Determination 200850042: IRS revokes exemption for private benefit and nonexempt activities

Plain-English summary

The IRS revoked an organization's § 501(c)(3) exemption effective January 1 of a redacted year and directed it to file corporate income tax returns. The examination report describes payments connected with the president, personal expenses paid by the organization, and undocumented, interest-free loans from the president. It also describes activities outside the organization's stated exempt purpose, including web services for local businesses, which the report says represented 8.66% of its activities. Funeral-related payments represented 39.88% of expenses and 34.9% of gross receipts, although the dollar amounts were redacted. The IRS concluded that the organization was not operated exclusively for exempt purposes and had not adequately documented several transactions. The final revocation letter is dated September 2, 2008.

Ruling snapshot

• Question: Is an organization operated exclusively for exempt purposes when its president receives payments from other entities connected with the organization's activities and the organization receives undocumented, interest-free loans from him?
• Outcome: Exemption revoked retroactively to January 1 of the redacted year; Forms 1120 required; state officials notified under section 6104(c).
• Key authorities: Section 501(c)(3); Treas. Reg. 1.501(c)(3)-1(c)(1), (c)(2), and (d); Better Business Bureau v. United States; Revenue Ruling 73-127, 1973-1 CB 221; Birmingham Business College; Texas Trade School.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
TE/GE: EO Examination
625 Fulton Street, Room 503

Brooklyn, NY 11201
TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION Date: September 2, 2008
UIL:501.03-01
Release Number: 200850042
Release Date: 12/12/08
Legend
ORG = Organization name XX = Date Address = address
Taxpayer Identification Number
ORG Person to Contact:
ADDRESS Identification Number
Contact Telephone Number:
LAST DATE FOR FILING A PLEADING
WITH THE TAX COURT, THE CLAIMS
COURT, OR THE UNITED STATES
DISTRICT COURT FOR THE
DISTRICT OF COLUMBIA:
December 1, 20XX
Dear

This is a final determination regarding your exempt status under section 501(c)(3) of the
Internal Revenue Code (IRC). Recognition of your exemption from Federal income tax
as an organization described in Internal Revenue Code section 501(c)(3) is retroactively
revoked to January 1, 20XX because it is determined that you are not operated
exclusively for an exempt purpose.

IRC 501(c)(3) exempts from taxation organizations which are organized and operated
exclusively for charitable or educational purposes, no part of the net earnings of which
inure to the benefit of any private shareholder or individual, no substantial part of the
activities of which is carrying on propaganda, or otherwise attempting to influence
legislation and which do not participate in, or intervene in, any political campaign on
behalf of (or in opposition to) any candidate for public office.

We have determined that you are not operating exclusively for any charitable purpose,
educational purpose, or any other exempt purpose. Our examination reveals that you
are not engaged primarily in activities which accomplish charitable, educational or other
exempt purposes as required by Treas. Reg. 1.501(c)(3)-1(c)(1). Your activities,
including your financial transactions, more than insubstantially furthered non-exempt
purposes. Moreover, you failed to establish that you were not operated for the benefit

of private interests of your founder and principal officer, as required for continued
recognition of exemption pursuant to Treas. Reg. 1.501(c)(3)-1(d)(1)(ii).

We are revoking your exemption from Federal income tax as an organization described
in section 501(c)(3) of the Internal Revenue Code effective January 1, 20XX.

Contributions to your organization are no longer deductible under section 170 of the
Internal Revenue Code.

You are required to file Federal income tax returns on Form 1120. These returns
should be filed with the appropriate Service Center for all years beginning January 1,
20XX.

Processing of income tax returns and assessment of any taxes due will not be delayed
should a petition for declaratory judgment be filed under section 7428 of the Internal
Revenue Code.

If you decide to contest this determination in court, you must file a pleading seeking a
declaratory judgment in the United States Tax Court, the United States Court of Federal
Claims, or the United States District Court for the District of Columbia before the g1*
day after the date this final determination was mailed to you. Please contact the clerk
of the appropriate court for rules regarding filing pleadings for declaratory judgments
and refer to the enclosed Publication 892. You may write to these courts at the
following addresses:

You have the right to contact the office of the Taxpayer Advocate. Taxpayer Advocate
assistance is not a substitute for established IRS procedures, such as the formal
appeals process. The Taxpayer Advocate cannot reverse a legally correct tax
determination, or extend the time fixed by law that you have to file a petition in a United
States court. The Taxpayer Advocate can, however, see that a tax matter that may not
have been resolved through normal channels gets prompt and proper handling. You
may call too-free and ask for Taxpayer Advocate Assistance. If you prefer, you may
contact your local Taxpayer Advocate.

We will notify the appropriate State Officials of this action, as required by section
6104(c) of the Internal Revenue Code.

If you have any questions, please contact the person whose name and telephone
number are shown in the heading of this letter.

Sincerely Yours,

Vicki L. Hansen
Acting Director, EO Examinations

Enclosure:
Publication 892

' Form 886A Department of the Treasury - Internal Schedule No. or
Revenue Service Exhibit
Explanation of Items
Name of Taxpayer: EIN: Year/Period
Ended
ORG
20XX12
LEGEND
ORG = Organization name XX = Date XYZ = State City = city
motto = motto CM-1 & CM-2 = 15 & 279 cM FAIR-1, FAIR-2, FAIR-3 & FAIR-
4 = 187, 2NP, 38° g 47 FAIR EMP-1 & EMP-2 = 15° & 2"¢ EMP Secretary =
secretary Director = director WK-1 = 15* WK CO-1 thru CO-31 = 1*,

opal ges qth 5th 6th, ha gth gth 10°, LAs, 1Q¢8,, 13t, 14%, 15th, 16%, 17%,
rete, a9t, goth, 218t, 2279, 2379, aath, a5th peth o7th, ogth, 29t 300 & 315

companies Payer-lthru Payer -12 = 1%t, 2™4, 379, at, 5th, gt, 7th, gth, oth)
rot, ait? g 12** payer Payee-1 = 15* payee
Issue

Is ORG operating exclusively for Motto, charitable, and educational, purposes described in
Internal Revenue Code (IRC) § 501(c)(3) in which no part of its net earnings inure to the benefit
of any private shareholder or individual?

Facts

Organizing documents

ORG (referred to as the “organization” was formed on January 19, 20XX for purposes within the
meaning of IRC § 501(c)(3). The Service recognized the Foundation as an organization exempt
from tax as an organization described in section 501(c)(3), and classified it as a publicly
supported organization described in section 509(a)(1), in a determination letter dated May 20XX.

The Articles of incorporation state that the organization’s specific purpose in Article II (B):
“Community sports activity - conducting clinics, workshops, lessons, and seminars at municipal
parks and recreational areas to instruct and educate individuals in a particular sport is operated
exclusively for educational purposes and qualifies for exemption under IRC 501(c)(3).”

Article II (C): “Said organization is organized exclusively for charitable, motto, and scientific
purposes, including for such purposes, the making of distributions to organizations, that qualify
as exempt organizations under section 501(c)(3) of the Internal Revenue Code...” The Articles
include all the clauses required under IRC 501(c)(3), including the prohibition on inurement of
any part of the net income or assets of the corporation to any director, officer, member thereof.

The Organization and Affiliated Entities
The Organization’s board consisted of BM-1, who also goes by the name BM-1, BM-3, and BM-
2.

Organization’s Form 1023 Application
On February 11, 20XX, ORG applied to the Service for exemption under IRC § 501(c)(3).

The organization stated on its application that its proposed activities will be “Ministry services
conducted by BM-3 BM-1 Building Gods church, healing the sick, and teaching financial

Form 886-A Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -1-

' Form 886A Department of the Treasury - Internal Schedule No. or
Revenue Service Exhibit
Explanation of Items
Name of Taxpayer: EIN: Year/Period
Ended
ORG
20XX12

prosperity spiritually, mentally, and physically. Internet website to teach, communicate, and
worship nationally and worldwide [sic].”

Part II, Question 2, what are or what will be the sources of financial support? The Organization
responded “membership donations, marketing for contributions, sales of CD’s and tapes. In
Question 3, the Organization described that its fundraising program was its “Website sell of
CD’s and tapes, consultant BM-2 _ [sic]”

On its application, Form 1023 page 3, the Organization stated its governing body was BM-1,
Pres., BM-3, Secretary, BM-2, Director. The Organization listed on its application that the
officers’ annual compensation was “n/a”.

The Service sent Letter 1312 from the Organization on March 22, 20XX, stating that the Form
1023 application was incomplete and the Service needed more information to verify that the legal
requirements for exemption have been met.

The letter requested:

conformed copy of Articles of Incorporation that have been filed with the State of XYZ.
Amended the Articles (approved by of filed with the proper state official). The organizational
document submitted by ORG did not meet the organizational test of Section 501(c)(3).

A list of questions regarding the organization’s church status (on 5/4 t service received a fax
from the organization seeking public charity status as opposed to church status.)

A chronology and complete description of all past activities of your organization as well as
activities planned for the next three years. (the information submitted did not contain sufficient
detail to fully describe proposed activities.) Describe in detail how you carry on or plan to carry
on your motto activities by priests, prophets, pastor, ministers, in forums, by radio or television,
through recorded or print media, and the internet. State whether your organization has audio,
video, or literature of its own. State how your recording and publishing activities further your
exempt purpose. State how your recording or publishing activities are distinguishable from for-
profit enterprises. State whether your video or literature is distributed free of charge, if not what
is used to determine the sales price. Describe your method of distribution for literature and
videos. Indicate whether your video or literature will be copyrighted. If so, whose the copyright
held by?

Agent was unable to obtain any response to the above questionnaire.

Form 990
The Organization did not file a form 990 for the 20XX tax year.

Form 886-A rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -2-

Form 886A Department of the Treasury - Internal Schedule No. or
Revenue Service Exhibit
Explanation of Items
Name of Taxpayer: EIN: Year/Period
Ended
ORG
20XX12

The Service mailed Letter 4041 on February 21, 20XX to the Organization asking for it to
complete Form 13770, Credit Counseling and Form 990 Filing Requirements. The Organization
reported its gross receipts were for one year or less $ and reported total assets $.

Organization’s Revenues and Activities in 20XX

Motto:

The organization and BM-1 (BM-1), received the following payments for creating and
maintaining websites for for-profit businesses:

Payer Amount Payee Date Check
Payer-1 $ BM-1 1/31/20XX Computer Work
Payer-1 $ BM-1 3/1/20XX Computer Work
Payer-1 $ BM-1 3/15/20XX Website
Payer-1 $ BM-1 5/4/20XX Computer Work
Payer-1 $ BM-1 11/1/20XX Computer Work
Payer-1 $ BM-1 12/12/20XX
Payer-2 $ Payee-] 8/23/20XX Web-site
Payer-3 $ Payee-1 1/11/20XX Motto
Payer-3 $ Payee-1 5/11/20XX Website
Payer-3 $ Payee-1 8/19/20XX Web work
Payer-4 $ Payee- | 1/31/20XX Website
Payer-5 $ 7/28/20XX
Payer-4 $ Payee-1 10/12/20XX Hosting
Payer-4 $ Payee-1 12/12/20XX_ Final Payment
Payer-6 $ 1/21/20XX
Payer-6 $ Payee-1 3/7/20XX March Motto
Payer-6 $ Cash
Payer-7 $ Payee-1 6/14/20XX Website
Payer-7 $ Payee-1 7/22/20XX Website
Payer-7 $ Payee-1 10/12/20XX Website
Payer-7 $ Payee-1 12/7/20XX payment
Payer-8 $ Payee-] 8/15/20XX Web-site
$
Form 886-Arev.4-68) Department of the Treasury - Internal Revenue Service

Page: -3-

‘Form 886A Department of the Treasury - Internal Schedule No. or
Revenue Service Exhibit
Explanation of Items
Name of Taxpayer: EIN: Year/Period
Ended
ORG
20XX12

CO-1 (CO-1:
The CO-1 (XYZ ) is a program that allows low-income households a

reduced energy bill (up to 20%). CO-1 contracted with ORG. ORG’s would hand out pamphlets
and also assist individuals complete the CO-1 application. The Organization was to be paid a
capitation fee for each new customer enrolled in the program.

The Organization shared booths with CO-1 and distributes pamphlets for the CO-1 at fairs. The
fairs that the Organization handed out pamphlets were: FAIR-1, FAIR-2, FAIR-3, FAIR-4. The
Organization also mailed out pamphlets.

The organization also submitted a copy of one television broadcast (on DVD) that it produced for
the CO-1. The DVD consists of BM-1 and EMP-1, supervisor of the CO-1, discussing the
program and how to qualify for the program and two advertisements for ORG. The discussion is
approximately 17 minutes. Next on the DVD is a gospel music video of EMP-2 performing.
This segment lasts approximately six minutes. The video then solicits volunteers and donations
of “love offerings” followed by an advertisement for ORG’s multimedia services: motto, motto,
and email list distribution with the organization giving reference cites. The total length of the
DVD was 27 minutes and 39 seconds. The camera men for the video was CM-1 and CM-2.

The organization also submitted a DVD containing a public service announcement it produced
for channel in the City for Black History Month Celebration. The announcement was
34 seconds.

The organization also stated that the organization conducted internet broadcast, but has not
shown this internet broadcast activity to the Service. The Organization stated that the broadcast
aired on CO-2 to $ subscribers and production and airing cost was $ plus the video camera
receipt. The organization has not shown any documentation to the Service to sustain its claim
that the production cost was $. The invoice provided shows that the camera was paid for in cash
for $ on December 20, 20XX. The camera purchase is not reflected in the organization’s bank
statements.

The Organization’s receipts for the CO-1:

CO-1 $ 1/21/20XX CO-1
CO-1 $ Payee-1 3/22/20XX CO-l
CO-1 $ Payee-1 3/31/20XX CO-l
CO-1 $ 4/19/20XX CO-1
CO-1 $ Payee-1 6/17/20XX CO-1
CO-1 $ Payee-1 7/20/20XX CO-1
Form 886-A Rev.4-68) Department of the Treasury - Internal Revenue Service

Page: -4-

‘ Form 886A Department of the Treasury - Internal Schedule No. or
Revenue Service Exhibit
Explanation of Items
Name of Taxpayer: EIN: Year/Period
Ended
ORG
20XX12
CO-1 $ Payee-1 8/19/20XX CO-1
CO-1 $ 9/21/20XX CO-l
CO-1 $ 11/22/20XX CO-1
CO-1 $ Payee- 1 CO-1
$

The organization had links on its website (during the year under audit and currently) for services
that are unrelated to its exempt purpose: offering music CD’s (11 in total ranging from $ to $),
web services (motto, Motto, Motto, and 5 different email services.

The organization also accepted donations (cash and non-cash items) on its website and sold an
EBook authored by BM-1: . BM-1 stated to the Service that the
organization did not have any CD sales in 20XX, that it stopped online transactions in 20XX
despite the fact that the services are still present on the website.

According to BM-1, other activities conducted by the organization include:
BM-1 spoke at youth graduation for basketball players approximately six times,

Held approximately four seminars on restoring credit. Credit seminars are held at CO-3 and are
community events telling about the basics of credit,

Book — - building and repairing credit Score. Only available in e-book
form. The book is available on the website in CD format for $. The book is available for
purchase/donation request, however those who were unable to donate were given the book for
free during the seminar,

Meditation - non traditional ministry services on a spiritual level.

The organization received vehicle donations — (per the initial interview) approximately 12
vehicles in 20XX totaling $. Payee-1 is contracted with has a list
of nonprofits. Individuals donating their vehicle choose which nOnerenit will receive the
donation / funds .

The actual receipts per the bank statements show that the organization received only $
from

Payer Amt Payee Date
$ Payee-1 6/7/20XX
$ Payee-1 8/19/20XX
$ Payee-1 11/10/20XX
Form 886-A rev.4-68) Department of the Treasury - Internal Revenue Service

Page: -5-

*’ Form 886A Department of the Treasury - Internal Schedule No. or
Revenue Service Exhibit
Explanation of Items
Name of Taxpayer: EIN: Year/Period
Ended
ORG
20XX12
$ Payee-1 12/6/20XX
$
$ Payee-1 4/5/20XX

Revenues (other):

The organization receives donations from the public in the form of cash or check.

Payer Amt Payee Date Purpose

CM-1 $ 1/20/20XX Rent Utility Bill
CM-1 $ BM-1 1/28/20XX _ Rent/

CM-1 $ BM-1 3/2/20XX March Rent
CM-1 $ BM-1 4/4/20XX April Rent
CM-1 $ BM-1 5/2/20XX May Rent
CM-1 $ BM-1 6/1/20XXX Rent

$

The organization has not explained to the Service why BM-1 was receiving rent payments or
what activity was conducted to generate rent income and how such activity furthered its exempt

purpose.

Payer Amt Payee Date # Purpose
Payer-9 $ BM-1 4/15/20XX Funeral BM-3 Escrow

The organization has not explained to the Service why this check was paid to BM-1, and how
this activity furthered its exempt purpose.

Payer Amt Payee Date # Memo Explanation
Payer-10 $ Payee-1 8/3/ Business "credit tutoring"
4/15/
CO-4 $ BM-1 Loan Web Loan
4/19/
Payer-11 $ BM-1 Donation
1/20/
Payer-9 $ BM-1 Donation
Payer-12 $ BM-1 4/22/ Love Offering Donation

The organization has not explained to the Service why services and donations were paid to BM-1
rather than ORG. The organization did not fully explain what services constitute “credit
tutoring” for check number for $.

Form 886-A cev.4-68) Department of the Treasury - Internal Revenue Service
Page: -6-

Form 886A Department of the Treasury - Internal Schedule No. or
Revenue Service Exhibit
Explanation of Items
Name of Taxpayer: EIN: Year/Period
Ended
ORG
20XX12
CM-2 $ Payee-1 1/14/20XX Donation
CO-5 $ Payee-1 9/21/20XX TV ad

The following are escrow payments and ‘loans’ made by BM-1 to the org in which no contracts
exist. The loans were purportedly used for general expenses, purchase of supplies, upgrades,
equip, stated in the minutes that they are for 15 years at no interest.

BM-1! $ Loan 8/29/20XX
BM-1 $ Donation 9/14/20XX
BM-1 $ (cash) Funeral BM-3 Escrow __10/14/20XX
BM-1 $ Loan 10/19/20XX
BM-1 $ (cash) Loan 10/28/20XX
BM-1 $ (cash) Loan 12/8/20XX
BM-1 $ (cash) Loan 12/12/20XX
$
BM-2 $ Payee-1 1/18/20XX Loan
BM-2 $ Payee-1 2/11/20XX Loan
BM-2 $ Payee-1 3/11/20XX Donation
BM-2 $ Payee-1 4/11/20XX Loan
BM-1 $ Payee-1 5/11/20XX Loan
BM-1 $ 5/11/20XX Cash Loan
BM-1 $ Payee-1 6/14/20XX Loan
BM-1 $ Payee-1 7/6/20XX Loan
BM-1 $ Payee-1 9/23/20XX Loan
BM-2 $ Payee-1 3/7/20XX Loan
$

BM-1 informed the Service that the organization did not pay him a salary and that BM-1 spent
his time full- time with the organization and did not have any other job or employment. The
source of money constituting the loans to the organization are from real estate mortgage loans
from property owned by BM-1.

The money was used from escrow to pay for the funeral of BM-3
Organization’s Expenses in 20XX

The Organization’s bank statements for checking CO- checking account revealed the following
expenses:

kK kek ok
' Check number from CO-31, was paid to BM-1, Trustee totaling $ for “CO-32”

Form 886-A cev.4-68) Department of the Treasury - Internal Revenue Service
Page: -7-

Form 886A

Department of the Treasury - Internal
Revenue Service
Explanation of Items

Schedule No. or
Exhibit

Name of Taxpayer:

ORG

EIN:

Year/Period
Ended

20XX12

Bank Card payments:
Payee

CO-6 $
Credit cards
Gas
CO-7
CO-8 $
CO-9
CO-10
CO-11 $
CO-12
CO-13
CO-14 $
CO-15
Counter Withdrawals:
Counter Check
Counter Check
ATM Withdrawals:
Checks:
Payee
BM-1
Tax Collector

Total

$ (personal credit cards)
$
$

$
$
$
$

$

Total Date
$ 4/4/20XX
$ 8/31/20XX
$ throughout the year

Total
$ 8/30/20XX

Parcel $ Check number
Check number was for property Tax for address, City, XYZ, BM-1’s personal address.

CO-2

CO-16.

CO-17

CO-1

CO-18

CO-19 $

CO-20

CO-23 $

CO-21

CO-22 $

Unknown

$
$
$
$
$
$
$ Check number dated 3/2/20XX

Form 886-Acrev.4-68)

Department of the Treasury - Internal Revenue Service

Page: -8-

Form 886A Department of the Treasury - Internal Schedule No. or
Revenue Service Exhibit
Explanation of Items
Name of Taxpayer: EIN: Year/Period
Ended
ORG
20XX12

Form 4564, Information Document Request (IDR) 02, was mailed to the organization on June
25,20XX asking the organization to provide the purpose of each expense, and how did each
expense further the organization's exempt purpose? Provide supporting documentation. The
organization did not provide any supporting documentation in the form of receipts or any other
contemporaneous substantiation to show how these expenditures further the organization’s
exempt purpose. The organization’s response to the IDR was a resolution of Board of Directors
of ORG, Inc, which simply stated that “the Treasurer of this corporation is hereby authorized and
directed to reimburse BM-1, President, for moneys advanced and expensed incurred and paid for
by and in connection with the proper business purposes of this corporation.”

The only substantiation provided by the organization include a receipt from CO-24 for a vault
purchase for $ an invoice from WK-1 for $ regarding CO-25, receipt from CO-26 for $, all of
which do not relate to the organization’s exempt purpose. The organization did provide a receipt
for cash purchase for a camera and equipment from CO-27 for $, however, this expenditure is not
reflected in the organizational expenses listed above in this report.

The organization The Organization has not shown to the Service that these expenditures
furthered its exempt purpose.

Law:

a. Requirement for Exemption under IRC 501(c)(3) Section 501(c)(3) of the Internal Revenue
Code provides for the exemption from federal income tax of organizations that are organized and
operated exclusively for charitable purposes, no part of the net earnings of which inures to the
benefit of any private shareholder or individual.

Section 1.501(c)(3)-1(a)(1) of the Income Tax Regulations provides that an organization must be
both organized and operated exclusively for one or more of the purposes specified in section
501(c)(3) of the Code in order to be exempt as an organization described in such section.

Section 1.501(c)(3)-1(c)(1) of the regulations provides that an organization will be regarded as
“operated exclusively” for one or more exempt purposes only if it is engaged primarily in
activities that accomplish one or more of such exempt purposes specified in section 501(c)(3).
An organization will not be so regarded if more than an insubstantial part of its activities is not in
furtherance of an exempt purpose.

Section 1.501(c)(3)-1(c)(2) of the regulations provides that an organization is not operated
exclusively for one or more exempt purposes if its net earnings inure in whole or in part to the
benefit of private shareholders or individuals.

Form 886-A crev.4-68) Department of the Treasury - Internal Revenue Service
Page: -9-

Form 886A Department of the Treasury - Internal Schedule No. or
Revenue Service Exhibit
Explanation of Items
Name of Taxpayer: EIN: Year/Period
Ended
ORG
20XX12

Section 1.501(c)(3)-1(d)(ii) of the regulations states that an organization is not organized or
operated for one or more exempt purposes unless it serves a public rather than a private interest.
Accordingly, it is necessary for an organization to establish that it is not organized or operated for
the benefit of private interests such as designated individuals, the creator, shareholders, or
persons controlled, directly or indirectly, by such private interests.

Treas. Reg. §1.501(a)-1(c) defines a private shareholder or individual as those persons having a
personal and private interest in the activities of an organization. In general, a private shareholder
or individual is considered an “insider” with respect to the exempt organization.

Section 1.6033-2(i)(2) of the Income tax regulations provides that "Every organization which is
exempt from tax, whether or not it is required to file an annual information return shall submit
such additional information as may be required by the Internal Revenue Service for the purpose
in inquiring into its exempt status and administering the provisions of subchapter F (section 501
and following), chapter 1 of subtitle A of the Code...."

b. Cases: Existence of a Substantial Single Non-Exempt Purpose, can Destroy Exemption under
501(c)(3)

Better Business Bureau v. United States, 316 U.S. 279 (1945), holds that the existence of a single
non-exempt purpose, if substantial in nature, will destroy the exemption under section 501(c)(3).
An organization will be regarded as operated exclusively for one or more exempt purposes only
if it engages primarily in activities that accomplish one or more of such purposes.

c. Cases Where Exemption under 501(c)(3) Was Revoked Due to Inurement or Private Benefit

Unitary Mission Church of Long Island, Petitioner v. Commissioner of Internal Revenue,
Respondent 74 TC 507, Filed June 3, 1980--The court found: “Net earnings benefited private
individuals. ]--Petitioner’s financial decisions are controlled by X, one of petitioner’s ministers,
and his wife. X received widely fluctuating ‘parsonage allowances’ over a three year period as
compensation for leading Sunday services and for being available for pastoral counseling. There
is no evidence in the administrative record of any differing duties that he performed over these
years. .... Held, petitioner is not entitled to exemption from Federal taxation under secs. 501 (a)
and 501(c)(3), I.R.C. 1954, as amended, because a part of its net earnings inures to the benefit of
private shareholders or individuals”.

People of God Community, Petitioner v. Commissioner of Internal Revenue, respondent 75 TC
127, Filed October 14, 1980- The tax court decided that a portion of gross earnings inured to the
benefit of private shareholders or individuals. The court stated: “An organization will qualify
under section 501(c)(3) only if (1) it is organized and operated exclusively for exempt purposes,

Form 886-A rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -10-

Form 886A Department of the Treasury - Internal Schedule No. or

Revenue Service Exhibit
Explanation of Items
Name of Taxpayer: EIN: Year/Period
Ended
ORG
20XX12

(2) no part of its net earnings inures to the benefit of any private shareholder or individual, and
(3) it devotes no substantial part of its activities to political or lobbying activity...

Respondent argues that petitioner’s loan policies and ministers’ compensation each demonstrate
both private inurement of net earnings and prohibited private purposes. While not necessarily
identical, the prohibitions against private inurement and private purposes overlap to a great
extent ... we will confine our discussion herein to the private inurement issue....

... The burden falls upon petitioner to establish the reasonableness of the compensation paid to
Donhowe and petitioner’s other ministers. Bubbling Well Church of Universal Love Inc. v.
Commissioner [Dec. 36,999], 74 T.C. 531 (1980). Petitioner has failed to do so inasmuch as the
record on this point contains little more than conclusory assertions and the fact that Dowhowe’s
compensation was partly based on his personal needs. Moreover, the method by which
ministers’ compensation was determined shows clearly that a part of petitioner’s net earnings
was paid to private shareholders or individuals.”

In Founding Church of Scientology v. U.S., 412 F.2d 1197 (Ct. Cl. 1969), a wide variety of
devices were employed, including fees, commissions, excessive rental payments, loans and
excessive salaries, to divert the organization's funds to its founder, L. Ron Hubbard, and his
immediate family. The principle of inurement was summarized when the Court stated, "what
emerges from these facts is the inference that the Hubbard family was entitled to make ready
personal use of the corporate earnings."

In John Marshall Law School v. U.S., 81-2 U.S.T.C. 9514 (Ct. Cl. 1981), in which the Court
found that the Commissioner acted properly in revoking exemption under IRC 501(c)(3) on the
grounds of inurement to the controlling officers and their families. The inurement included, but
was not limited to, payments to the families as follows: automobile, education and travel
expenses, insurance policies, basketball and hockey tickets, membership in a private eating
establishment, membership in a health spa, interest-free loans, home repairs, personal household
furnishings and appliances, and golfing equipment.

In Texas Trade School v. Commissioner 30 TC 642, Filed June 18, 1958 [1939 Code Sec.
101(6)--same as 1954 Code Sec. 501(c)(3)] Under “Opinion” the judge stated:

“Section 101(6) of the Internal Revenue Code of 1939, in so far as here material, provides for
exemption from taxation of corporations organized and operated exclusively for educational
purposes “no part of the net earnings of which inures to the benefit of any private shareholder or
individual.”

The respondent determined that the petitioner was not entitled to exemption from taxation under
Section 101(6) for the years ended May 31, 1947 and May 31, 1948. The basis of his
determination was that five individuals, members of the Jennings group, shared in petitioner’s

Form 886-A (rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -11-

Form 886A Department of the Treasury - Internal Schedule No. or
Revenue Service Exhibit
Explanation of Items
Name of Taxpayer: EIN: Year/Period
Ended
ORG
20XX12

net earnings as the result of the payment to them of excessive and unreasonable rent for real
estate leased to or used by petitioner and as the result of the construction by petitioner of
buildings and improvements which attached to and became part of their real estate. The burden
of proving that the respondent erred in his determination was on the petitioner. It has not
sustained this burden.”

In US-CT-APP-5, [60-1 USTC 99371], Birmingham Business College, Inc.; John Ike Griffith;
Hulon A. Spears and Audrey Spears; Carl B. Carter and Jewell Carter, and Jewell Carter,
Petitioners v. Commissioner of Internal Revenue, Respondent , (Apr. 04, 1960); The court
found that: “Taxpayer, an incorporated business college owned and operated by a brother and
two sisters, was not a tax-exempt educational ... Substantial portions of its net earnings were
distributed to its owner-operators for their personal benefit.”

In US-CT-APP-8, [63-1 USTC $9200], Cleveland Chiropractic College, a Corporation,
Petitioner v. Commissioner of Internal Revenue, Respondent,--, (Jan. 17, 1963) Affirming Tax
Court, 21 TCM 1, Dec. 25,299(M), T. C. Memo. 1962-1 [1939 Code Sec. 101(6)--similar to
1954 Code Sec. 501]--The court found: “A college was not entitled to exemption from corporate
income tax for 1948-1951 where part of the net earnings of the college was found to have inured
to the benefit of one of its trustees through payment of his personal expenses.”

Revenue Ruling 73-127, 1973-1 CB 221, (Jan. 01, 1973)

A nonprofit organization that operates a cut-price retail grocery outlet and allocates a small
portion of its earnings to provide on-the-job training to hard-core unemployed does not qualify
for exemption from income tax.

Advice has been requested whether the activities of the organization described below qualify for
exemption from Federal income tax under section 501(c)(3) of the Internal Revenue Code of
1954 where the organization otherwise qualifies for such exemption.

The organization was formed to operate a retail grocery store to sell food to residents of a poverty
area at prices substantially lower than those charged by competing grocery stores, to provide free
grocery delivery service to residents who need it, to participate in the Federal food stamp
program, and to provide job training for unemployed residents

The store is operated by a staff of employees experienced in the retail food industry. The store is
operated in a manner similar to profit-making businesses in the area, but has a smaller markup
than the competing stores. The organization is organized as a nonprofit corporation and no
individual has any proprietary interest in its earnings. The store’s gross earnings are used
principally to pay salaries and other customary operating expenses incurred in the operation of a
retail grocery store and to expand the operations of the store. About two percent of earnings is
retained as surplus, to be used as a contingency reserve.

Form 886-Acrev.4-68) Department of the Treasury - Internal Revenue Service
Page: -12-

Form 886A Department of the Treasury - Internal Schedule No. or
Revenue Service Exhibit
Explanation of Items
Name of Taxpayer: EIN: Year/Period
Ended
ORG
20XX12

About four percent of the store’s earnings is allocated for use in a continuous training program
for the hard-core unemployed. The organization selects only individuals from the hard-core
unemployed of the poverty area for training in the various jobs in a retail food store. The training
program includes lectures, demonstrations of retail store techniques, and on-the-job training. A
trainee receives a small salary during the training period. At the conclusion of his training, he is
qualified for employment in the retail food industry. The organization does not plan for the
majority of the trainees to continue as its employees. Rather, they are expected to seek
employment elsewhere in the retail food industry and new trainees are selected for the program.

Section 501(c)(3) of the Code provides for the exemption from Federal income tax of
organizations organized and operated exclusively for charitable or educational purposes.

Section 1.501(c)(3)-1(a)(1) of the Income Tax Regulations provides that to be exempt an
organization must be both organized and operated exclusively for one or more exempt purposes.

Section 1.501(c)(3)-1(d)(2) of the regulations defines the term “charitable” as used in section
501(c)(3) of the Code as including the relief of the poor and distressed or of the under-privileged
and the advancement of education.

Section 1.501(c)(3)-1(d)(3)(i)(a) of the regulations defines the term “educational” as including
the instruction or training of the individual for the purpose of improving or developing his
capabilities.

The organization’s purpose of providing job training for the hard-core unemployed is charitable
and educational within the meaning of the common law concept of charity, section 501(c)(3) of
the Code, and sections 1.501(c)(3)-1(d)(2) and 1.501(c)(3)-1(d)(3)()(a) of the regulations.
However, the organization’s purpose of operating a retail grocery store where food is sold to
residents of a poverty area at low prices is not recognized as a charitable purpose under the basic
common law concept of charity and within the meaning of section 501(c)(3) of the Code and
section 1.501(c)(3)-1(d)(2) of the regulations.

Although the nature of the job training in this case is primarily “on-the-job” training and thus
requires the existence of an operating business as its “campus,” the size and manner of the food
store operation and the facts relating to the actual purpose of the undertaking evidence that the
operation of the store as a low cost retail grocery outlet is in itself an independent objective of the
organization. This is true notwithstanding that the store operation is used in part as a vehicle for
the training program. It is conducted on a scale larger than is reasonably necessary for the
performance of the organization’s training program and was not intended to, nor does it in fact,
serve solely as a vehicle for carrying out the training program of the organization.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -13-

Form 886A Department of the Treasury - Internal Schedule No. or
Revenue Service Exhibit
Explanation of Items
Name of Taxpayer: EIN: Year/Period
Ended
ORG
20XX12

Neither may the store operation be characterized as an investment or business undertaking for the
production of income for use in carrying on qualified charitable purposes of the organization.
The facts show that such is not the purpose of the undertaking, but that the store is operated in
part for the purpose of providing a low cost retail grocery outlet in the community as an end in
itself.

Thus, it is concluded that operation of the store and operation of the training program are two
distinct purposes, that is, ends or objects sought to be accomplished by the organization through
use of its resources. Since the former purpose is not a recognized charitable purpose, the
organization is not organized and operated exclusively for charitable purposes.

Accordingly, it is held that the organization does not qualify for recognition of exemption from
Federal income tax under section 501(c)(3) of the Code.

Rev. Rul 59-95, An organization previously held exempt from Federal income tax was requested
to produce a financial statement as of the end of the year and a statement of its operations during
such year. However, its records were so incomplete that it was unable to furnish such statements.
Section 6033 of the Internal Revenue Code of 1954 provides that every organization, except as
provided therein, exempt from taxation under section 501(a) of the Code shall file an annual
return, stating specifically the items of gross income, receipts, and disbursements, and shall keep
such records, render under oath such statements, make such other returns and comply with such
rules and regulations as the Secretary of the Treasury or his delegate may from time to time
prescribe. Held, failure or inability to file the required information return or otherwise to comply
with the provision of section 6033 of the Code and the regulations which implement it, may
result in the termination of the exempt status of an organization previously held exempt, on the
grounds that the organization has not established that it is observing the conditions required for
the continuation of an exempt status.

Taxpayer’s Position
Is yet to be received

Government’s Position

Is ORG operating exclusively for public, charitable, and educational purposes described in
Internal Revenue Code (IRC) § 501(c)(3) in which no part of its net earnings inure to the benefit
of any private shareholder or individual?

The Government contends that ORG failed the operational test of IRC 501(c)(3) on the following
grounds:

Form 886-Acrev.4-68) Department of the Treasury - Internal Revenue Service
Page: -14-

' Form 886A Department of the Treasury - Internal Schedule No. or
Revenue Service Exhibit
Explanation of Items
Name of Taxpayer: EIN: Year/Period
Ended
ORG
20XX12

ORG’s earnings inured to the benefit of its private shareholders, and a substantial part of the
organization’s activities are in the furtherance of non exempt activities, thus it did not operate
exclusively for one or more exempt purposes as required under Treas. Reg. 1.501(c)(3)-1()(2).
ORG’s key officer and shareholder is BM-1, as he meets the definition of such under Treas. Reg.
§1.501(a)-1(c) because he is a “person having a personal and private interest in the activities of
an organization.” BM-1 devoted all of his time to the organization and was not an employee nor
did he received any salary or compensation from the organization. The organization did not file
any W-2 or Forms 1099-MISC on behalf of BM-1.

ORG’s earnings inured to its shareholders by way of:

(1) paying the organization’s funds for the personal expenses of its shareholder, BM-1. ORG
paid BM-1’s personal credit card expenses totaling , property tax payment for BM-1’s personal
residence totaling $, CO-6 for personal use $, bank counter withdrawals totaling $, ATM
Withdrawals totaling $ throughout the year, check payable to the key officer BM-1 for $ on
8/30/20XX, and the following other miscellaneous expenses:

CO-2 $
CO-16.

CO-17

Co-1

CO-18

CO-19 $

CO-20 $
CO-23 $

CO-21 $

CO-22 $

FPA eA

Unknown (# dated 3/2/ $

The Service asked the organization to show how each of these expenditures furthered the
organization’s exempt purpose, and the organization was unable to show the Service any
contemporaneous substantiation or the purpose of these expenses. Thus, ORG operated in a way
that was comparable to the organizations described in Birmingham Business College, Cleveland
Chiropractic College, and Texas Trade School ,and;

(2) The organization engaged in substantial activities that were unrelated to the organization’s
exempt purpose.

(a) The organization’s web services generated $ and is unrelated to the organization’s exempt
purpose. The web services consisted of maintaining websites for local businesses. The web
services represent 8.66% of the organization’s activities.

Form 886-A crev.4-68) Department of the Treasury - Internal Revenue Service
Page: -15-

’ Form 886A Department of the Treasury - Internal Schedule No. or
Revenue Service Exhibit
Explanation of Items
Name of Taxpayer: EIN: Year/Period
Ended
ORG
20XX12

(b) The organization also received $ from Check number from CO-31, which was payable to
BM-1, Trustee totaling $ for “CO-32” and deposited into ORG. However, BM-1 stated this
amount was a loan to the organization. The organization also received cash from BM-1 totaling
$ for Funeral BM-3. It appears these two amounts were earmarked for the funeral expenses. The
receipts provided relating to the funeral totaled $ ($ vault, $ — attorney, $ funeral services) or
39.88% of the organization’s total expenses and 34.9% of the organization’s gross receipts.

The organization’s gross receipts were $ for 20XX. Although BM-1 asserts that the amounts he
‘loaned’ to the organization were in fact loans, the mere declaration that the funds were intended
on being loans is insufficient since the transaction fails to exhibit reliable indicia of debt. See
Williams v. Commissioner, 627 F.2d 1032, 1034 (10" Cir. 1980). There was no promissory note
or other evidence of indebtedness, no interest charged, no security or collateral, no records
maintained. See Vinikoor v. Commissioner, TC Memo 1998-152. The Service contends that
these amounts should have been included in the organization’s gross receipts in which ORG
would be liable for filing a Form 990.

Conclusion

As described above, ORG’s recognition as an organization described under section 501(c)(3)
should be revoked effective January 1, 20XX, because it did not operate exclusively for 501(c)(3)
exempt purposes. The Organization’s income inured to, and served, the private interests of its
shareholder. Form 1120 US Income Tax Return should be filed for tax years ending December
31, 20XX. Subsequent returns are due no later than the 15" day of the 3 month following the
close of the Corporation’s accounting period. Returns should be sent to the following mailing
address:

Form 886-A cev.4-68) Department of the Treasury - Internal Revenue Service
Page: -16-

DEPARTMENT OF THE TREASURY
Internal Revenue Service
Tax Exempt & Government Entities
450 Golden Gate Avenue, MS 7401
TAX EXEMPT AND San Francisco, CA 94102-3412

GOVERNMENT ENTITIES
DIVISION

October 26, 2007

Taxpayer Identification Number:

ORG
ADDRESS Form:

Tax Year(s) Ended:
Person to Contact/ID Number:

Contact Numbers:
Telephone:
Fax:

Certified Mail - Return Receipt Requested

Dear

We have enclosed a copy of our report of examination explaining why we believe
revocation of your exempt status under section 501(c)(3) of the Internal Revenue Code
(Code) is necessary.

If you accept our findings, take no further action. We will issue a final revocation letter.

if you do not agree with our proposed revocation, you must submit to us a written
request for Appeals Office consideration within 30 days from the date of this letter to
protest our decision. Your protest should include a statement of the facts, the
applicable law, and arguments in support of your position.

An Appeals officer will review your case. The Appeals office is independent of the
Director, EO Examinations. The Appeals Office resolves most disputes informally and
promptly. The enclosed Publication 3498, The Examination Process, and Publication
892, Exempt Organizations Appeal Procedures for Unagreed Issues, explain how to
appeal an Internal Revenue Service (IRS) decision. Publication 3498 also includes
information on your rights as a taxpayer and the IRS collection process.

You may also request that we refer this matter for technical advice as explained in
Publication 892. If we issue a determination letter to you based on technical advice, no
further administrative appeal is available to you within the IRS regarding the issue that
was the subject of the technical advice.

Letter 3618 (04-2002)
Catalog Number 34809F

If we do not hear from you within 30 days from the date of this letter, we will process
your case based on the recommendations shown in the report of examination. If you do
not protest this proposed determination within 30 days from the date of this letter, the
IRS will consider it to be a failure to exhaust your available administrative remedies.
Section 7428(b)(2) of the Code provides, in part: "A declaratory judgment or decree
under this section shall not be issued in any proceeding unless the Tax Court, the
Claims Court, or the District Court of the United States for the District of Columbia
determines that the organization involved has exhausted its administrative remedies
within the Internal Revenue Service." We will then issue a final revocation letter. We
will also notify the appropriate state officials of the revocation in accordance with section
6104(c) of the Code.

You have the right to contact the office of the Taxpayer Advocate. Taxpayer Advocate
assistance is not a substitute for established IRS procedures, such as the formal
appeals process. The Taxpayer Advocate cannot reverse a legally correct tax
determination, or extend the time fixed by law that you have to file a petition in a United
States court. The Taxpayer Advocate can, however, see that a tax matter that may not
have been resolved through normal channels gets prompt and proper handling. You
may call toll-free 1-877-777-4778 and ask for Taxpayer Advocate Assistance. If you
prefer, you may contact your local Taxpayer Advocate at:

If you have any questions, please call the contact person at the telephone number
shown in the heading of this letter. If you write, please provide a telephone number and
the most convenient time to call if we need to contact you.

Thank you for your cooperation.

Sincerely,

Marsha A. Ramirez
Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Report of Examination

Letter 3618 (04-2002)
Catalog Number 34809F