Legal Memorandum

[Susan Earley]

To the Members of the Society for Creative Anachronism:

Last winter, a document was circulated to the Board and Members
of the Society which questioned our tax-exempt status.  This
document was written by Lisa Steele, a tax attorney who is also a SCA
participant, at the request of Mark Schuldenfrei, also a participant. 
This document spurred the Board to contact a well- respected
California law firm (Silk, Adler & Colvin) which specializes in
non-profit law.  Rosemary Fei, who is their specialist in non-profit
tax law, prepared the following response.

Please note that the preparation of this document was not donated to
the Society, and it was not cheap.  (The standard rate for attorney
time is approximately $200/hour.)  If you have any questions about the
contents of this document, please do not contact the attorneys.  Write
to the Board at the Milpitas office or at directors at sca.org and we
will try our best to either answer your questions or obtain answers
from the appropriate parties.

Please note further that the footnotes were typed into the body
of the document ((within double parentheses)) by myself.  I
assume all blame for any errors in transcription -- but I did
double-proof them.

This document is the property of The Society for Creative
Anachronism, Incorporated. and of its authors.  Members of the
Society for Creative Anachronism may copy and distribute this
document to other members of the Society so long as proper credit is
given and no changes are made in the text.  The governing version of
this document is the original, which is held at the SCA Corporate
Office in Milpitas.  If you wish a copy of the original document,
please write to the office.

  --- Lee Forgue, Director, for the SCA Inc.



MEMORANDUM

TO:       Board of Directors
          Society for Creative Anachronism, Incorporated

FROM:     Rosemary E. Fei

DATE:     May 8, 1996

RE:       Allegations of Violations of Tax-Exempt Status
Requirements

          Some members of Society for Creative Anachronism,
Incorporated (the "Society"), have expressed concerns over the
Society's operations, alleging that the Society is in danger of
losing its tax-exempt status.  We are a law firm exclusively
engaged in representing tax-exempt and nonprofit organizations,
and advise extensively on tax-exemption compliance issues.  In
January and February, 1996, we conducted a brief preliminary
investigation ((The brevity of our review was dictated by the
Board's desire to determine the seriousness of the allegations
before expending potentially very substantial legal fees for an
in-depth review of the numerous, complex, and widespread
activities of the Society.  Based on this initial review, while
we recommend some areas for remediation, we do not believe a
full-scale tax compliance audit is warranted at this time.)),
including review of the documents listed in Exhibit A, in light
of these allegations, and this memorandum presents our results
and conclusions.

Summary

          While our investigation revealed some areas of
corporate and tax law compliance which may require further review and
to which the Board should attend in the future, these were not serious
enough to be grounds for revocation of the Society's exempt status,
and we found no reason to believe the Society is materially out of
compliance with its tax exemption.  A more in- depth investigation
could, of course, reveal a different picture, but the Board will have
to balance the costs of undertaking such a process against its likely
value to the Society and the charitable and educational uses to which
the Society's assets might otherwise be put.

          The members' concerns appear to be unwarranted, arising from
an overly strict reading of applicable tax statutes, regulations, and
cases.

Background

          The Society was incorporated in 1968.  In 1971, the IRS
determined the organization to be exempt from taxation under IRC
501(c)(3).  Because regulations under Code Section 509 were at that
time in the process of promulgation, the organization did not receive
its public charity status under Code Section 509(a)(2) until 1972. 
The IRS issued a "no change" letter to the organization in 1978, and
in 1989 issued a letter confirming the Society's public charity
status.  In 1990,  the IRS conducted an audit and concluded that no
change in the Society's exempt status was in order.

          In 1989, the Society amended its Articles of
Incorporation.  Its specific purposes are, according to the
amended articles (Article II):

     a)   Research and education in the field of pre-17th
          Century Western Culture.

     b)   Generally, to engage in research; publish material
          of relevance and interest to the field of pre-17th
          Century Western Culture; to present activities and
          events which re-create the environment of said
          era, such as, but not limited to, tournaments,
          jousts, fairs, dances, classes, et cetera; to
          acquire authentic or reproduced replicas of
          chattels representative of said era; and to
          collect a library.

          According to the Bylaws (Article III), "[t]he Society
shall be dedicated primarily to the promotion of research and re-
creation in the field of pre-17th century Western culture . . . ."

          The Society operates on a multinational scale with
members in the United States, Canada, Australia, several
countries in Europe, and U.S. armed forces bases around the
world.  A Board of Directors takes responsibility for the entire
organization which is divided into regions (Kingdoms), which are
further divided into local units.  The Society sponsors a wide
variety of "events" including tournaments, feasts, and other
similar gatherings where members display the results of their
researches into period culture and technology in an environment
which evokes the atmosphere of the Middle Ages and Renaissance,
as well as conducting more traditional educational activities
such as classes, seminars, workshops, and meetings.

Analysis of Allegations

          The allegations made by concerned members can be
categorized into four areas:  (1) errors by the Society in filing
reports and maintaining corporate records; (2) the Society's receipt
of unrelated business income which is subject to tax and for which
reports have not been filed nor taxes paid; (3) private inurement of
Society assets to benefit insiders; and (4) the existence of a
substantial nonexempt purpose in the form of social activity at
Society events.  Each of these allegations is addressed in turn below.

          Reports and record keeping.  The Society is required to file
Form 990, as well as employment tax filings, with the Internal Revenue
Service ("IRS") annually.  In addition to filings with the IRS, the
Society must make similar filings with the California equivalent of
the IRS, the Franchise Tax Board, or FTB, on Form 199.  To maintain
its corporate status in good standing, the Society must file annually
a one-page statement with the Secretary of State listing its current
officers. Finally, the Society must file Form CT-2 with the Registry
of Charitable Trusts in the Attorney General's office, concerning its
assets, which are held in charitable trust.  With the exception of the
Society's 1993 Form 990 and Form 990-T, we have not reviewed the
Society's tax or corporate filings.  We have been informed by
corporate officers that each of the filings listed above has been made
as required. We have not, of course, audited the content of each
filing, but we presume the Society's auditors have done such due
diligence in preparing these filings as they deemed required by their
profession.  The members allege possible filing irregularities with
the IRS such as incomplete forms or unsigned forms, not reporting
bylaw amendments to the IRS, and "a history of incomplete CT-2 reports
with the State of California."  We cannot verify or deny these
allegations based on our review.  More seriously, the members imply
that the Society fraudulently underreported its total income as
$40,000 on its 1993 Form 990.  Our review showed that the Society
actually reported total income of $2,503,105.

          Failure to adhere to filing requirements could result
in penalties being imposed on the Society; in some cases, these
penalties can be substantial.  However, in our experience, such
penalties are typically waived by regulators if the organization
can demonstrate that its failure was due to reasonable causes and not
the result of willful neglect.  Inadvertent failures to file reports
or mistakes in filings are not grounds for revocation of exempt
status.  The Society would have to ignore numerous notices from
regulators and refuse to make required filings before revocation of
tax-exempt status would become an issue.  The Board is responsible for
seeing that appropriate personnel, outside consultants, and procedures
are in place so as to ensure that required filings are made accurately
and on time.

          Other than the corporation's Amended Articles of
Incorporation, Bylaws, and 1995 Organizational Handbook, we have
not reviewed the Society's internal governance, membership,
financial, contractual, or other records.  If the Board deems it
appropriate, we would be happy to undertake such a review; with
respect to certain types of records, such an undertaking is more
efficiently performed by independent CPA auditors than attorneys,
should the Board feel it is needed.  

          Unrelated business income taxes.  The members allege
the Society may be underreporting its unrelated business income,
and therefore also failing to pay taxes due on such income. 
Specifically, the concern relates to advertising income received
by the Society for advertisements placed in Society publications.

          The Code does not prohibit a charity such as the
Society from engaging in, and earning income from, activities
outside its exempt purposes; however, the law does impose a tax
on any net income from such unrelated activities. ((Code Sections
501(b) and 511.))  To be subject to tax, the activity must (1)
constitute a trade or business (meaning any activity usually carried
on for profit), (2) be regularly carried on, and (3) not directly
further the organization's charitable mission.  Unless an activity
satisfies all three of these requirements, it will not be subject to
tax.  Even if it does meet these requirements, the unrelated business
income tax provisions include numerous exceptions, so that a great
deal of unrelated business activity escapes taxation.

          Aside from the payment of taxes, if an exempt
organization has too much unrelated activity, it may be deemed to have
a substantial nonexempt purpose, and will not qualify for tax
exemption at all. ((Indiana Retail Hardware Association v. United
States, 366 F.2d 998 (Ct.Cl. 1966).))  The exact level of income from
unrelated activities that will endanger an organization's exempt
status is a matter of some debate among tax practitioners. ((Thomas A.
Troyer, "Quality of Unrelated Business Consistent with Charitable
Exemption -- Some Clarification, " The Exempt Organization Tax Review,
Vol.6., No. 2 at 409 (August 1992).))

           While advertising income is a common source of
unrelated business taxable income for exempt organizations, not
all advertising income is automatically subject to tax as
unrelated.  The U.S. Supreme Court ((U.S. v. American College of
Physicians, 475 U.S. 834 (1986).)) has held that the sale of
advertising should be evaluated under the general rules for
distinguishing related and unrelated trades or businesses,
discussed above.  The sale of advertising in an exempt journal
will be an unrelated trade or business unless it contributes
importantly to the accomplishment of the organization's exempt
purposes.  This determination requires intensive analysis of the
facts and circumstances of the advertising activity in question.

          The members allege that "advertising in TI is almost
certainly unrelated business income."  Based on our review of
Tournaments Illuminated (Summer 1995, Issue 115) and the SCA
Marketplace brochure, we disagree.  To the contrary, we believe
convincing arguments can be made that most of the advertising in
Society publications is substantially related to the Society's
educational purposes, and therefore the associated net income
would be exempt from tax.  For example, we found advertising for
educational books and materials, musical instruments, Elizabethan
costuming, pavilions, rattan fighting swords, aquitaines, feastware,
and Middle Ages-style cloaks.  Each of these products is directly
related to the Society's exempt activities; in many cases,
participants in the Society's educational activities would be unable
to acquire information, tools, and materials for historically accurate
props and costumes, or other items that contribute to historical
re-creation, without access to the products advertised by vendors in
the magazine.

          We did note one advertisement for greeting cards in
Tournaments Illustrated that is not related to the Society's
exempt purposes, in our opinion, the net income from which should be
treated as taxable.

          A separate but related issue is raised by products sold by
the Society.  The Society's educational experience -- "living history"
-- relies to a great extent upon individual participation in the
historical reconstruction of pre-17th century Europe. Everyone who
attends Society events is expected to conform to the style of dress,
speech and behavior appropriate to that period.  Because the costumes,
objects and technologies suitable to a historically accurate
reconstruction are rarely found in today's world, the "SCA
Marketplace" offers a wide variety of instructional articles, patterns
and how-to books.  In our opinion, sales of these products directly
further the Society's exempt purposes by providing Society
participants with reference works as well as reproduced historical
objects which are utilized in the research and re-creation of medieval
history. Under these circumstances, the sales should not generate
taxable income to the Society.  
          Based on the foregoing and our review of the Society's
Form 990-T (on which an exempt organization reports its taxable
unrelated business income), we conclude that it is possible that
the Society is in fact overreporting, rather than underreporting, its
unrelated business taxable income.  Unfortunately, the Society's
history of treating its advertising income as taxable would probably
be treated by the IRS as evidence that the activity is unrelated. 
Therefore, the Society would have to meet a heavier than usual burden
of proof were it to change its reporting position at this point.  The
Board might wish to obtain an in-depth, closely-researched legal
opinion before proceeding, which could be expensive, off-setting the
benefits of eliminating much of the Society's taxable income, assuming
that result were approved.  The Society's accountant should be able to
determine how much tax savings might result from a favorable legal
opinion, to assist the Board in deciding how to proceed.

          The Board should also ensure that Society staff who
accept advertising in Society publications or who develop
products to be offered for sale by the Society understand the
unrelated business income rules so that they can screen out
inappropriate advertisements or products, or ensure that any
associated net income is treated correctly as unrelated business
income subject to tax.

          Private inurement.  Section 501(c)(3) of the Code
states that only organizations "no part of the net earnings of
which inures to the benefit of any private shareholder or
individual".  Private inurement refers to an abuse by those who
control the organization: one prominent treatise states that
"inurement is a private benefit provided to insiders who have the
institutional opportunity to direct the organization's resources to
themselves, to entities in which they have an interest, or to family
members." ((Frances R. Hill and Barbara L. Kirschten, FEDERAL AND
STATE TAXATION OF EXEMPT ORGANIZATIONS, 2-84 (1984).))  Private
inurement is absolutely prohibited for a Section 501(c)(3)
organization like the Society and, if present, would be grounds for
revocation of the Society's tax exemption. ((Treas. Regs. Section
1.501(c)(3)-1(c)(2).))

          Private inurement must be distinguished from private
benefit.  As noted above, private inurement results from an
insider misdirecting an organization's assets away from its
proper exempt purposes.  Private benefit, on the other hand, does not
require any insider control; it is often evident just from the
non-exempt purposes of the organization, but can occur even where the
organization has proper exempt purposes, but operates in a way that
appears to be directed at benefitting private, rather than public,
interests.  To illustrate the difference, private inurement occurs
where a director causes the Board to approve excessive compensation to
him- or herself; private benefit occurs where the Board approves a
relationship with an unrelated consultant that pays excessive
compensation to the outsider.  IRS regulations permit an
"insubstantial" amount of private benefit. ((See Code Section
501(c)(3) and Tres. Regs. Section 1.501(c)(3)-1(c)(1).))  Whether or
not a private benefit is "insubstantial" is to be determined in light
of all the facts and circumstances of that particular case. 
Generally, private benefit that is incidental to and a necessary side
effect of achieving an exempt purpose is considered insubstantial.

          The members allege specific instances amounting to a
pattern of private inurement.  The allegations include the
advertisement of a private, for-profit event in a regional
newsletter as if it were a Society-sponsored event (an incident
that happened ten years ago and which the members acknowledge was an
oversight by responsible Society officers and fraudulent on the part
of the private individuals involved), the theft of money from the
Society, and the questionable use of Society funds for personal
travel.

          An isolated incident of theft or a mistake in
advertising does not amount to private inurement.  While the
Board has a fiduciary duty to take reasonable steps to protect
the Society's assets, no organization can realistically guarantee the
honesty or competence of every individual who volunteers for it, nor
does the tax law require it.  We presume that the Society has
responded or will respond to the alleged incidents appropriately, both
with respect to pursuing recovery of assets and preventing similar
incidents from occurring in the future. So long as the organization
has appropriate procedures to minimize the opportunities for
misappropriation or misuse of its assets, and attempts reasonably and
in good faith to enforce them, isolated failures of the system do not
amount to private inurement and will not endanger the Society's exempt
status.

          The members, in their allegations, also seem to have
confused private inurement with private benefit.  Specifically,
the members allege that the Society "frequently operate[s] in a
fashion which allows merchants to benefit privately.  This MAY be
private inurement."  However, the presence of "merchants" at an exempt
organization's events raises a question of private benefit, not
private inurement, and whether or not the level of private benefit is
so substantial as to bring into question the organization's exempt
status is to be determined based on a full exposition of the facts and
circumstances surrounding that particular event or transaction. ((St.
Louis Science Fiction Limited v. Commissioner, 49 T.C.M. (CCH) 1126
(1985).))  While we have not attended a Society event as part of this
investigation, it appears that the purpose of the Society's events is
not to benefit vendors, but to provide educational experiences through
historical re-creation, and the presence of the vendors, subject to a
variety of requirements ensuring historical accuracy in their
presentations, makes a more realistic re-enactment of historical
settings possible and attracts more members of the public to attend
and be educated, thus directly furthering the Society's educational
purposes.  Of course, the Board should always monitor merchant
participation at its events to ensure that it is not only compatible
with, but in fact enhances, the events' educational value.

          Substantial non-exempt purpose.  Finally, the members
allege that the Society is not operated, in the language of
Section 501(c)(3), "exclusively" for its exempt purpose --
promotion of research and re-creation in the field of pre-17th
century Western culture for the public's benefit -- but rather is also
operated for social or recreational purposes.  This allegation is the
most serious of those made by the members, both because it appears at
first glance to be factually true, and because the consequences to the
Society would be severe.

          Section 501(c)(3) of the Code exempts from Federal
income tax organizations "organized and operated exclusively for"
exempt (i.e., charitable, educational, etc.) purposes.  Section
1.501(c)(3)-1(c)(1) of the Treasury Regulations implementing the Code
elaborates that an organization will be regarded as "operated
exclusively" for exempt purposes only if it engages primarily in
activities which accomplish one or more of the exempt purposes
specified in Code Section 501(c)(3).  An organization will not be
exempt if more than an "insubstantial" part of its activities is in
furtherance of a non-exempt purpose.

          Education, for purposes of tax exemption, is defined by
Treas. Regs. Section 1.501(c)(3)-1(d) as either "(a) [t]he instruction
or training of the individual for the purpose of improving or
developing his capabilities; or (b) [t]he instruction of the public on
subjects useful to the individual and beneficial to the community." 
While this definition encompasses traditional educational institutions
like schools, universities, and the like that have a set curriculum,
an identifiable faculty, and a student body, it is far broader.
Museums of every type, zoos, orchestras, theaters, organizations which
disseminate information (ranging from facts on environmental
degradation to the reasons for international cooperation),
organizations which re-create Civil War battles, garden clubs, and gem
and mineral clubs, have all qualified as educational organizations.

          Determining whether an organization is organized and
operated primarily for educational purposes requires an
investigation of the specific facts and circumstances of the
organization and its activities.  Tension between the educational and
the recreational or social is not uncommon, and has been addressed by
the IRS repeatedly.  For example, a gem and mineral club can be
organized and operated either as an educational organization, or as a
social club. ((Rev. Rul. 67-139, 1967-1 C.B. 129.))  A club formed "to
advance the earth sciences by stimulating interest and encouraging
study" that holds monthly lectures, sponsors field trips, issues a
bulletin, assists local museums, maintains a library, and annually
conducts a show for the general public at which members and nonmembers
exchange lapidary techniques, display collections of gems and
minerals, and compete with one another for prizes and awards, with the
public invited to attend its functions and programs, will qualify for
exemption under Section 501(c)(3).  The IRS explicitly acknowledged
the social aspects of club operation.  Nevertheless, the IRS found
that the club's educational methods (i.e. lectures, discussions,
shows, field trips) are "educational" within the meaning of the Code
and Regulations, and that "[t]hese activities are educational within
the meaning of the regulations even though they serve recreational
interests."  

          In contrast, another gem and mineral club, which was
"formed to disseminate knowledge of mineralogical and lapidary
subjects, to promote their application so that greater pleasure
may be derived from these activities, and to promote good
fellowship among its members," was determined to be a social
club.  This club held monthly social meetings where minerals and
gems were informally discussed, issued a bulletin containing news of
members' social activities and their rock and mineral collections, and
held an annual show.  The IRS found that the club was operated
primarily "to accommodate its members in their recreational pursuits. 
The gem and mineral show serves to stimulate the members' hobby
interests and is, thus, consistent with the [club]'s recreational
purposes."

          Where recreational, social, and educational purposes
are intertwined in a single activity, the IRS looks to the
content of the activity to make a judgment as to whether the non-
educational purpose of the activity is substantial.  This is a
fact-intensive inquiry.  St. Louis Science Fiction Limited v.
Commissioner ((Supra, note 7.)) ((which said "St. Louis Science
Fiction Limited v. Commissioner, 49 T.C.M. (CCH) 1126 (1985)."))
presents a good example.  The science fiction society's principal
activity was its annual convention.  Its purposes were "to promote and
stimulate interest in speculative fiction (in print, movie and video
form) and art and related activities."  At the convention, science
fiction authors and personalities gave readings and panel discussions.
 Other activities included masquerade parties, a pool party, a
sing-a-long program, a 24- hour video room, a 24-hour game room,
movies, an art show and auction, and a "huckster's room."  The IRS
found that many of these component activities (such as the pool party,
the "dead dog" party, etc.) served strictly recreational or social
purposes.  Even the more educational activities, like the panel
discussions, "contained a predominantly recreational tone." Among the
films shown, the IRS acknowledged the educational value of such
science fiction classics as 2001: A Space Odyssey but questioned the
showing of Hardware Wars (a spoof on Star Wars) and Star Trek
Bloopers.  Under these circumstances, the IRS concluded that the
organization had substantial non-exempt purposes, and was therefore
not entitled to exemption.  This case demonstrates how substantial a
level of recreational and social activity must be present to bring
exempt status into question.

          In another close case involving exempt and nonexempt
purposes intertwined, the IRS's ruling against the organization
was reversed by the courts.  Cleveland Creative Arts Guild
((Cleveland Creative Arts Guild v. Commissioner, 50 T.C.M. (CCH)
272 (1985).)) involved an organization formed to promote the
arts.  Among other activities, it sponsored art festivals and
craft shows featuring competitions and sales by artists and
craftspeople.  The IRS, focusing on the sales, ruled that the
organization had a substantial commercial purpose, precluding
exemption.  The Tax Court reversed the IRS decision, on the
grounds that the sales must be viewed in the overall context of
the group's activities.  The Court stated that, in determining
whether an activity was engaged in for a substantial non-exempt
purpose, the relevant factors included (1) the manner in which
the activities are conducted, (2) the "commercial hue" of the
activities, and (3) the existence and amount of profit from the
activities.  The Court criticized the IRS's focus on sales
activities and portions of festival advertising, finding that, in
context, "the sales activities in question are incidental to the
exempt purpose of promoting the arts . . .".

          These examples show that the question of whether or not the
Society is operated primarily for educational purposes as the law
requires, is a complex one not given to glib or easy answers. Our
review of the Society's publications and the "Rialto" on the Internet
revealed an ongoing and consistent effort to accomplish the
organization's stated educational purposes.  Tournaments Illuminated
(Summer 1995) contains six articles, all dealing with one aspect or
another of pre-17th Century Western culture.  The two issues we
reviewed of the newsletter of the Kingdom of the West (June and
November 1995) present a listing of upcoming events, classes, and
tournaments.  There are no purely social announcements and no events
noticed other than Society events, all cast in the style of pre-17th
Century Europe.  If these publications and fora are representative of
Society publications and events, and of the Society as a whole, the
Board may rest assured that the Society is entitled to its educational
tax- exempt status.

          The members specifically criticize some of the
Society's events, such as the Pensic, as overly recreational and
social.  We suspect this criticism arises from a
misunderstanding.