Determination 1033039: IRS revoked a private school’s section 501(c)(3) exemption

Plain-English summary

The IRS revoked a private school’s section 501(c)(3) exemption because the school failed to establish that it operated exclusively for exempt purposes and failed to overcome the inference of racial discrimination arising from its history and operations. The school had adopted a nondiscrimination policy and reported some outreach and minority enrollment, but the IRS found those steps insufficient under the facts presented. The determination also relied on the school’s limited minority enrollment, lack of Black faculty and administrators, and failure to show intensive, comprehensive, and good-faith efforts to reach the Black community. The revocation meant that donors could not deduct contributions under section 170 and that the school had to file federal income tax returns.

Ruling snapshot

• Question: Did the private school overcome the inference of racial discrimination and satisfy the operational test for section 501(c)(3) exemption?
• Outcome: Revocation
• Key authorities: IRC §§ 170, 501(c)(3), 6104(c), 6110, and 7428; Treas. Reg. § 1.501(c)(3)-1; Rev. Rul. 71-447; Rev. Proc. 75-50

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

U.I.L. – 501.03-23 No Third Party Contacts

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Release Number: 201033039 Contact Person:
Release Date: 8/20/10

Date: May 28, 2010 Identification Number:

Contact Number:
Employer Identification Number:
Form Required To Be Filed:

Tax Years:

Dear

This is our final determination that you do not qualify for exemption from Federal income tax
under Internal Revenue Code section 501(a) as an organization described in Code section
501(c)(3).

We made this determination for the following reason(s): You failed to establish that you
operated exclusively for exempt purposes described in section 501(c)(3) of the Code. You
failed to demonstrate that you have taken sufficient steps to overcome inference of racial
discrimination in your operation of a school.

Because you do not qualify for exemption as an organization described in Code section
501(c)(3), donors may not deduct contributions to you under Code section 170. You must file
Federal income tax returns on the form and for the years listed above within 30 days of this
letter, unless you request an extension of time to file. File the returns in accordance with their
instructions, and do not send them to this office. Failure to file the returns timely may result in a
penalty

If you decide to contest this determination under the declaratory judgment provisions of Code
section 7428, you must initiate a suit in the United States Tax Court, the United States Court of
Federal Claims, or the District Court of the United States for the District of Columbia before the
91st day after the date that we mailed this letter to you. Contact the clerk of the appropriate
court for rules for initiating suits for declaratory judgment. Filing a declaratory judgment suit
under Code section 7428 does not stay the requirement to file returns and pay taxes.

We will make this letter and our proposed adverse determination letter available for public
inspection under Code section 6110, after deleting certain identifying information. Please read
the enclosed Notice 437, Notice of Intention to Disclose, and review the two attached letters that
show our proposed deletions. If you disagree with our proposed deletions, you should follow

the instructions in Notice 437. If you agree with our deletions, you do not need to take any
further action.

In accordance with Code section 6104(c), we will notify the appropriate State officials of our
determination by sending them a copy of this final letter and the proposed adverse letter. You
should contact your State officials if you have any questions about how this determination may
affect your State responsibilities and requirements.

If you have any questions about this letter, please contact the person whose name and
telephone number are shown in the heading of this letter. If you have any questions about your
Federal income tax status and responsibilities, please contact IRS Customer Service at
1-800-829-1040 or the IRS Customer Service number for businesses, 1-800-829-4933. The
IRS Customer Service number for people with hearing impairments is 1-800-829-4059.

Sincerely,

Robert Choi
Director, Exempt Organizations
Rulings & Agreements

Enclosure
Notice 437
Redacted Proposed Adverse Determination Letter
Redacted Final Adverse Determination Letter

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND GOVERNMENT ENTITIES
U.I.L. – 501.03-23 No Third Party Contacts
DIVISION
Release Number: Contact Person:
Release Date: 8/20/10
Date: May 28, 2010 Identification Number:
Contact Number:
Employer Identification Number:
Form Required To Be Filed:
Tax Years:
Dear

This is our final determination that you do not qualify for exemption from Federal income tax
under Internal Revenue Code section 501(a) as an organization described in Code section
501(c)(3).

We made this determination for the following reason(s): You failed to establish that you
operated exclusively for exempt purposes described in section 501(c)(3) of the Code. You
failed to demonstrate that you have taken sufficient steps to overcome inference of racial
discrimination in your operation of a school.

Because you do not qualify for exemption as an organization described in Code section
501(c)(3), donors may not deduct contributions to you under Code section 170. You must file
Federal income tax returns on the form and for the years listed above within 30 days of this
letter, unless you request an extension of time to file. File the returns in accordance with their
instructions, and do not send them to this office. Failure to file the returns timely may result in a
penalty.

If you decide to contest this determination under the declaratory judgment provisions of Code
section 7428, you must initiate a suit in the United States Tax Court, the United States Court of
Federal Claims, or the District Court of the United States for the District of Columbia before the
91st day after the date that we mailed this letter to you. Contact the clerk of the appropriate
court for rules for initiating suits for declaratory judgment. Filing a declaratory judgment suit
under Code section 7428 does not stay the requirement to file returns and pay taxes.

We will make this letter and our proposed adverse determination letter available for public
inspection under Code section 6110, after deleting certain identifying information. Please read
the enclosed Notice 437, Notice of Intention to Disclose, and review the two attached letters that
show our proposed deletions. If you disagree with our proposed deletions, you should follow

the instructions in Notice 437. If you agree with our deletions, you do not need to take any
further action.

In accordance with Code section 6104(c), we will notify the appropriate State officials of our
determination by sending them a copy of this final letter and the proposed adverse letter. You
should contact your State officials if you have any questions about how this determination may
affect your State responsibilities and requirements.

If you have any questions about this letter, please contact the person whose name and
telephone number are shown in the heading of this letter. If you have any questions about your
Federal income tax status and responsibilities, please contact IRS Customer Service at
1-800-829-1040 or the IRS Customer Service number for businesses, 1-800-829-4933. The
IRS Customer Service number for people with hearing impairments is 1-800-829-4059.

Sincerely,

Robert Choi
Director, Exempt Organizations
Rulings & Agreements

Enclosure
Notice 437
Redacted Proposed Adverse Determination Letter
Redacted Final Adverse Determination Letter

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES
U.I.L. – 501.03-23 No Third Party Contacts
DIVISION

Contact Person:

Date: April 15, 2010
Identification Number:

Contact Number:
FAX Number:

Employer Identification Number:

Legend:

Date 1
Date 2
Date 3
Date 4
Date 5
School
City
County
State

Dear

This refers to your application for recognition of exemption from Federal income tax under
Internal Revenue Code section 501(a).

We have previously issued you a ruling recognizing you as exempt under section 501(c)(3) of
the Code, which we subsequently revoked. You petitioned the court for the retention of your
exempt status, which on Date 3, the Tax Court decided that you are not exempt under section
501(c)(3) retroactive to Date 2.

We have considered your re-application for recognition of exemption under section 501(c)(3) of
the Code, which you filed on Date 4. Based on the information provided, we have concluded
that you do not qualify for exemption under Code section 501(c)(3). The basis for our
conclusion is set forth below.

You were incorporated on Date 1 under the laws of the State for the purpose of operating one or
more schools as nonprofit institutions of learning. You were formed a month after a court
ordered desegregation of school districts in the County and other counties in State.

You operate School in the City within the County of State. The City’s racial population is
approximately 95% black and 5% white.

You began to operate School two months after your incorporation with 8 students enrolled in
Grade 1. You expanded the operation of School the following school year in which you offered
Grades 2 - 8 and after 4 years offered Grades 9-12. You currently offer grades K3 - 12.

You have operated School for almost 45 years but no information indicates that you have
enrolled black students until the school year ending 2007. You indicated that you had 1 black
student in your total student body of 195 for the school year ending 2007, 1 black student in
your total student body of 183 for the 2008 school year and 3 black students in your total
student body of 150 for the 2009 school year. The racial composition of the rest of the student
body for each of those years was white except for 1 American Indian in 2008. You now indicate
that the current school year ending has a total student body of 163 consisting of 156 white
and 7 black students. You also indicated that all but one of these black students was provided
financial assistance for enrollment.

One month prior to the date of filing your exemption application on Date 4, you amended your
Bylaws to include your adoption of a nondiscriminatory policy. That amendment states that any
school you operate will “comply with all non-discriminatory policies as required under section
501(c)(3) of the Internal Revenue Code.” You indicated that you changed the wording of the
non-discriminatory policy to reflect the applicable statement to students. You state that the
newly worded policy will be adopted by your Board in The newly worded policy is as
follows:

School admits students of any race, color, national and ethnic origin to all the rights,
privileges, programs, and activities generally accorded or made available to students at
the school. It does not discriminate on the basis of race, color, national and ethnic origin
in administration of its educational policies, admission policies, scholarship and loan
programs, athletic and other school-administered programs.

This policy is included in your annual advertisements on newspapers in the County, your
website, in student admission contracts and registration forms, and student handbooks.

You indicate that your main outreach for black enrollment is your annual newspaper
advertisement. The submitted copies of newspaper advertisement do not include languages
designed to attract black enrollment. Instead, one copy of such advertisements for school year

shows the date and time of “open house” registration for kindergarten classes, 50%
tuition reduction on 1st semester for new students, certain school promotions described under
the heading of “We Offer’, and a statement of the nondiscriminatory policy. You indicated that
you do not hold annual “open house” but have held a couple a few years ago. You indicated
other outreach efforts to have included sending letters and having contacted and met with some
black families within the community.

You have also advertised on radio. A submitted transcript of a 30-second radio advertisement
did not include a statement of your nondiscriminatory policy. You stated, however, that the
failure to include the nondiscriminatory policy in the radio commercial was a mistake.

School operates with no black person in its faculty or administrative staff. All members of its
faculty and administrative staff are white. You indicated distributing applications to black
teachers who inquire about vacancies but no black teachers have ever submitted applications
for position at School. You stated that your difficulty in recruiting black teachers is because of
the significant difference in compensation between the salaries of your teachers, which you
indicated as approximately % of those in the State’s public schools. However, you had 1
black teacher in school year ending 2009 and another 1 black teacher and 1 dual enrollment
coordinator in school year ending The black teachers and the coordinator were not part
of your faculty nor were they staff members. Instead, they were provided and their salaries
were paid by an unrelated school.

While lagging in enrollment of black students and employment of black teachers and
administration staff, you did however, employ 3 black persons working separately as a
maintenance worker, janitor and driver.

The State has a program established to provide for distribution and free loan of textbooks to
students of any participating public, private and other nonpublic schools. Under the rules
promulgated by the State Board of Education, an eligible school must have received
accreditation status and documented that it operates in a non-discriminatory manner in its
admission and enrollment practices. Notwithstanding the benefits of free textbook that the
program will provide your students and the school, you indicated that you “very seldom
participate” in that program and choosing instead to “order (books) directly from publishers for
lower prices as well as having books that are not ‘watered’ down.” It appears, however, that
several years ago, you withdrew entirely from participation in the program.

Section 501(c)(3) of the Code provides, in part, for the exemption from federal income tax of
organizations organized and operated exclusively for educational, charitable or other exempt
purposes.

Section 1.501(c)(3)-1(c)(1) of the Income Tax Regulations (regulations) provides that an
organization will be regarded as “operated exclusively” for one or more exempt purposes only if
it engages primarily in activities which 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(d)(1)(ii) of the regulations provides that an organization is not organized or
operated exclusively for one or more of the purposes unless it serves a public rather than a
private interest.

Rev. Rul. 71-447, 1971-2 C.B. 230, provides that a private school which does not have a racially
nondiscriminatory policy as to students does not qualify for exemption from federal income tax
under section 501(c)(3) of the Code. It defines a racially nondiscriminatory policy to mean “the
school admits the students of any race to all the rights, privileges, programs, and activities
generally accorded or made available to students at that school and that the school does not

discriminate on the basis of race in administration of its educational policies, admissions
policies, scholarship and loan programs, and athletic and other school-administered programs."

Rev. Proc. 75-50, 1975-2 C.B. 587, sets forth guidelines and recordkeeping requirements for
determining whether private schools that are applying for recognition of exemption from federal
income tax under section 501(c)(3) of the Code or are presently recognized as exempt from tax
have racially nondiscriminatory policies as to students. Section 2.02 provides that a school must
show affirmatively both that it has adopted a racially nondiscriminatory policy as to students that
is made known to the general public and that since the adoption of that policy the school has
operated in accordance therewith. Section 4.03 provides that a school must make its racially
nondiscriminatory policy known to all segments of the general community served by the school.
A school may demonstrate that it follows a racially nondiscriminatory policy by showing
enrollment of student of racial minority groups in meaningful numbers and whether that is
satisfied will be determined on the basis of facts and circumstances of each case. Actual
enrollment, however, is a meaningful indication of a racially nondiscriminatory policy in the case
in which schools become subject to desegregation orders of a federal court or otherwise
expressly became obligated to implement a desegregation plan under the terms of any written
contracts or other commitment to which any Federal agency was a party.

Section 4.07 of Rev. Proc. 75-50 also provides that the existence of a racially discriminatory
policy with respect to employment of faculty and administrative staff is indicative of a racially
discriminatory policy as to students.

In Green v. Connally, 330 F. Supp. 1150(D. D.C. 1971), affd sub nom., Coit v. Green, 404 U.S.
997, 92 S. Ct. 564, 30 L. Ed. 2d 550 (1971), and in the revised injunction orders issued on May
5 and June 2, 1980, the Internal Revenue Service is prohibited from:

according .. . and from continuing the tax-exempt status now enjoyed by, all Mississippi
private schools or the organizations that operate them, which: (1) have in the past been
determined in adversary or administrative proceedings to be racially discriminatory, or
were established or expanded at or about the time the public school districts in which
they are located or which they serve were desegregating, and which cannot demonstrate
that they do not racially discriminate in admissions, employment, scholarships, loan
programs, athletics, and extra-curricular programs. (2) The existence of conditions set
forth in paragraph (1) herein raises an inference of present discrimination against blacks.
Such inference may be overcome by evidence which clearly and convincingly reveals
objective acts and declarations establishing that such is not proximately caused by such
school's policies and practices. Such evidence might include, but is not limited to, proof
of active and vigorous recruitment programs to secure black students or teachers,
including students’ grants in aid; or proof of continued meaningful public advertisements
stressing the school's open admissions policy; or proof of meaningful communication
between the school and black groups and black leaders within the community
concerning the school's nondiscrimination policies, and any other similar evidence
calculated to show that the doors of the private school and all facilities and programs
therein are indeed open to students or teachers of both the black and white races upon
the same standard of admission or employment.

In Prince Edward Sch. Found. v. Commissioner, 478 F. Supp. 107 (D. D.C. 1979), affd, D.C.
Cir. June 30, 1980, cert. denied, 450 U.S. 944, 101 S. Ct. 1408, 67 L. Ed. 2d 376 (1981), the
court held that private schools administering racially discriminatory admissions policies are
excluded from tax-exempt status under section 501(c)(3) of the Code. The court further held
that the foundation had failed to meet is burden of establishing its entitlement to exemption
under section 501(c)(3) because the foundation's record was completely devoid of evidence that
it was administering a nondiscriminatory admissions policy. The court also stated that the
inference that the plaintiff administered a racially discriminatory policy may be drawn from the
circumstances surrounding the school's establishment. Similar inferences as to the existence of
a racially discriminatory policy based on facts surrounding a school's establishment and lack of
minority enrollment have been drawn by other courts.

In Norwood v. Harrison, 382 F. Supp. 921 (N.D. Miss. 1974) on remand from the Supreme
Court, 413 U.S. 455, 93 S. Ct. 2804, 37 L. Ed. 2d 723 (1973) and Brumfield v. Dodd, 425 F.
Supp. 528 (E.D. La. 1976), the courts held that a prima facie case of racial discrimination arises
from proof (a) that the schools' existence began close upon the heels of the massive
desegregation of public schools within its locale, and (b) that no blacks are or have been in
attendance as students and none is or has ever been employed as a teacher or administrator at
the private school.

In Bob Jones University v. United States, 461 U.S. 574, 103 S. Ct. 2017, 76 L. Ed. 2d 157
(1983), the Supreme Court found that petitioner, a nonprofit private school that prescribes and
enforces racially discriminatory admissions standards on the basis of religious doctrine, did not
qualify as a tax-exempt organization under section 501(c)(3) of the Code. The court held that
racially discriminatory private schools violate a fundamental public policy and cannot be viewed
as conferring a public benefit within the meaning of common law standards of charity and
congressional intent underlying section 501(c)(3).

In Calhoun Academy v. Commissioner, 94 T.C. 284 (1990), the Tax Court held that a private
school failed to show that it operated in good faith in accordance with a nondiscriminatory policy
toward black students and concluded that the school did not qualify for exemption under section
501(c)(3) of the Code. The school was formed at the time of desegregation of the public
schools, and never enrolled a black student or employed a black teacher. The school and its
students participate in some educational and vocational programs and other school-sponsored
activities that directly involved blacks.

An organization applying for exemption under section 501(c)(3) must establish that it is
organized and operated exclusively for an exempt purpose and in the case of a school must
include establishing that it has a racially nondiscriminatory policy as to students consistent with
the guidelines set forth in Rev. Proc. 75-50 and findings by the courts.

The information submitted indicates that you were formed around the time the court handed the
desegregation of schools in the county where you operate a private school. Also, in the past,
you have been determined in adversary or administrative proceedings to be racially
discriminatory. As such, the strict mandate in Green v. Connally, 330 F. Supp. 1150(D. D.C.

1971), applies to you in prohibiting us from according tax exempt status unless you clearly and
convincingly demonstrate and overcome the inference of racial discrimination against black
students. In this regard, we find that while you have operated a school for almost 45 years
since the court-ordered desegregation, you only recently decided in the last few years to adopt
a racially discriminatory policy that you termed as “applicable” for students.

While you have adopted a racially nondiscriminatory policy and even conduct outreach efforts,
your school operations, however, failed to show significant enrollment of black students. Your
main outreach of an annual advertisement in newspapers does not appear to show that the
advertisement was primarily designed to solicit black enrollment. Your current school year
shows enrollment of 7 black students, that number pales significantly when compared to the
overwhelming 156 enrollment of white students, and in particular when considering you are
operating in an area with a significant black population. While we acknowledged that you
provided financial assistance toward enrollment of your black students, we also noticed that this
assistance could be part of your advertised 50% discount for new students.

We believe that the lack of substantial black students, as well as the lack of teachers and
administrative staff in your school is because of your failure to make intensive, comprehensive
and good faith efforts to reach the black community for their enrollment and employment. You
have not provided us with sufficient evidence supporting any such efforts in your submitted
materials. Moreover, while you may interact with the blacks only outside of your classroom, like
in participation in sports, such interaction is unavoidable and does not prove that you have
implemented your nondiscrimination policy. The relevant criteria deal here is with restrictions on
those who may become insiders, i.e. students at your school.

Furthermore, Rev. Proc. 75-50, at section 4.07, provides that the existence of a racially
discriminatory policy with respect to employment of faculty and administrative staff is indicative
of a racially discriminatory policy as to students. To date, even with 40 years of existence and
operation, you have not employed any black teacher or administrative staff. Instead all your
teachers and administrative staff member are whites. In this regard, you stated that your only
concern in hiring teachers is to employ teachers who are the best qualified and who concentrate
on the best means of teaching the students. Also, you indicated that your emphasis is placed
on the best possible environment possible for a student, regardless of his color or nationality, to
learn.

Therefore, although you have adopted a policy of nondiscrimination and created an
outreach committee, it appears that your adoption of a nondiscriminatory policy and creation of
an outreach committee are merely done for compliance in form purposes and not in good faith.
Also, any efforts toward outreach to the black community are minimal.

Moreover, we think that the presence of your school discriminatory policy is further evidenced in
your decision not to participate in the State’s free textbook program because of its strict
requirement that participating schools must be documented to be operating in a non-
discriminatory manner in its admission and enrollment practices, which you may not be able to
show.

Based on the foregoing, we conclude that you failed to demonstrate that you have taken
sufficient steps to overcome inference of racial discrimination sets forth in the court cases cited
herein. As a school without a nondiscriminatory policy to students, as such term is defined in
Rev. Rul. 71-447, you are not considered operated exclusively for exempt purposes under
section 501(c)(3) of the Code. Moreover, and in particular on the basis of your situation, under
the court injunction orders issued on May 5 and June 2, 1980, we cannot accord you tax
exemption under section 501(c)(3) of the Code.

Therefore, you do not qualify for exemption under section 501(c)(3) of the Code.

You have the right to file a protest if you believe this determination is incorrect. To protest, you
must submit a statement of your views and fully explain your reasoning. You must submit the
statement, signed by one of your officers, within 30 days from the date of this letter. We will
consider your statement and decide if the information affects our determination.

Your protest statement should be accompanied by the following declaration:

Under penalties of perjury, | declare that | have examined this protest statement, including
accompanying documents, and, to the best of my knowledge and belief, the statement
contains all the relevant facts, and such facts are true, correct, and complete.

You also have a right to request a conference to discuss your protest. This request should be
made when you file your protest statement. An attorney, certified public accountant, or an
individual enrolled to practice before the Internal Revenue Service may represent you. If you
want representation during the conference procedures, you must file a proper power of attorney,
Form 2848, Power of Attorney and Declaration of Representative, if you have not already done
so. For more information about representation, see Publication 947, Practice before the IRS
and Power of Attorney. All forms and publications mentioned in this letter can be found at
www.irs.gov, Forms and Publications.

If you do not file a protest within 30 days, you will not be able to file a suit for declaratory
judgment in court because the Internal Revenue Service (IRS) will consider the failure to protest
as a failure to exhaust available administrative remedies. Code section 7428(b)(2) provides, in
part, that a declaratory judgment or decree shall not be issued in any proceeding unless the Tax
Court, the United States Court of Federal Claims, or the District Court of the United States for
the District of Columbia determines that the organization involved has exhausted all of the
administrative remedies available to it within the IRS.

If you do not intend to protest this determination, you do not need to take any further action. If

we do not hear from you within 30 days, we will issue a final adverse determination letter. That
letter will provide information about filing tax returns and other matters.

Please send your protest statement, Form 2848 and any supporting documents to this address

Internal Revenue Service
SE:T:EO:RA:T:2

1111 Constitution Ave, N.W.
Washington, DC 20224

You may also fax your statement using the fax number shown in the heading of this letter. If
you fax your statement, please call the person identified in the heading of this letter to confirm

that he or she received your fax.

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

Sincerely,

Robert Choi
Director, Exempt Organizations
Rulings & Agreements