Determination 1036030: IRS revoked an organization's section 501(c)(3) exemption for private benefit

Plain-English summary

The IRS issued a final adverse determination revoking an organization's exemption under IRC § 501(c)(3), effective January 1, 2006. It found that a substantial amount of the organization's assets inured to the private benefit of its founder, so the organization was not operated exclusively for exempt purposes. Contributions to the organization were no longer deductible under IRC § 170, and the organization was directed to file Forms 1120 for specified tax periods. The organization had waived its right to contest the determination under IRC § 7428 by executing a closing agreement.

Ruling snapshot

• Question: Did the organization's use of assets for its founder's private benefit disqualify it under IRC § 501(c)(3)?
• Outcome: Revocation
• Key authorities: IRC §§ 501(c)(3), 170, 6104, and 7428

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Appeals Office
312 Elm Street, Suite 2330 Person to Contact:
Cincinnati, OH 45202-2763 ileiaieial
Employee ID Number: *
Tel:
Number: 201036030 Fax:
Release Date: 9/10/2010 Refer Reply to:
AP:FE:OH:CIN:**
In Re:

Date: June 16, 2010 EO Revocation

Form Required to be Filed:

aunniee 41120
KkkKKK EIN:
. KKK

Tax Period(s) Ended:
12/2006 12/2007
UIL: 501.33-00

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 January 1, 2006.

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. 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 have waived your right to contest this determination under the declaratory judgment
provisions of Section 7428 of the Code by your execution of Form 906, Closing
Agreement Concerning Specific Matters, an executed copy of which is being sent to you
under separate cover.

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.

Sincerely,

Ke

APPEALS TEAM MANAGER

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

20f 2

DEPARTMENT OF THE TREASURY
Internal Revenue Service
550 Main Street, Room 6417
Cincinnati, OH 45202-3222

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

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.

lf 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

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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,

Sunita Lough
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 Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
“pay December 31, 20XX
ORG December 31, 20XX
LEGEND
ORG = Organization name XX = Date State = state President =
president CO-1 & CO-2 = 1% & 2™ Companies
ISSUES:

Whether ORG meets the operational requirements under Section 501(c)(3), since a
significant amount of revenues inured to the benefit of an officer and it was only
incidentally engaged in charitable undertakings.

FACTS:

ORG, (hereinafter referred to as ORG), is an entity that was incorporated as a non-
profit corporation in the State of State on May 18, 19XX. ORG is a subsidiary
organization, to CO-1 — CO-1, under Group Ruling Number 8298, granted exemption
under Internal Revenue Code Section 501(c)(3) on July 1, 19

The amended Articles of Incorporation, dated March 5, 20XX, identify President as the
President of ORG. The articles further provide the purposes of the corporation are as
follows:
e To provide support and assistance to the educational systems through tutoring
centers and tutoring programs.
e To financially assist, accredited, non-profit schools in an effort to maintain quality
educational facilities, equipment and special needs.
e To provide charitable services and financial aid to other community 501(c)(3)
organizations. ,

Analysis of the bank statements and canceled checks, account number, revealed the
following:

20XX % 20XX %
Gross Receipts
Disbursements
Wages and Form 1099(MISC) Income $ % $ %
Health & Life Insurance $ % $ %
Distributions $ % $ '%
Other $ % $ %
Payments to President $ % $ %
Sprint $ % %
Form 886- Acrev.468) Department of the Treasury - Internal Revenue Service

Page: -1-

Foun 8 8 6 A Department of the Treasury- Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
December 31, 20XX
ORG December 31, 20XX

See Exhibit #1 — Spreadsheet of Disbursements and Deposits

The review of the books and records also revealed only an incidental amount of gross
receipts were expended for charitable purposes. Substantial disbursements were made
to CO-2, which is a 501(c)(19) organization. No evidence was provided that these
funds were subsequently used for charitable purposes. Only a minimal amount of
grants were made to 501(c)(3) organizations. No other charitable activities were
conducted by ORG.

20XX % 20XX %

CO-2 $ % $ %

Distributed for charitable purposes $ % $ %

Payments made to President, were identified as overtime, and reimbursement for
automobile, utility, accounting, supplies, office, and miscellaneous expenses. ORG had
no accountable plan in place for expense reimbursement. Additional payments for
services were not reported as, Compensation of Officers, on line 25 of Form 990 and
were not included in wages reported on Forms 941.

LAW:

Section 501(c)(3) of the Internal Revenue Code (IRC) exempts from federal income tax
organizations that are both organized and operated exclusively for one or more of the
exempt purposes specified in section 501(c)(3). An organization that fails to meet
either the organizational or the operational test is not exempt. Treas. Reg. §
1.501(c)(3)-1(a)(1).

For IRC § 501(c)(3), exempt purposes include religious, charitable, scientific, testing for
public safety, literary, educational, and prevention of cruelty to children or animals.
Treas. Reg. § 1.501(c)(3)-1(d)(1).

The term “charitable” is used in section 501(c)(3) in its generally accepted legal sense,
and should not be limited by the separate enumeration in section 501(c)(3). The term
includes relief of the poor or underprivileged, advancement of religion, advancement of
education or science, lessening of the burdens of government, promotion of social
welfare, lessening neighborhood tensions, and combating community deterioration.
Treas. Reg. § 1.501(c)(3)-1(d)(2).

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

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
December 31, 20XX
ORG December 31, 20XX

Organizational test — The organizational test is met through an organization's articles of
organization, which includes the corporate charter, trust instrument, or any other written
document by which an organization is created. Treas. Reg. § 1.501(c)(3)-1(b)(2).

An organization is organized exclusively for one or more exempt purposes onlly if its
articles of organization limit the purposes of the organization to exempt purposes and
do not expressly empower the organization to engage, except in an insubstantial
manner, in activities that do not further its exempt purposes.

in meeting the organizational test, the organization’s purposes, as stated in its articles
of organization, may be as broad as, or more specific than, the purposes stated in IRC
§ 501(c)(3). If the articles state that the organization is formed for “charitable
purposes”, such articles ordinarily shall be sufficient for purposes of the organizational
test. Treas. Reg. § 1.501(c)(3)-1(b)(1)(ii).

Operational test — An organization meets the operational test only if it engages primarily
in activities which accomplish one or more of the exempt purposes specified in IRC §
501(c)(3). An organization will not be so regarded if more than an insubstantial part of
its activities is not furtherance of an exempt purpose. Treas. Reg. § 1.501(c)(3)-1(c)(1).

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.
Treas. Reg. § 1.501(c)(3)-1(c)(2).

An organization is not organized or operated exclusively for one or more exempt
purposes unless it serves a public rather than private interest. To meet this
requirement, an organization must establish “that it is not organized or operated for the
benefit of private interest such as designated individuals, the creator or his family,
shareholders of the organization, or persons controlled, directly or indirectly, by such
private interests’.

The existence of a substantial nonexempt purpose regardless of the number or
importance of exempt purposes will cause failure of the operational test. Better
Business Bureau v. U.S., 326 U.S. 279 (1945)

Section 61 of the Internal Revenue Code (IRC) provides that gross income means all
income from whatever source derived, including compensation for services, fees,
commissions, fringe benefits, and similar items.

IRC section 62(a)(2)(A) and section 1.62-2(b) of the Income Tax Regulations provide
that, for purposes of determining adjusted gross income, an employee may deduct
certain business expenses paid by the employee in connection with the performance of

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

Form 886 A Department of the Treasury- Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
December 31, 20XX
ORG December 31, 20XX

services as an employee under a reimbursement or other expense allowance
arrangement with his employer.

IRC section 62(c) provides that, for purposes of section 62(a)(2)(A), an arrangement will
be treated as a reimbursement or other expense allowance arrangement if (1) the
arrangement requires the employee to substantiate the expenses to the payor, and (2)
the arrangement requires the employee to return to the payor any amount in excess of
the substantiated expenses.

Thus, a reimbursement or other expense allowance arrangement satisfies the
requirements of section 62(c) only if it meets the requirements of business connection,
substantiation, and returning amounts in excess of substantiated expenses. If an
arrangement meets these requirements, all amounts paid under the arrangement are
treated as paid under an accountable plan. Treas. Reg. §1.62-2(c)(2)(i). Amounts
treated as paid under an accountable plan are excluded from the employee's gross
income, are not required to be reported on the employee's Form W-2, and are exempt
from the withholding and payment of income and employment taxes. Treas. Reg.
§1.62-2(c)(4).

if an arrangement does not satisfy these requirements, all amounts paid under the
arrangement are treated as paid under a “nonaccountable plan.” Treas. Reg. §1.62-
2(c)(3). Amounts treated as paid under a nonaccountable plan are included in the
employee's gross income, must be reported as wages or other compensation of the
employee's on Form W-2, and are subject to withholding and payment of income and
employment taxes. Treas. Reg. §1.62-2(c)(5).

TAXPAYER’S POSITION:

President, President of ORG, stated he believed distributions made to CO-2, were
charitable. He reimbursed himself for what he felt was appropriate for vehicles,
contract labor, utilities, office, professional fundraising, supplies, postage, shipping,
occupancy, printing, and travel. Receipts for items such as postage, shipping, travel,
printing, supplies, etc., were not kept. The amount of reimbursement was only an
average and or estimate from past years of operation.

GOVERNMENT’S POSITION:

ORG was not engaged primarily in activities that accomplish an exempt purpose. Only
four percent of gross receipts were distributed for charitable purposes. Part of ORG’s
activities was making distributions to CO-2, a 501(c)(19) organization, which serves
private benefit rather than public interests. A substantial part of the net earnings of
ORG inured to the benefit of President, a disqualified person with respect to ORG.

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

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/ Period Ended
December 31, 20XX
ORG December 31, 20XX
CONCLUSION:

ORG is not a charitable organization exempt from tax under I.R.C. § 501(c)(3) for the
taxable years of 20XX and 20XX. Net earnings inured to the benefit of the president of
the organization. We are revoking its exempt status effective January 1, 20XX. This
organization is required to file Forms 1120 for all tax periods beginning after December

31, 20XX

Form 886- Acrev.4-68)

Department of the Treasury - Internal Revenue Service

Page: -5-