Paul Newman's death in September rightly garnered a lot of attention. In addition to being a skilled actor, an accomplished race car driver and a successful businessman, he was a philanthropist whose generosity changed the lives of many. Lost in all the commentary on his passing was an ironic point noted only by tax lawyers.
His food company, Newman's Own Inc., was well known for donating all of its after-tax profits to charity. He ran a for-profit enterprise, which had a stated purpose of generating funds for tax-exempt purposes.
Why, then, didn't he organize the company as a non-profit that would enjoy a tax-
exemption? And could he have done so?
There was a time when the Tax Code would have allowed Newman's Own to do just that. But in the Revenue Act of 1950, Congress enacted Section 502 of the Tax Code, outlawing "feeder organizations." A feeder organization, prior to 1950, could get exempt status, even if it was by all appearances engaging in a commercial trade or business, if its profits were given over to charities. The problem, as Congress saw it, was that these feeder organizations were competing with for-profit businesses without paying any income tax. As a result, companies such as General Foods and Sara Lee never had to worry that their rival would enjoy a tax advantage over them in the competitive food market.
Congress also went after bona fide non-profits such as hospitals and universities that operated substantial businesses to finance their charitable programs if those businesses competed with for-profits. An example was the university that operated a large laundry that also took in nonstudent business. The result was the still not fully understood Unrelated Business Income Tax (UBIT). It provided that a university, for example, could operate a laundry that competed for nonstudent business, but it would have to pay a tax on the income derived from that business--the portion not related to its exempt purpose of housing and educating those students.
Clearly, Newman's Own was never disadvantaged by a lack of a tax exemption, and probably benefited by being free of its burdens. For example, as a private company it did not have to file a Form 990 and did not have to worry that it might be paying its executives more than the IRS thought appropriate. It also was free to invest its funds in other businesses, as it did in 1993 when it set up Newman's Own Organics, a company Newman's daughter, Nell, created. She said her father was happy to provide the financing as long as it was paid back because it came out of money that normally went to charity. Like her father's company, Newman's Own Organics is responsible for popular products such as Fig Newmans, and it, too, supports several charities with its profits. These include an environmental law group and an organic farming research foundation.
All told, since 1982 Newman's Own has generated more than $250 million for more than 1,000 charities around the world. One standout has been the Hole in the Wall Gang Camp--a summer camp for children with cancer and other illnesses. Starting with a $10 million investment from Newman in 1988, it has now expanded to about a dozen associated camps around the world and created a year-round program serving more than 11,000 children yearly. And all of these good works emanate from a single for-profit business without benefit of a tax exemption.
In one sense, this is a win-win for society--we get all the social benefits from Paul Newman and we get his tax money too. The thinking is that he didn't need a tax incentive to hand over his profits to charity, so why should he get one? Yet, the case of Newman's Own raises a larger question about whether the tax code impedes rather than aids the charitable impulse. Maybe more flexibility would permit more profit-minded philanthropy.