Determination 1035038: Exempt status revoked for private benefit

Plain-English summary

The IRS issued a final adverse determination revoking an organization's section 501(c)(3) exemption effective October 1, 2003. The IRS found that a substantial amount of the organization's assets benefited its founder and two for-profit corporations owned and controlled by the founder. The attached examination materials describe loans made to the founder at below-market interest rates and expenditures treated as personal expenses, including property, vehicle, insurance, and other costs. Because the organization was not operated exclusively for exempt purposes and its charitable assets were used for private purposes, contributions were no longer deductible under section 170. The organization was required to file Forms 1120 for tax periods beginning on or after the effective date and was advised of its appeal rights.

Ruling snapshot

• Question: Did the organization's private-benefit transactions disqualify it from section 501(c)(3) exemption?
• Outcome: Revocation
• Key authorities: IRC §§ 501(c)(3), 170, 6104(c), and 7428(b)(2); Treas. Reg. § 1.501(c)(3)-1(d)(1)(ii)

Full text (IRS public release)

+Internal Revenue Service
Appeals Office
312 Elm Street, Suite 2330
Cincinnati, OH 45202-2763

Department of the Treasury

Person to Contact:

Employee ID Number: *
Tel:
Fax:
Refer Reply to:
AP:FE:OH:CIN:***
In Re:
EO Revocation
Form Required to be Filed:
1120
EIN:

Tax Period(s) Ended:

UIL: 501.33-00

Release Number: 201035038
Release Date: 9/3/10
Date: June 9, 2010

Certified Mail

Dear

This is a final adverse determination regarding your exempt status under Internal
Revenue Code (IRC) section 501(c)(3). It is determined that you do not qualify as
exempt from Federal income tax under IRC section 501(c)(3) effective October 1, 2003.

Our adverse determination was made for the following reason(s):

A substantial amount of your organization's assets inured to the private benefit of
your founder and to the private benefit of two for-profit corporations owned and
controlled by your founder. Because a substantial amount of your charitable assets
were used for private purposes, the organization is not operated exclusively for
exempt purposes described in section 501(c)(3) of the Code.

Contributions to your organization are not deductible under section 170 of the Code.

You are required to file Forms 1120, U.S. Corporation Income Tax Return, for tax
periods beginning on and after October 1, 2003 with the Cincinnati Service Center,
Cincinnati, OH, 45999-0012.

You also 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 is not able to reverse legally correct
tax determinations, nor extend the time fixed by law that you have to file a petition in the
U.S. Tax 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. If
you want Taxpayer Advocate assistance, please contact the Taxpayer Advocate for the
IRS office that issued this letter. See the enclosed Notice 1214, Helpful Contacts for
Your “Notice of Deficiency’, for Taxpayer Advocate telephone numbers and addresses.

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

We have sent a copy of this letter to your authorized representative.

Sincerely,

vk

APPEALS TEAM MANAGER

Enclosure:
Notice 1214 Helpful Contacts for your “Notice of Deficiency’

2 of 2

DEPARTMENT OF THE TREASURY
Internal Revenue Service
N14 W24200 Tower Place, Suite 20z
Waukesha, WI 53186

an TAX EXEMPT ANC
ee ; GOVERNMENT ENTITIES
: OtvISiON

Taxpayer Identification Number:
; ADDRESS: | Form:

pe | Tax Year(s) Ended:

Person to Contacv/iD Number:
Contact Numbers:

Telephone:
Fax:

Certified Mail - Return Receipt Requested

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

;, 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

nN

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,

Renee Wells
Acting Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Report of Examination

Letter 3618 (04-2002)
Catalog Number 34809F

‘ Form 886 A | Department of the Treasury - internal Kevenue Service Schedule No. or Exhibit
Explanation of Items
Name of Taxpayer Year/Period Ended
September 30, 20XX

• ORG September 30, 20XX
  September 30, 20XX
  LEGEND
  | ORG = Organization name XX = Date Sate = state President =
  ‘president Vice-President = Vice-President DIR-1 & DIR-2 = 18* & 27
  -. DIRECTORS CO-1, co-Z, Co-3, C004, CO-5, CO-6 & CO-7 = 157, 2™°, 3F°, 4™,

~s™, 6™, & 77 COMPANIES

oe - Primary Issue:
Sy “Whether ORG, exempt under IRC Section 501(c)(3), should retain their exempt status?

ORG was granted under IRC Section 501(c)(3) by the Internal Revenue Service in

ted. sii gross receipts and $$ in expenses for they year r ending September 30, 20XX; $$
ees and $$ in expenses for the year ending pied 30, 20XX; and $$ in gross

a "During: an ‘examination of the organization’s records for the years ending September 30, 20XX,
ORS and 20XX the following was noted:

n interest rate of 9%. Throughout the course of this loan there were various advances
President, increasing the loan balance. It was determined, by the Internal Revenue
: e, that for a loan of this type, a 9.9% interest rate represented fair market value. This loan
a was’ shown by the exempt organization to have been paid off by President in May of 20XX, at an
os interest rate of 5%, which was less then the loan agreement stipulated.

In addition there was a second loan of $ extended to President by the exempt organization in
_ January of 20XX. Throughout the course of this Joan there were various advances made to

• President, increasing the loan balance. This loan was shown by the exempt organization to have
  ‘been paid off by President in December of 20XX, at a 0% interest rate. It was determined that
• for a loan of this type, a 9.9% interest rate represented fair market value.

Form 886-A (Rev.468) Department of the Treasury - Internal Revenue Service
Page: -1-

t

i; Department of the Treasury- Internal Revenue Service Schedule No. or Exhibi
Form 886A | Explanation of Items
Name of Taxpayer Year/Period Ended
September 30, 20XX
ORG . | September 30, 20XX
September 30, 20XX _

In cases of both loans, the record shows that the exempt organization provided President with a
private source of credit at rates below fair market value.

In addition to these loans there were various expenditures made from the exempt organization by
President, or on her behalf, that were for her personal benefit. The majority of these expenditures
represent those of the type that were questionable and for the most part unsubstantiated. The
amount of expenditures attributed as being made for the personal benefit of President and her
related interests (her for-profit organizations) total more than § during the years in question.

These expenditures have been documented as follows:

A). TThere was a total of $ in Leasehold Improvement expenses. Financial records indicate the
expenditures were for a new fence and landscaping. However, during an initial tour of the

facility, there was no new fence or landscaping observed. President provided no further

explanation that would indicate the expenditures were that of the exempt organization. Based on
visual inspections and the lack of substantiation, it was determined that 50% of the amounts
expended on leasehold improvements were reasonably made for the exempt organization and
50% of the expenditures were made for the personal benefit of President.

B). TThere was a total of $ in Operating Supply expenses. The request to substantiate the
expenditures was not provided. Based on the lack of substantiation, it was determined that 50%
of the amounts expended were reasonably made for the exempt organization and 50% were
made for the personal benefit of President.

C). TThere was a total of $ in Utilities expenses. A review of the exempt organization’s canceled
checks showed a number payments made on various utility accounts. The request for account
information to substantiate the owners of the utility accounts was not provided; in fact, President
stated that she did not know who owned the utility accounts. Based on the lack of substantiation
it was determined that all payments made to the unknown accounts were made for the personal

benefit of President.

D). TThere was a total of $ in Telephone expenses. A review of the exempt organization’s
invoices shows that the oroorganization had a number of telephone lines at different locations; in
addition the exempt organization shares its cell phones with President related for profit
organization (CO-1). Based on the substantiation provided, and the sharing of resources between
the exempt organization and related for-profit, it was determined that 50% of the expenditures
were reasonably made for the exempt organization and 50% were made for the personal benefit

of President.

E). TThere was a total of $ in Repairs and Maintenance expenses. Financial records show that the
organization was leasing camera systems to provide 24-hour monitoring of the facility.

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

' Form 886 A Department of the Treasury - Intemal Kevenue Service Schedule No. or Exhibit
Explanation of Items
Name of Taxpayer Year/Period Ended
September 30, 20XX
ORG September 30, 20XX
September 30, 20XX

'- Financial records also reveal that payments were being made to two different security companies.
.... The request to provide receipts to substantiate payments to the camera monitoring company and
-. the various security companies was not provided. Therefore, it was determined that 50% of these

“expenditures were reasonably made for the exempt organization and 50% were made for the

oe personal benefit of President.

F). TThere was a total of $ in Advertising & Promotion expenses. Financial records show that the
oorganization had ads in.the White Pages, Yellow Pages and the One Book. It also, revealed that
roorganization had a website that was managed and set up by the Yellow Pages phone book
company. Review of the advertisements showed listings for three different locations during the
OXX and 20XX years. In the 20XX year, the ads were only for two locations. The exempt
‘ganization only had one location. Based on a lack of substantiation it was determined that 33% ©
f the expenditures made were for the benefit of the exempt organization and 67% of the
xpenditures were made for the personal benefit of President.

There was a total of $ in Property Taxes expenses. Financial records show that the exempt
organization paid property taxes for the building it leases from President. A review of the
exempt organization’ s lease does not state that the lessee shall pay property taxes. A review of
exempt organization’s cancelled checks also show that the Tax ID number on some of the
celled checks: represents the Tax ID number of President’ home address. Because there was
documentation to show that the exempt organization was responsible for paying the property
xes on the building under the lease agreement and as President’ personal property taxes was
aid with the. exempt organization’s funds it was determined that all payments made to cover
‘property taxes were made for the personal benefit of President.

). There were a total of $ in Vehicles expenses. Financial records show that the exempt
rganization made a.number of payments out of this account for rereimbursements and payments

on President’s personal CO-2 Credit Card. The request to provide receipts to substantiate the
reimbursements was not ‘provided. Copies of the CO-2 Credit Card statements were provided |
‘and revealed that some of the amounts had already been reimbursed to employees out of petty
‘cash. Documentation requested to provide clarification on the use of the vehicle expense and
‘petty cash accounts was not provided. Based on the details provided, it was determined that 33%
of the vehicle expenditures were made for the benefit of the exempt organization and 67% were
_:. made for the personal benefit of President.

_..-]). There was a reported $ in Office expenses. Financial records show that there were a number
'_of rereimbursements made with these funds. The request to provide receipts to substantiate the
_rereimbursements was not provided. Based on the lack of substantiation, it was reasonably

• determined that 50% of the expenses were made for the benefit of the exempt organization and
  50% of the expenditures were made for the personal benefit of President.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -3-

Form 886A |__Pepariment of the Treasury Imemal RevemseServee | Schedule No. or Exhibit
| Explanation of Items
Name of Taxpayer Year/Period Ended
September 30, 20XX
ORG September 30, 20XX
September 30, 20XX

J). There was a reported $ in Vehicle Lease expenses. Financial records show that the exempt
organization was ]easing six passenger cars and had ownership of four passenger vans. A review
of the Day Care Center State Inspection for the year (performed by the State of State) shows that
the exempt organization was cited for using the passenger cars to transport children; these
vehicles were not authorized by the state to transport children. In addition, a review of the
insurance policy showed that the exempt organization’s insurance policy provided full coverage
on all of the passenger vehicles it leased as well as the passenger vans it owned. Copies of the
lease agreements were provided to show the vehicles were all being leased to the exempt
organization. Because the vehicles are not and have never been authorized to transport children,
they were not leased to further the exempt purpose of the organization. Since there was no
documentation showing why the exempt organization needed the vehicles and how they were
used to further exempt purposes, it was reasonably determined that 33% of the expenditures were
made for the exempt organization and 67% of the expenditures were made for the benefit of

President.

K). There was a reported $ in Insurance expenses. The insurance covered the commercial, auto,
property, marine and liability insurance for the exempt, ORG and President’ for profit
organizations. Included in this coverage were the unauthorized passenger vehicles that the
exempt organization was leasing. Based on the information provided, it was reasonably .
determined that 33% of these expenditures were made for the exempt organization’s benefit and
67% of the expenditures were made for the benefit of President.

L). There was reported $ of Health Insurance expenses with Co-3. A review of the policy
indicated that coverage was provided for employees of both President’ exempt and non-profit day
care centers. Based on the documentation provided, it was determined that 50% of the
expenditures were made for the exempt organization and 50% of the expenditures were made for

the personal benefit of President.

M). There was a reported $ in Officer Life Insurance expenses. A review of the financial records
shows that payments were made to five different companies: CO-4, CO-5 (2 policies), CO-6 and
CO-7. Copies of CO-4 and CO-5 and CO-6 were provided; the CO-7 policy was not provided.
The policies that were provided have a face value of more than $$. It was determined that the
total cost of the insurance premiums is not an excludable fringe benefit; only group term life
insurance limited to a face amount of $ would have qualified as an excludable fringe benefit
based on the internal revenue code. It was thus determined that the full amount of the
expenditures represents payments made for the benefit of President.

Overall between the provision of loans at advantageous terms and the personal expenditures
made on President behalf, the record shows that the assets of ORG were improperly used to

benefit private interests.

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

| Form 886A Department of the Treasury- Internal Revenue Serve | Schedule No. or Exhibit
Explanation of Items
Name of Taxpayer Year/Period Ended
September 30, 20XX
ORG _ | September 30, 20XX
September 30, 20XX

= “The assets of an organization exempt under IRC Section 501(c)(3) are not allowed to benefit
private interests. Where the assets of an organization exempt under IRC Section 501(c)(3)
benefit private interests, the law provides that such organization is not exempt.

Let ‘Law:

IRC Section 501(c)(3) (in specifying the attributes for exemption) Corporations, and any
ommunity chest, fund, or foundation, organized and operated exclusively for religious,
charitable, scientific, testing for public safety, literary, or educational purposes, or to foster
national or international amateur sports competition (but only if no part of its activities involve
on of athletic facilities or equipment), or for the prevention of cruelty to children or
) part of the net earnings of which inures to the benefit of any private shareholder or
il, no substantial part of the activities of which is carrying on propaganda, or otherwise
, to influence legislation (except as otherwise provided in subsection (h)), and which
i articipate in, or intervene in n (including the publishing or ‘distributing of statements),

ate: “shat ‘eholder or “individual” defined. —The words “private shareholder or
‘in section 501 refer to persons having a personal and private interest in the activities

(2) ‘Distribution - earnings. —An organization is not operated exclusively for one or more
2 exempt purposes if its net earnings inure in whole or in part to the benefit of private shareholders
or individuals: For the definition of the words “private shareholder or individual”, see paragraph

f §1.501(a)-1.

Treasury Regulation Section 1.501(c) (3)-1(d) (1)(ii)

An organization is not organized or operated exclusively for one. or more of the purposes
7 - specified in subdivision (i) of this subparagraph unless it serves a public rather than a private

• jnterest. Thus, to meet the requirement of this subdivision, 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 or his family, shareholders of the organization, or persons controlled,

~ directly or indirectly, by such private interests.

Rameses School of San Antonio, Texas v. C.I.R., Tax Court 2007, T.C. Memo 2007-85

In this case the court upheld the revocation of the tax-exempt status of the Rameses School of
San Antonio, Texas. The court found that the assets of the exempt organization inured to the

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -5-

+

Form 886 A | Department of the Treasury - Internal Revenue Service Schedule No. or Exhibi
Explanation of Items
Name of Taxpayer Year/Period Ended
September 30, 20XX
ORG September 30, 20XX
September 30, 20XX _

benefit of the President and CEO of the school. The private benefit and inurement in this case
included undocumented expenditures and withdrawals made on the President and CEO’s behalf,
and questionable payments made for real estate transactions and lease payments. The court also
found that there was not proper oversight, as the CEO and President was allowed to direct
questionable payments for her benefit, unchecked by the board of directors or any other internal
contro] mechanism.

In making its determination the court noted the following:

“Nonetheless, the presence of a single nonexempt purpose, if substantial in nature, precludes
exempt status, regardless of the number or importance of truly exempt purposes. Better Bus.
Bureau v. United States, 326 U.S. 279, 283, 66 S.Ct. 112, 90 L.Ed. 67 (1945); Redlands Surgical
Servs. v. Commissioner, 113 T.C. 47, 71-72, 1999 WL 513862 (1999), affd. 242 F.3d 904 (9th

Cir.2001); Nationalist Movement v. Commissioner, supra at 576; Am. Campaign Acad. v.
Commissioner, 92 T.C. 1053, 1065, 1989 WL 49678 (1989)..

“If an organization can be shown to benefit private interests, a limitation substantially
overlapping but encompassing more than simply the inurement of earnings to insiders, it will be
deemed to further a nonexempt purpose. Am. Campaign Acad. v. Commissioner, supra at 1066,
1068-1069; Church of the Transfiguring Spirit, Inc. v. Commissioner, 76 T.C. 1,5 & n. 5, 1981
WL 11377 (1981). Private benefits within the scope of the prohibition may include an advantage,
profit, fruit, privilege, gain, or interest. Am. Campaign Acad. v. Commissioner, supra at 1065-

1066...”

“Factors emerging repeatedly as indicative of prohibited inurement and private benefit include
control by the founder over the entity's funds, assets, and disbursements; use of entity moneys for
personal expenses; payment of salary or rent to the founder without any accompanying evidence
or analysis of the reasonableness of the amounts; and purported loans to the founder showing a
ready private source of credit. See, e.g., Founding Church of Scientology v. United States, supra
at 1200-1202;Church of Eternal Life & Liberty, Inc. v. Commissioner, supra at 927-928;Church
of the Transfiguring Spirit, Inc. v. Commissioner, supra at 5-6;Basic Bible Church v.
Commissioner, supra at 857-858;Bubbling Well Church of Universal Love, Inc. Vv.
Commissioner, supra at 534-538; Unitary Mission Church v. Commissioner, supra at 513-515...”

“As this Court has noted, such circumstances provide “an obvious opportunity for abuse of the
claimed tax-exempt status” and make incumbent “open and candid disclosure of all facts’;
otherwise, “the logical inference is that the facts, if disclosed, would show that petitioner fails to
meet the requirements of section 501(c)(3).”Bubbling Well Church of Universal Love, Inc. v.
Commissioner, supra at 535; see also, e.g., Founding Church of Scientology v. United States,
supra at 1201 ;Basic Bible Church v. Commissioner, supra at 858.” “

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

x
a ‘tw

: Department of the Treasury - Iniemal Revenue Service Schedule No. or Exhibr
Form 886A Explanation of Items
Name of Taxpayer Year/Period Ended
September 30, 20XX
ORG September 30, 20XX
September 30, 20XX

Revenue Procedure 84-46, 1984-1 CB 541
-. Where there is a material change, inconsistent with exemption, in the character, the purpose, or
“>. .the method of operation of an organization, revocation or modification will ordinarily take effect
“as of the date of such material change.

‘Government’s Position:

he assets of ORG inured to the private benefit of President and her related interests. The
Internal Revenue Code and Regulations provide that an organization exempt under IRC Section
501(c)(3) can not. allow its asassets to benefit private interests; an organization that allows their
assets to benefit private interests is not exempt. —

( e fact pattern in this case is similar to the fact patterns noted in the case, Rameses School of
an: Antonio. Texas v. Commissioner of Internal Revenue Service. This case involved the
rovision | of. loans- as a source of credit to the President and CEO of the organization as well as a
cord of. undocumented expenses, and noted personal expenditures made on the President and
EQ’s behalf... eto court established that these transactions constitute prohibited private

Revenue Code, Regulations and case law, it has been determined that the exempt status of ORG
should be revoked 7

Taxpayer stated that she was unaware of the issues involving inurement and would not have
applied. for exempt status had she known.

As the organization’s exempt status is being revoked, the organization is required to file
-- Forms 1120 for all tax years beginning October 1, 20XX; the organization is also no longer

.. exempt from FUTA Tax and is responsible for filing Forms 940.

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