves (sic) to these predetermined contractual obligations. Furthermore, the contract stipulates each contestant is an independent contractor, indicating the monetary awards are in fact payments for services.

Fundraising Activities: In addition to pageant ticket sales, funding for the organization is provided by corporate sponsors and through various fundraising events held throughout the year. Fundraising events include—bingo and poker tournaments, concession stands, an annual golf tournament and an annual ball. These fundraising events are staffed by volunteers.

To qualify for monetary awards, applicants must first establish themselves as contestants in beauty pageants, and perform all duties associated with the pageants by means of a signed contract. The contract places substantial and ongoing obligations and services upon each pageant contestant. As such, the monetary awards are inextricably linked with services performed in conjunction with pageant operations; the monetary awards are, therefore, compensatory in nature. As compensatory payments aren't scholarships, no basis for tax exemption under IRC 501(c)(3) exists.

Not a pretty picture for the scholarship winners. In revoking the organization’s tax-exemption, the IRS also held that the monetary awards to contestants weren’t qualified scholarships; thus, they weren't excludable from the income of the recipients.

The monetary awards provided to pageant contestants, referred to as "scholarships" by the taxpayer, are compensatory in nature and are not qualified scholarships per IRC 117. As such, they serve no valid basis for any form of tax exemption, and are not excludable from recipients' taxable income under Section 117. These service related payments represent compensation in accordance with Treasury Regulation 1.117-4(c)(1), and Revenue Ruling 68-20, 1968-1 CB 55.

Letter Ruling 201432037

*Query: Shouldn't this qualify for a farm subsidy?

© Conrad Teitell 2014. This is not intended as legal, tax, financial or other advice. So, check with your adviser on how the rules apply to you.

 

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Conrad Teitell

Conrad Teitell, A.B., LL.B., LL.M., 98.6. Chairman, National Charitable Planning Group, Cummings & Lockwood, Stamford Conn. cl-law.com. For information about Conrad Teitell's publications...
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