## Facts

- Federation Pharmacy Services, Inc. was a Minnesota nonprofit corporation organized in 1976 to operate a pharmacy in the Minneapolis–St. Paul area.
- It arose after a commercial pharmacy that had offered discounts to seniors ceased operations; Federation was formed to acquire remaining inventory and operate the pharmacy.
- Federation’s organizing documents contemplated serving the general public, with special discount rates for senior citizens and handicapped persons.
- In practice, Federation proposed to sell prescription drugs to members at 5% below the lowest locally verified retail price and to nonmembers at the surveyed price.
- Membership was tied to possession of a buying-plan card available to qualifying persons who paid a fee; discounts were not conditioned on financial need.
- Federation priced drugs based on cost and had no commitment to use excess receipts to provide drugs below cost or free to elderly or handicapped persons.
- The pharmacy operated in competition with profitmaking drug stores and relied primarily on sales revenue rather than charitable contributions.

## Issues

1. Whether Federation was organized and operated exclusively for charitable purposes within the meaning of I.R.C. § 501(c)(3).
2. Whether operating a discount, cost-based pharmacy for elderly and handicapped persons, without need-based relief and while competing with for-profit pharmacies, satisfies the “operated exclusively” requirement under the Treasury regulations.

## Decision

- The Tax Court held that Federation operated a pharmacy primarily for commercial purposes and did not qualify for exemption under § 501(c)(3).
- The Eighth Circuit affirmed, agreeing that Federation’s activities were not operated exclusively in furtherance of charitable purposes.
- Declaratory judgment was entered for the Commissioner, and exemption recognition was denied.

## Legal Principles

- Under Treas. Reg. § 1.501(c)(3)-1(c)(1), “operated exclusively” requires that no more than an insubstantial part of an organization’s activities be nonexempt; a primarily commercial purpose defeats exemption.
- Selling health-related goods does not by itself establish a charitable purpose under § 501(c)(3).
- A pricing model based on cost or modest discounts, without a program to provide below-cost or free goods and without targeting assistance based on financial need, supports a finding of commercial rather than charitable operation.
- Competition with for-profit businesses and a self-supporting revenue model may corroborate that an organization’s activities have a commercial character inconsistent with § 501(c)(3).

## Conclusion

Federation did not qualify for § 501(c)(3) status because its discount pharmacy functioned like an ordinary commercial enterprise—cost-based sales and competitive pricing without need-based relief or a commitment to subsidize the poor—so it was not operated exclusively for charitable purposes.


Federation Pharmacy Servs., Inc. v. Comm’r, 625 F.2d 804 (8th Cir. 1980)