Determination 1037036: IRS proposed revocation of a veterans organization's exemption

View official IRS release (PDF)

Plain-English summary

The IRS examined a veterans organization that operated a bar and related entertainment activities while claiming exemption under IRC § 501(c)(19). The report questions whether the organization operated exclusively for exempt purposes, whether its net earnings benefited its president, and whether it met recordkeeping and reporting requirements. The IRS concluded that the organization primarily operated a bar open to the general public, that income inured to its founder and president, and that required records and returns were not maintained. The report states that recognition of exemption should be revoked and alternatively treats income from bar, vending, Keno, and gaming activities as unrelated business income under IRC § 512, subject to tax under § 511. The release includes the proposed-action letter and the attached examination report.

Ruling snapshot

• Question: Did the veterans organization qualify under IRC § 501(c)(19), and alternatively was its activity income unrelated business income?
• Outcome: Revocation
• Key authorities: IRC §§ 501(a), 501(c)(19), 511, 512, 6001, and 6033; Treas. Reg. §§ 1.501(c)(19)-1(c), 1.513-1(a), 1.513-1(d)(1), and 1.513-1(d)(2)

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
Internal Revenue Service
TE/GE EO Examinations
1122 Town and Country Commons Room 128
[illegible] Chesterfield, MO 63017-8293

GOVERNMENT ENTITIES
DIVISION

February 16, 2010

Taxpayer Identification Number:
Release Number: 201037036

Release Date: 9/17/10 Form:

UIL Code: 501.19-00

ORG Tax Year(s) Ended:
ADDRESS

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 an
adjustment of your organization's exempt status is necessary.

If you do not agree with our position you may appeal your case. The enclosed
Publication 3498, The Examination Process, explains 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.

If you request a conference, we will forward your written statement of protest to the
Appeals Office and they will contact you. For your convenience, an envelope is
enclosed.

If you and Appeals do not agree on some or all of the issues after your Appeals
conference, or if you do not request an Appeals conference, you may file suit in United
States Tax Court, the United States Court of Federal Claims, or United States District
Court, after satisfying procedural and jurisdictional requirements as described in
Publication 3498.

Letter 3610 (04-2002)
Catalog Number 34801V

You may also request that we refer this matter for technical advice as explained in
Publication 892, Exempt Organization Appeal Procedures for Unagreed Issues. Ifa
determination letter is issued to you based on technical advice, no further administrative
appeal is available to you within the IRS on the issue that was the subject of the
technical advice.

If you accept our findings, please sign and return the enclosed Form 6018, Consent to
Proposed Adverse Action. We will then send you a final letter modifying or revoking
exempt status. If we do not hear from you within 30 days from the date of this letter, we
will process your case on the basis of the recommendations shown in the report of
examination and this letter will become final. In that event, you will be required to file
Federal income tax returns for the tax period(s) shown above. File these returns with
the Ogden Service Center within 60 days from the date of this letter, unless a request
for an extension of time is granted. File returns for later tax years with the appropriate
service center indicated in the instructions for those returns.

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.

Letter 3610 (04-2002)
Catalog Number 34801V

Thank you for your cooperation.

Sincerely,

Nanette M. Downing
Acting Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Form 6018

Report of Examination
Envelope

Letter 3610 (04-2002)
Catalog Number 34801 V

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or Exhibit:

Explanation of Items Sveti WL
Exhibit 3, I¢xhibir 4,

Exhibit A, Exhibit B,
Exhibit C.Form 6018-A
Year/Period Ended

Name of Taxpayer

ORG 12/31/20XX
DBA ORG, Address, City, State
LEGEND
ORG = Organization name XX = Date Address = address City = city
State = State RA-1 & RA-2 = 157 & 2° RA President = president Vice
President = vice president CO-1, CO-2, CO-3, CO-4, CO-5 & CO-6 = 1%, 2%,
3, 4°" 5°" & 6° COMPANTES
Issue:

1. Whether ORG, doing business as ORG is operated exclusively for purposes listed in
   Treas. Reg. § 1.501(c)(19)-1(c).

2. Whether the net earnings of ORG inured to the benefit of the President.

3. Whether ORG has satisfied the recordkeeping and reporting requirements set forth in
   I.R.C. §§ 6001 and 6033.

4. Whether ORG’s exemption under I.R.C. § 501(a), as an organization described in I.R.C.
   § 501(c)(19), should be revoked effective January 1, 20XX.

5. Alternatively, if ORG’s exemption under I.R.C. § 501(a), as an organization described in
   I.R.C. § 501(c)(19), is not revoked, whether the income that ORG received from its
   kitchen and drink operations, pool tables, and juke box should be treated as unrelated
   business income under I.R.C. § 512, and whether such income is subject to tax
   pursuant to I.R.C. § 511.

Facts: Background Information

ORG (hereinafter referred to as ORG) is a veterans organization that holds a group exemption
for veterans organizations described in I.R.C. § 501(c)(19). ORG’s web page states that its
mission is to “unite veterans and their families by forming social clubs throughout the United
States, which interact with other social veterans clubs.”

ORG's website lists several advantages to be included in its group exemption as a subordinate
organization. These advantages include selling liquor, operating on Sundays, holding bingo
games, and obtaining liquor licenses in dry counties. ORG’s website markets ORG and its
group exemption to existing bars and restaurants located in State as a way to avoid restrictive
local liquor laws and as a way to operate on a tax-exempt basis. ORG’s website states that
ORG will assist in a club's formation and application for a liquor license. ORG refers to its
subordinate organizations as “clubs.”

ORG's website requires that its clubs have at least 10 veteran members. ORG also requires its
subordinate organization to send it proof of all veterans affiliation. One question that appears
on ORG's web page is “do | have to be a members only club?” The response is “[a]lthough the
tax advantages of being a members only club are greater, we do not require you to limit your
organization to members.....Your doors may be kept open. By incorporating separately, you

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

Form 886A Department of the ‘Treasury - Internal Revenue Service Schedule No. or Exhibit:

Explanation of Items HepsloTen Th, Sista
Txhibit 3, Exhibit 4,

Exhibit A, {exhibit B,

Exhibit C,Form 6018-A

Year/Period Ended
12/31/20XX

Name of Taxpayer
ORG
DBA ORG, Address, City, State

keep control of your own club. It is your choice if you wish to keep your doors open or closed.
We only ask that you honor members of other chapters.”

ORG’s Formation and Purpose

The ORG (hereinafter referred to as ORG) opened for business in 20XX under the ORG. ORG
learned about the HQ from the President of the ORG’s daughter. The ORG provided a packet
of information to the president of the ORG to be filled out and filed with the ORG. According to
ORG's Articles of Incorporation, the organization was formed to support all veterans and their
families.

According to the bylaws, ORG’s stated purpose is “uniting fraternally, veterans and the families
of veterans, in order to work together to better the lives of all veterans and their families and to
assist with any difficulties encountered by them.” The bylaws further state that these purposes
include, but are not limited, to the following:

Helping fellow veterans and their families receive the benefits for which they are
entitled:

Finding employment for veterans and their families;

Helping the homeless veterans find housing and re-adjust to civilian life;

Carrying on programs to perpetuate the memory of deceased veterans and

members of the armed forces, and to comfort their survivors;

Sponsoring or participating in activities of a patriotic nature;

Providing social and recreational activities for its members;

Assisting the disabled and needy war veterans and their dependents;

Promoting awareness of the prisoners of war and the missing in action issues;

Promoting the general welfare and prosperity of all ORG corporations;

Presenting and supporting the purposes of ORG before the public and the

government.

Vv

VV NVVN

ORG’s Business Operations, Business Activities, and Members

ORG operates its business on a cash basis at Address, City, State. The building's facade
exhibits signs reflecting the name “ORG” but no signs indicating that this is a Veterans
organization. (See Exhibit 1.) The facility consists of a main floor with an area of approximately
20XX sq. ft. of space for dancing. There are tables on the main floor and upstairs that surround
the dance floor. There are two full service bars and a kitchen in the back. (See Exhibits 2 and
3.) There is another area, CO-1, in a separate room that has pool tables, televisions, dart
boards, and a juke box. CO-1 has a separate entrance that can be accessed from outside the
building by a separate door, if the customers choose not to come in through the main entrance.
(See Exhibit 4.)

ORG has one web site on MySpace.com, website. The web site does not mention anything
about this organization being an organization. There are photos on the web site

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

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or Exhibit:

Explanation of Items Iéxhibit 1, Exhibit 2,
Exhibit 3, Exhibit 4,

Exhibit A, Exhibit B,

Exhibit C Form 6018-A

Year/Period Ended
12/31/20XX

Name of Taxpayer
ORG
_DBA ORG, Address, City, State

showing customers riding the mechanical bull, dancing on the dance floor, and playing pool in
the CO-1 facility. (See Exhibit 5.)

ORG's facilities are open Friday and Saturday nights, 8 pm until 1:30 am. The organization is
also open on Sunday from 8 pm until midnight. The kitchen is open from 8 pm until 1 AM. It is
freely open to both members and nonmembers (general public). The ORG averages
approximately 100 people per night. For a special event, the organization may have 200 to 300
people.

ORG, as of December 20XX, had 15 veterans’ members. The ORG pays the headquarters $
per year in dues. Dues for the members to the ORG are $ per year. No register is kept for
members or nonmembers to sign in to use the facilities. The ORG is open to the public based
on interview testimony from the principle officer. ORG does not account for member and
nonmember bar/kitchen sales separately. According to the organization, more of the
bar/kitchen receipts are from nonmembers than from members. According to the interview of
the organization's President, member benefits are discounted food and drinks.

Employees of ORG have the option to buy insurance through CO-2 and accident insurance,
and to have a membership at CO-3. The employees do not receive discounted drinks or food.
Sodas are free to veterans, employees, and designated drivers.

ORG stated that it has the following activities:

a. Quarterly meetings and minutes have to be provided to the HQ organization.

b. Operation of the bars, kitchen, dart boards, juke box, mechanical bull, and pool
tables is open to both members and nonmembers.

c. Hold fundraisers for different organizations, such as: CO-4; the Sheriff's
Department: and the Fraternal Order of the Police.

A review of the ORG'’s activities could not determine the extent of member participation since
the organization did not keep adequate records showing member participation vs nonmember
participation.

ORG’s Financial Information
Membership Facts do not show bona fide members.

According to ORG’s 20XX Form 990 return, the gross sales’ of the organization totaled
$. The organization's gross receipts per the audit were $, and its expenses for liquor,
rent, utilities, taxes, advertising, food, and other services were (after examination) $ for

! For purposes of this discussion, the term “gross sales” means “gross receipts” as reported on the
organization’s Form 990.

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

Foun 886A Department of the ‘Treasury - Internal Revenue Service Schedule No. or Exhibit:

Explanation of Items Exhibit 1, exhibit 2,
Exhibit 3, lexhibic 4,

Exhibit A, Exhibit B,

| Exhibit C.Form 6018-A

Year/Period Ended
12/31/20XX

Name of Taxpayer
ORG
DBA ORG, Address, City, State

the year 20XX.The organization's gross receipts on the Form 990 return for 20XX totaled $.
ORG's gross receipts per the audit for 20XX were $, and the expenses for liquor, rent, utilities,
taxes. advertising, food, and other services were (after examination) $. For information
regarding the revenue and expenses, see Exhibit A.

ORG pays the ORG $ per year in dues. The books and records of the organization did
confirm these payments for 20XX and 20XX.

The President of the organization provided a copy of a contract that is a divorce agreement for
splitting the profits with his ex-wife. This contract reads as if this is a regular business and not
an exempt organization. The purpose of this contract, per the President, is that if the business
is sold, the ex-wife would receive 30% of the President's 55% of the business. If there’s any
profit, she receives part of the profit. The President of the organization is paying her money
every Monday based on the net profit of the organization, with the maximum of $ that is to be
paid to her, according to the contract. See Exhibit B.

In reviewing the installment agreement between the organization and CO-6, the signature page
states the borrower is “a general partnership” and is signed by President, President; Vice-
President, Vice President; and RA-1, Vice-President’s wife. See Exhibit C.

ORG’s Activities, Revenues, and Expenses

In reviewing the activities for ORG, the organization was unable to provide a breakdown of the
hours being spent: the amount of revenue generated; and / or the expenses incurred for the
years under examination. In reviewing the minutes, nothing is mentioned about special events /
fundraisers for veterans.

ORG's activities consist of:

1. Quarterly meetings and minutes;
2. Operation of the bars, kitchen, dart boards, juke box, mechanical bull, and pool
   tables; and,
3. Fundraisers that are held for different organizations.

In touring the facility, there were posters and flyers for male and female strippers to be seen.
The largest part of the building consists of a large dance floor; tables on the main floor and
upstairs; two bars; and a stage for bands or a DJ. The organization rents a mechanical bull
once a month per their web site. In the interview of one of the bar tenders, he stated that when
he started working there, he wasn’t aware that the organization was an organization
and that he thought it was just a regular bar.

The organization will have sports nights such as Super Bowl Sunday or UFC fights to bring in
customers. ORG sponsors a golf charity twice a month with donations going to Shriners. ORG
sponsors a local softball team and a Dirt track car. ORG has a cover charge when bands play.
The DJ gives away T-Shirts and T-shirts are provided as uniforms for the staff.

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

Form 886A Department of the Treasury = Internal Revenue Service Schedule xe or Exhibit:
Explanation of Items Exhibit 1, Exhibit 2,
| [ixhibit 3, Exhibit 4,
Lixhibit A, Exhibit B,

Exhibit C,form 6018-A
Name of Taxpayer Year/Period Ended
12/31/20XNX

ORG
DBA ORG, Address, City, State

LAW AND ANALYSIS

Tax Exemption — Veterans Organizations

Prior to the enactment of I.R.C. § 501(c)(19) by Public Law 92-418, 1972-2 C.B. 675, many
veterans organizations qualified for exemption from federal income tax under I.R.C. § 501(c)(4)
because most of the traditional activities of these organizations were recognized by the IRS as
primarily promoting social welfare. Staff of Joint Comm. on Taxation, 109" Cong., Historical
Development and Present Law of the Federal Tax Exemption for Charities and Other Tax-
Exempt Organizations, JCX-29-05 NO 8, (Comm. Print 20XX). The traditional activities of
veterans organizations that were social welfare organizations included promoting patriotism,
preserving the memory of those who died in war, and assisting veterans in need. Id. A
veterans organization whose primary activity consisted of operating social facilities for its
members was not able to qualify for exemption as a § 501(c)(4) social welfare organization, but
it could qualify as a social club under § 501(c)(7). Rev. Rul. 66-150, 1966-1 C.B. 147; S. Rep.
No. 1082, 92d Cong., 2d Sess. 2 (1972) reprinted in 1972-2 C.B. 713; H.R. Rep. No. 851, 92d
Cong., 2d Sess. 1 (1972).

In 1972, Congress enacted I.R.C. § 501(c)(19) and I.R.C. § 512(a)(4) to address the concern
that a veterans organization exempt under |I.R.C. § 501(c)(4) or (7) may be subject to unrelated
business income tax on the provision of insurance to its members. S. Rep. No. 1082, 92d
Cong., 2d Sess. 2 (1972) reprinted in 1972-2 C.B. 713.? Section 512(a)(4) excludes amounts
attributable to, or set aside by a §501(c)(19) veterans organization for the payment of life, sick,
accident, or health insurance benefits for their members and their members’ dependents.
Public Law 92-418, 1972-2 C.B. 675.

The Section 501(c)(19) Exemption Requirements

In General

Section 501(c)(19) of the Internal Revenue Code provides for the exemption from federal
income tax of a post or organization of past or present members of the United States Armed
Forces if it is:

(a) organized in the United States or any of its possessions,

kk kK

° “Before the enactment of the Tax Reform Act of 1969, there was no tax on the insurance activities of the
veterans’ organizations since the unrelated business income did not apply to social welfare organizations
and social clubs. However, the 1969 Act extended the application of the unrelated business income tax to
virtually all exempt organizations including social welfare organizations and social clubs.” S. Rep.

No. 1082, 92d Cong,, 2d Sess. 2 (1972) reprinted in 1972-2 C.B. 713

Form 886-Ace 4-68) Department of the Treasury - Internal Revenue Service
Page: -5-

] Department of the Treasury - | Qevenue Service ‘ 'xhibit:
‘ asury - Internal Revenue Service Schedule No. or Lexhibit:
Form 886A panne ins ol erate ern :

Explanation of Items Eexhibic 1, Exhibit 2,
EExhibit 3, exhibit 4,

{exhibit A, Lixhsbit B,

lixhibir C. Porm 6018-A

Year/Period Ended
12/31/20XX

|

|
Name of Taxpayer
ORG
DBA ORG, Address, City, State

(b) at least 75 percent of its members are past or present members of the Armed
Forces of the United States,

(c) substantially all of its other members are individuals who are cadets or are

spouses, widows, widowers, ancestors or lineal descendants of past or present

members of the Armed Forces of the Unites States or of cadets, and

(d) no part of the net earnings of which inures to the benefit of any private

shareholder or individual.

Membership Requirements

Under I.R.C. § 501(c)(19), at least 75 percent of an organization’s members must be past or
present members of the Armed Forces of the United States (“veterans”). Section 501(c)(19)
does not define the term “Armed Forces of the United States.” The regulations under I.R.C. §
501(c)(19), likewise, do not define the term. Section 7701(a)(15) of the Code, however, defines
“Armed Forces” to include all regular and reserve components of the uniformed services which
are subject to the jurisdiction of the Secretary of Defense, the Secretary of the Army, the
Secretary of the Navy, or the Secretary of the Air Force, and the Coast Guard.

In addition, I.R.C. § 501(c)(19)(B) requires that substantially all other members of an
organization be cadets or spouses, widows, widowers, ancestors, or lineal descendants of
veterans or cadets. According to the Senate Report accompanying the legislation,
“substantially all’? means 90 percent. See S. Rep. No. 1082, 92™ Cong. 2d Sess. 5 (1972),
reprinted in 1972-2 C.B. 713, 715. Therefore, of the 25 percent of the members that do not
have to be veterans, 90 percent must be cadets, or spouses, etc. Consequently, no more than
2.5 percent (10% x 25%) of an I.R.C. § 501(c)(19) organization's total membership may consist
of individuals not mentioned in the statute.”

Neither, I.R.C. § 501(c)(19), its legislative history, nor the regulations under I.R.C. § 501(c)(19)
define what it means to be a member of a veterans organization. However, whatever the
organization requires for one to become a member, the organization must maintain records
tracking who its members are and the proportions in the various categories of membership
permitted under I.R.C. § 501(c)(19)(B) (member of armed forces, cadet, relative, etc.) to
substantiate that its members are veterans or other permitted members. See I.R.C. § 6001 and
Treas. Reg. §1.6001-1(c).*

---

° Prior to 20XX, ancestors and lineal descendent were not included in the statutory list of persons
permitted to be members. In 20XX, Congress amended I.R.C. § 501(c)(19) to include ancestors or lineal
descendents of present or former members of the United States Armed Forces or cadets in the statutory
list of individuals who may be members of an organization. The regulations have not been updated to
reflect this change nor do they reflect the 1982 statutory change eliminating a requirement that veterans
be veterans of war

“ Section 6001 of the Code provides that every person liable for any tax imposed by the Code, or for the
collection thereof, shall keep adequate records as the Secretary of the Treasury of his delegate may from
footnote continues next page

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

Fotm 886A | Department of the Treasury - Internal Revenue Service Schedule No. or exhibit:

Explanation of Items [exhibie 1, lixhibit 2
Exhibit 3, Exhibit 4,

Iixhtbit A, exhibit B,

[Exhibir C.Form 6018-A

Year/Period Ended
12/31/20XX

Name of Taxpayer
ORG
DBA ORG, Address, City, State

Operational Test

Section 1.501(c)(19)-1(c) of the regulations provides that an organization exempt under I.R.C. §
501(c)(19) must be operated exclusively for one or more of the following purposes:

1) To promote the social welfare of the community as defined in section 1.501(c)(4)-1(a)(2)
of the regulations,

2) To assist disabled and needy war veterans and members of the United States Armed
Forces and their dependents and widows and orphans of deceased veterans,

3) To provide entertainment, care, and assistance to hospitalized veterans or members of
the Armed Forces of the United States,

4) To carry on programs to perpetuate the memory of deceased veterans and members of
the Armed Forces and to comfort their survivors,

5) To conduct programs for religious, charitable, scientific, literary, or educational
purposes,

6) To sponsor or participate in activities of a patriotic nature,

7) To provide insurance benefits for their members or the dependents of their members or
both, or

8) To provide social and recreational activities for their members.

Treas. Reg. § 1.501(c)(19)
Social and Recreational Activities for Members

While Treas. Reg. §1.501(c)(19)-1(c)(8) does not address what it means to “exclusively”
provide social and recreational activities for members it is similar to the exempt purpose
contained in I.R.C. § 501(c)(7), as both provisions permit an exempt organization to operate
social and recreational facilities for its members. In fact, prior to the enactment of IL.R.C. §
501(c)(19), a veterans organization whose primary activity consisted of operating a bar or
restaurant for the benefit of its members would have to qualify as § 501(c)(7) social club to be
tax-exempt. See Rev. Rul. 60-324 and Rev. Rul. 69-219.° These organizations, prior to 1976,

continued footnote

time to time proscribe. Every organization exempt from tax under § 501(a) and subject to the unrelated
business income tax, including veterans organizations, must keep such records. Treas. Reg. § 1.6001-
1(a). These books and records are required to be available for inspection by the Service. Treas. Reg. §
1.6001-1(a). In addition, veterans organizations are required to keep books and records to substantiate
information reported on their information return. See I.R.C. § 6033 and Treas. Reg. § 1.6001-1(c). They
are also required to submit additional information to the Service for the purpose of enabling the Service to
inquire further into its exempt status.

In 1976, Congress amended § 501(c)(7) replacing “exclusively” with “substantially all." This change was
effected to establish that social clubs will not jeopardize their exempt status if they receive 35% of their
gross receipts from non-membership sources. Only 15% of their gross receipts, however, may be derived
from nonmembers’ use of club facilities or services. Pub. L. No. 92-568, S. Rep. 1318, 94 Cong, 2d
Sess. (1976)

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

Form S86A Department of the Preasury - Internal Revenue Service Schedule No. or Lixhibit:

Explanation of Items [Exhibie 1, Exhibit 2,
Exhibit 3, {exhibit 4,

Exhibit A, Exhibit B,
Exhibit C,Form 6018-A

Name of Taxpayer Year/Period Ended
ORG 12/31/20XX

_DBA ORG, Address, City, State

were required to operate “exclusively” for the pleasure and recreation of its members. See
I.R.C. § 501(c)(7) (1975). Thus, the rulings and case law under I.R.C. § 501(c)(7) are useful for
purposes of determining whether an I.R.C. § 501(c)(19) veterans organization is providing
social and recreational activities exclusively for its members.

Treas. Reg. § 1.501(c)(7)-1(b) provides that a club that engages in business, such as making
its social and recreational facilities available to the general public is not organized and operated
exclusively for pleasure, recreation, and other nonprofit purposes, and is not exempt under
I.R.C. § 501(a). Solicitation by advertisement or otherwise for public patronage of its facilities is
prima facie evidence that the club is engaging in business and is not being operated exclusively
for pleasure, recreation, or social purposes

In West Side Tennis Club v. Commissioner,111 F.2d 6 (2nd Cir. 1940), cert. denied, 311 U.S.
674 (1940), the Second Circuit upheld the board of tax appeals determination that a social club
was not exempt because a substantial amount of its income was received from the general
public. West Side Tennis Club was organized to provide tennis facilities for the use and
enjoyment of its members. The facilities were only available to members for most of the year;
the club hosted annual national championship tennis matches, however, that were open to the
general public. The club shared in the ticket proceeds from these matches. The Second
Circuit upheld the board of tax appeals determination that the national championship matches
were a substantial and profitable business which jeopardized the club’s exemption. West Side
Tennis Club, 111 F.2d at p. 7.°

In Rev. Rul. 60-324, 1960-2 C.B. 173 and Rev. Rul. 69-219, 1969-1 C.B. 153, the Service held
that a § 501(c)(7) social club is not operated exclusively for the pleasure or recreation of its
members if it makes its facilities available to the general public to a substantial degree. Id.
However, this does not mean that all dealings with the general public are necessarily
inconsistent with the club's exempt purposes. For instance, in Rev. Rul. 60-324, 1960-2 C.B.
173, the Service stated that:

[w]hile [the] regulations indicate that a club may lose its exempt status if it makes
its facilities available to the general public, [it] does not mean that any dealings
with outsiders will automatically cause a club to lose its exemption. A club will
not lose its exemption merely because it receives some income from the general
public, that is, persons other than members and their bona fide guests, or
because the general public may occasionally be permitted to participate in its
affairs, provided such participation is incidental to and in furtherance of its
general club purposes and the income therefrom does not inure to members.
*” * * *
° In 1976, Congress amended § 501(c)(7) replacing “exclusively” with "substantially all.” This change was
effected to establish that social clubs will not jeopardize their exempt status if they receive 35% of their
gross receipts from non-membership sources. Only 15% of their gross receipts, however, may be derived
from nonmembers’ use of club facilities or services. Pub. L. No. 92-568, S. Rep. 1318, 94 Cong., 2d
Sess. (1976)

Form 886-Acrev 4-68) Department of the Treasury - Internal Revenue Service
Page: -8-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or Exhibit:

Explanation of Items Exhibit Pb Exnieite,
Exhibit 3, exhibit 4,

Exhibit A, Eexhibic B,

Exhibit C,Form 6018-A

Year/ Period Ended
12/31/20XX

Name of Taxpayer
ORG
DBA ORG, Address, City, State

In 19XX, the Service issued Revenue Procedure 71-17, 19XX-1 C.B. 683, which contains
guidelines for determining the impact of an organization's nonmember gross receipts on its
exempt status under I.R.C. § 501(c)(7). The revenue procedure provides that “[a] significant
factor reflecting the existence of a nonexempt purpose is the amount of gross receipts derived
from use of a club’s facilities by the general public.” The revenue procedure went on to provide
a safe harbor for organizations serving the general public:

As an audit standard, [the gross receipts derived from the general public] alone
will not be relied upon by the Service if annual gross receipts from the general
public for [use of the club’s facility] is $2,500 or less or, if more than $2,500,
where gross receipts from the general public for use is five percent or less of
total gross receipts of the organization.

Rev. Proc. 71-17, 19XX-1 C.B. 683 at § 3.01.

The term “general public” is defined as persons other than members or their dependents or
guests. Id. at § 2.01. Section 3.03 of Rev. Proc. 71-17 provides four instances in which
nonmembers are assumed to be the guests of the members. The assumptions include:

Where a group of eight or fewer individuals, at least one of whom is a member,
uses club facilities, it will be assumed for audit purposes that the nonmembers
are the guests of the member, provided payment for such use is received by the
club directly from the member or the member's employer.

Where 75 percent or more of a group using club facilities are members, it will
likewise be assumed for audit purposes that the nonmembers in the group are
guests of members, provided payment for such use is received by the club
directly from one or more of the members or the member's employer.

Rev. Proc. 71-17, Section 3.03.

In Pittsburgh Press Club v. United States, 615 F.2d 600 (3d Cir. 1980), the Third Circuit

upheld the Commissioner’s determination that a social club failed to qualify for exemption from
income tax as a §501(c)(7) organization because it was operated for business and not for the
pleasure and recreation of its members. The Pittsburgh Press Club was organized for the
purpose of providing a professional and social meeting place for its members. During the years
under exam, however, the Pittsburgh Press Club hosted several functions for nonmember
outside groups, although each such group had been member sponsored. Based on the amount
of nonmember revenues ($281,000 of nonmember receipts), as well as the percentage of those
revenues (11 to 17 percent of gross receipts), the Third Circuit upheld the revocation stating
that the exemption from Federal income tax for §501(c)(7) organizations “is to be strictly
construed.” Pittsburgh Press Club, 615 F.2d at 606. The Court stated that such strict
construction cannot be reconciled with the fact that a substantial amount of the Club's activities

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

Form S86A Department of the Treasury - Internal Revenue Service Schedule No. or Exhibit:

Explanation of Items Peas Ty Pesalb iS
Exhibit 3, Exhibit 4,

Exhibit A, [exhibic B,

Exhibit C.Form 6018-A

Year/Period Ended
12/31/20XX

Name of Taxpayer
ORG
DBA ORG, Address, City, State

and income consisted of nonmember functions and nonmember income. Therefore, the Court
held “revocation of its exemption was proper.” Id.

Inurement

An organization fails to qualify for exemption under I.R.C. § 501(c)(19) if there is inurement.
Section 501(c)(19) of the Code prohibits inurement “to the benefit of any private shareholder or
individual.” The regulations contain corresponding language. See Treas. Reg. §1.501(c)(19)-

1(a)(1).

There are no cases or rulings interpreting this statutory or regulatory language under I.R.C. §
501(c)(19). The inurement prohibition set forth in I.R.C. § 501(c)(19), however, parallels exactly
the language found in I.R.C. § 501(c)(3). Thus, it is the government's position that the case
law, as well as the regulatory and other guidance, on inurement under I.R.C. § 501(c)(3) may
be used by analogy in interpreting prohibited inurement under I.R.C. § 501(c)(19).

An organization will not qualify for exempt status under I.R.C. § 501(c)(3) if it is 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. Treas. Reg. § 1.501(c)(3)-1(d)(1)(ii). Inurement refers to the non-incidental
diversion of assets, which are supposed to be dedicated to charitable purposes, to an insider of
the organization. See Treas. Reg. § 1.501(a)-1(c); Ginsburg v. Commissioner, 46 T.C. 47
(1966)

Inurement may take many forms and an organization’s earnings may inure to the benefit of
private individuals in ways other than by the actual distribution of dividends or payment of
excessive salaries. See Founding Church of Scientology v. United States, 412 F.2d 1197, 1200
(1969), cert. denied, 397 U.S. 1009 (1970) (excessive compensation paid to insiders); Founding
Church of Scientology, 412 F.2d 1197, 1200 (1969), cert. denied, 397 U.S. 1009 (1970)
(excessive rents paid to insiders as landlords); Easter House v. U.S., 12 Cl. Ct. 476 (1987)
(loans to insiders on advantageous terms); Rev. Rul. 56-138, 1956-1 C.B. 202 (excessive
employee benefits provided to insiders); Anclote Psychiatric Center, Inc. v. Commissioner, T.C.
Memo 1998-273 (purchase of assets from insiders for more than fair market value or sale of
assets to insiders for less than fair market value). Moreover, the unaccounted for diversions of
a charitable organization’s resources by one who has complete and unfettered control can
constitute inurement. Founding Church of Scientology of California v. United States, 823 F.2d
1310, 1316. See also, Parker v. Commissioner, 365 F.2d 792, 799 (8th Cir. 1966), cert. denied,
385 U.S. 1026 (1967); Kenner v. Commissioner, 318 F.2d 632 (7th Cir. 1963).

In People of God Community v. Commissioner, 75 T.C. 127 (1980), a newly formed Christian
religious organization, which was founded by one of its ministers, paid its founder and its other
ministers a predetermined percentage of the gross tithes and offerings that were received by
the organization. After determining that part of the organization’s net earnings inured to the
benefit of private shareholders or individuals (i.e., the ministers), the Tax Court held that the
organization was not exempt as an organization described in I.R.C. § 501(c)(3).

Form 886-A cirev.4-68) Department of the Treasury - Internal Revenue Service

Page: -10-

Form 886A Department of the ‘Treasury - Internal Revenue Service Schedule No. or Exhibit:

Exhibit 3, Exhibit 4,

Exhibit A, Exhibit B,

Lexhibit C,Form 6018-A

Year/ Period Ended
12/31/20XX

Name of Taxpayer
ORG
DBA ORG, Address, City, State

In Spokane Motorcycle Club v. United States, 222 F. Supp. 151 (E.D. Wash. 1963), the plaintiff,
a motorcycle club, claimed it was a non-profit, charitable corporation, and asserted that it was
exempt from Federal income tax under I.R.C. § 501(c)(7) and entitled to a refund. The District
Court disagreed with the plaintiff's assertions, held that part of the motorcycle club's net
earnings inured to its members, even though the amount involved was de minimus, and
concluded that the plaintiff was not exempt from Federal income tax.

In Mabee Petroleum Corp. v. United States, 203 F. 2d 872, 875 (5th Cir. 1953), a corporation
filed suit to recover overpayments of income taxes on grounds that it was entitled to charitable
exemption. The United States District Court for the Northern District of Texas entered judgment
against the plaintiff and the plaintiff appealed. The Court of Appeals affirmed the District Court's
judgment and concluded that the District Court's finding that the salary that was paid to the
founder of the charitable foundation, to which all of the founder’s stock in the corporation was
transferred, was excessive and constituted inurement of net earnings to the benefit of a private
individual, was not clearly erroneous.

In The Founding Church of Scientology v. United States, 412 F.2d 1197, 1201 (Ct. Cl. 1969),
cert. denied, 397 U.S. 1009 (1970), in addition to receiving salary, commission, and royalty
payments, the founder of the church, and several members of his family, received unexplained
payments in the nature of loans and reimbursements for expenditures made in plaintiff's behalf,
for expenses and other purposes. The Court of Claims held that the plaintiff was not entitled to
exemption from Federal income tax because it failed to prove that no part of the corporate net
earnings benefited private individuals. Thus, the plaintiffs claim was denied and the petition
was dismissed.

In Parker v. Commissioner, 365 F.2d 792 (8th Cir. 1966), after the Court of Appeals concluded
that the Tax Court was justified in ruling that the corporate petitioner was not entitled to tax
exemption as a religious organization under I.R.C. § 501, it turned its attention to the
unaccounted-for and unexplained withdrawals from the corporation’s bank accounts and the
checks, which were made payable to the founder, that were drawn on the organization's
account. The Commissioner credited the unidentified withdrawals to the founder's income. The
Tax Court sustained such action, and the Court of Appeals affirmed the Tax Court's
determination, noting that [dJue to the extremely close relationship between [the founder] and
the day-to-day financial activities of [organization] and due to [the founder's] complete and
unfettered control over [the organization], [the founder] has the burden of explaining
unidentified withdrawals from the [organization's] accounts.” Id. at 799, citing Reinecke v.
Spalding, 280 U.S. 227 (1930): Arc Realty Company v. Commissioner, 295 F.2d 98 (3 Cir.
1961). “If he is unable to do so the Commissioner may validly assume that the withdrawals
were income to the [founder].” Parker v. Commissioner, 365 F.2d 792, 799 (8th Cir. 1966). No
evidence of any kind was produced explaining the withdrawals or indicating that the founder did
not receive the benefit from them. Thus, the Court of Appeals concluded that the assessments
were proper. Id.

Form 886-Acre 4-68) Department of the Treasury - Internal Revenue Service
Page: -11-

Form S86A Department of the [reasury - Internal Revenue Service Schedule No, or Exhibit

Explanation of Items tesla ef ns 2
Exhibit 3, Exhibit 4,

Exhibit A, exhibit B,

Exhibit C.Form 6018-A

Year/Period Ended
12/31 /20XN

Name of Taxpayer
ORG
DBA ORG, Address, City, State

in Church of Scientology of California v. Commissioner, 823 F.2d 1310 (9th Cir. 1987), cert.
denied, 486 U.S. 1015 (1988), the Court of Appeals affirmed the Tax Court’s judgment which
upheld the Commissioner's assessment of tax deficiencies and penalties against the church,
following the revocation of the church’s tax exempt status. The Court of Appeals reviewed the
Tax Court's factual finding that a portion of the church's net earnings inured to the benefit of L.
Ron Hubbard, and his family, and OTC, a private for-profit corporation, for clear error. In
finding that a portion of the church's net earnings inured to the benefit of L- Ron Hubbard, his
family and OTC, the Tax Court isolated two indications of inurement, overt and covert
inurement. The overt indications included salaries, living expenses, and royalties, and the
covert indications included “debt repayments” and L. Ron Hubbard's unfettered control over
millions of dollars of church assets. The Tax Court concluded that these indications, when
viewed in light of the self-dealing associated with them, coupled with the church's failure to
carry its burden of proof and to disclose the facts candidly, proved conclusively that the church
was operated for the benefit of L. Ron Hubbard and his family. Id. at p. 1317. In addition to
Hubbard’s salary, the church paid for all of the Hubbards’ living and medical expenses aboard
the cruise ship Apollo. The church paid substantial royalties to L. Ron Hubbard for his books,
recordings and E-meters. The record revealed that L. Ron Hubbard had unfettered control over
millions of dollars in church assets, and supported the Tax Court's conclusion that L. Ron
Hubbard had unfettered control over Church of Scientology Trust Fund assets. Additionally, the
Tax Court found that church income incurred to the benefit of L. Ron Hubbard in a “grand scale”
in the form of “debt repayments.” Id. at p. 1319. In sum, the Tax Court held that “significant
sums of money inured to the benefit of L. Ron Hubbard and his family” during the years at
issue. The Court of Appeals found no clear error and noted that “[a]lthough neither the salaries
nor the living expenses necessarily constituted evidence of inurement, the cumulative effect of
Hubbard’s use of the Church to promote royalty income, Hubbard's unfettered control over
millions of dollars of church assets, and his receipt of untold thousands of dollars worth of “debt
repayments” strongly demonstrate inurement.” Id.

Recordkeeping and Reporting Requirements

Every person liable for any tax imposed by the Code, or for the collection thereof, shall keep
adequate records as the Secretary of the Treasury or his delegate may from time to time
prescribe. See I.R.C. § 6001. Every organization exempt from tax under I.R.C. § 501(a), and
subject to the tax imposed by I.R.C. § 511 on its unrelated business income, must keep such
permanent books or accounts or records, including inventories, as are sufficient to establish the
amount of gross income, deduction, credits, or other matters required to be shown by such
person in any return of such tax. Such organization shall also keep such books and records as
are required to substantiate the information required by §6033. See Treas. Reg. §§ 1.6001-
1(a) and 1.6001-1(c). The books or records required by section 1.6001-1 shall be kept at all
times available for inspection by authorized internal revenue officers or employees, and shall be
retained so long as the contents thereof may become material in the administration of any
internal revenue law. See Treas. Reg. §1.6001-1(e). Except as provided, every organization
exempt from tax under I.R.C. § 501(a) shall file an annual return, stating specifically the items
of gross income, receipts and disbursements, and such other information for the purposes of

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

Form 886A Department of the Treasury = Internal Revenue Service Schedule No. or Lixhibit:

lixhibit 3, Exhibit 4,

Exhibit A, exhibit B,

Exhibit C,Form 6018-A

Year/Period Ended
12/31/20XX

Name of Taxpayer
ORG
DBA ORG, Address, City, State

carrying out the internal revenue laws as the Secretary may by forms or regulations prescribe,
and keep such records, render under oath such statements, make such other returns, and
comply with such rules and regulations as the Secretary may from time to time prescribe. See
LR.C. § 6033(a)(1)

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 Service
for the purpose of inquiring into its exempt status and administering the provisions of
subchapter F (i.e., I.R.C. § 501 and following), chapter 1 of subtitle A of the Code, I.R.C. §
6033, and chapter 42 of subtitle D of the Code. See Treas. Reg. §1.6033-2(i)(2). See also,
I.R.C. § 6001, Treas. Reg. §1.6001-1.

An organization’s failure or inability to file required information returns or otherwise to comply
with the provisions of I.R.C. § 6033 and the regulations which implement it, may result in the
termination of the organization's exempt status based on the grounds that the organization has
not established that it is observing the conditions that are required for the continuation of its
exempt status. See Rev. Rul. 59-95. These conditions require the filing of a complete and
accurate annual information return (and other required federal tax forms) and the retention of
records sufficient to determine whether the organization is operated for the purposes for which
it was granted tax-exempt status and to determine its liability for any unrelated business income
tax. Id

Rev. Rul. 59-95, 1959-1 C.B. 627, concerns an exempt organization that was requested to
produce a financial statement and statement of its operations for a certain year. Its records
were so incomplete, however, that the organization was unable to furnish such statements.

The Internal Revenue Service held that the organization’s 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 its exempt status.

Unrelated Business Income Tax

Section 511(a) of the Code imposes a tax upon the unrelated business taxable income of
organizations exempt from federal income tax.

Section 512(a)(1) defines unrelated business taxable income as the gross income from any
unrelated trade or business regularly carried on by the organization.

Section 513(a) defines the term “unrelated trade or business” as any trade or business the
conduct of which is not substantially related (aside from the need of such organization for
income of funds or the use it makes of the profits derived) to the exercise or performance by
such organization of its exempt functions.

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

Explanation of Items Exhibit 1, Exhibit 2,
Exhibit 3, Exhibit 4,

exhibit A, Pixhtbie B,

Exhibit C,Form 6018-A

Year/Period Ended
12/31/20NN

Foren 886A [I Department of the ‘Treasury - Internal Revenue Service Schedule No. or [ixhibit:
|

Name of Taxpayer
ORG
DBA ORG, Address, City, State

Section 513(c) provides that the term “trade or business” includes any activity which is carried
on for the production of income from the sale of goods. An activity does not lose its identity as
trade or business merely because it is carried on within a larger aggregate of similar activities or
within a larger complex of other endeavors which may not be related to the exempt purposes of
the organization.

Treas. Reg. § 1.513-1(d)(2) provides that a trade or business is related to exempt purposes
only where the conduct of the business activities has a causal relationship to the achievement
of exempt purposes (other than through the production of income). It is substantially related,
for purposes of section 513 of the Code, only if the causal relationship is a substantial one. For
this relationship to exist, the production or distribution of the goods or the performance of the
services from which the gross income is derived must contribute importantly to the
accomplishment of those purposes. Whether activities productive of gross income contribute
importantly to the accomplishment of any purpose for which an organization is granted
exemption depends on each case upon the facts and circumstances involved.

In Rev. Rul. 68-46, 1968-1 C.B. 260 a war veterans’ organization did not qualify for exemption
from Federal income tax under I.R.C. § 501(c)(4) because it was primarily engaged in renting a
commercial building and operating a public banquet and meeting hall having bar and dining
facilities.

IRC §501(c)(19) provides for the exemption from federal income tax of a post or organization of
veterans of the Armed Forces of the United States if such post or organization is:

a) organized in the United States or any of its possessions,

b) atleast 75% of the members of which are past or present members of the Armed
Forces of the United States and substantially all of the other members of which are
individuals who are cadets or are spouses, widows, or widowers of past or present
members of the Armed Forces of the United States or of cadets, and

c) no part of the net earnings of which inures to the benefit of any private shareholder or
individual

With respect to the membership requirements under Section 501(c)(19) of the code, in Senate
Report No. 92-1082, g2" Cong. 2d Sess., 1972-2 C.B. 713 at 715, Congress stated that
“substantially all” means 90 percent. Therefore, of the 25 percent of the members that do not
have to be past or present members of the Armed Forces of the United States, 90 percent have
to be cadets, or spouses, etc. Thus, only 2.5 percent of a section 501(c)(19) organization's
total membership may consist of individuals not mentioned above.

IRC Section 6001 provides that every person liable for any tax imposed by the Code, or for the
collection thereof, shall keep adequate records as the Secretary of the Treasury or his delegate
may from time to time prescribe.

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

Page: -14-

Form 886A Deparument of the Ereasury = Internal Revenue Service Schedule No. or Exhibit:

Explanation of Items Exhibit 1, Exhibit 2,
Exhibit 3, Exhibit 4,

Lixhibit A, Exhibit B,
Exhibit C. Form 6018-A

Year/Period Ended

Name of Taxpayer
12/31/20XX

ORG
DBA ORG, Address, City, State

Section 1.501(c)(19)-1(c) of the Regulations provides that an organization exempt under
§501(c)(19) must be operated exclusively for one or more of the following purposes:

1) To promote the social welfare of the community as defined in Section 1.501(c)(4)-
1(a)(2),

2) To assist disabled and needy war veterans and members of the United States Armed
Forces and their dependents and widows and orphans of deceased veterans,

3) To provide entertainment, care, and assistance to hospitalized veterans or members of
the Armed Forces of the United States,

4) To carry on programs to perpetuate the memory of deceased veterans and members of
the Armed Forces and to comfort their survivors,

5) To conduct programs for religious, charitable, scientific, literary, or educational
purposes,

6) To sponsor or participate in activities of a patriotic nature,

7) To provide insurance benefits for their members or the dependents of their members or
both, or

8) To provide social and recreational activities for their members.

Section 1.6001-1(a) of the Regulations in conjunction with Section 1.6001-1(c) provides that
every organization exempt from tax under Section 501(a) of the Code and subject to the tax
imposed by Section 511 on its unrelated business income must keep such permanent books or
accounts or records, including inventories, as are sufficient to establish the amount of gross
income, deduction, credits, or other matters required to be shown by such person in any return
of such tax. Such organization shall also keep such books and records as are required to
substantiate the information required by Section 6033.

Section 1.6001-1(e) of the Regulations provides that the books or records required by this
Section shall be kept at all times available for inspection by authorized internal revenue officer
or employees, and shall be retained as long as the contents thereof may be material in the
administration of any internal revenue law.

Section 1.6033-2(a)(1) of the Regulations states in part that every organization exempt from
taxation under Section 501(a) shall file an annual information return specifically setting forth its
items of gross income, gross receipts and disbursements, and such other information as may
be prescribed in the instructions issued with respect to the return. Such return shall be filed
annually regardless of whether such organization is chartered by, or affiliated or associated
with, any central, parent, or other organization. Tax Regulation §1.6033-2(a)(2)(i) states in
pertinent part that every organization exempt from taxation under Section 501(a), and required
to file a return under Section 6033 and this Section (including, for taxable years ending before
December 31, 1972, private foundations, as defined in Section 509(a), other than an
organization described in Section 401(a) or 501(d), shall file its annual return on Form 990.

Section 1.6033-2(i)(1) of the Regulations states that an organization which is exempt from
taxation under Section 501(a) and is not required to file annually an information return required

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

Form 886A Department of the Treasury - Internal Revenue Serv ice Schedule No. or Lixhibit:

| Explanation of Items Lxhibit 1, Exhibit 2,
Exhibit 3, Exhibit 4,

exhibit A, Eexhibiec B,

Exhibit C.Form 6018-A

Year/Period Ended
12/31/20XX

Name of Taxpayer
ORG
DBA ORG, Address, City, State

by this Section shall immediately notify in writing the district director for the internal revenue
district in which its principal office is located of any changes in its character, operations, or
purpose for which it was originally created.

Section 1.6033-2(i)(2) of the Regulations states 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 of inquiring
into its exempt status and administering the provisions of subchapter F (Section 501 and
following), chapter 1 of subtitle A of the Code, Section 6033, and chapter 42 of subtitle D of the
Code. See Section 6001 and §1.6001-1 with respect to the authority of the district directors or
directors of service centers to require such additional information and with respect to the books
of accounts or records to be kept by such organizations.

Rev. Rul. 68-46, 1968-1 C.B. 260, describes another veterans’ post. After an analysis of all the
facts and circumstances, the Service determined that the post's primary activity was the
conduct of a business rather than social welfare activity. The organization's business activities
involved the rental of its commercial office building and operating a public banquet and meeting
hall with a bar and dining facilities. Although the organization carried on veterans' programs and
other social welfare activities, based on an analysis of the whole operation, it was concluded
that the business activities relating to the operation of the facility exceeded all other activities,
and the social welfare programs were not its primary activity.

Rev. Rul. 61-158, 1961-2 C.B. 115, describes an organization that was created exclusively for
the promotion of social welfare, but whose principal activity was conducting a lottery on a
weekly basis with the general public. Its principal source of income was the gross receipts from
the weekly lottery. The major portion of the profits of the lottery was used for the payment of
general expenses of the organization and only a small portion was used for social welfare
purposes. The ruling holds that the organization is not operated exclusively for the promotion of
social welfare because its primary activity is the conduct of a business for profit. Accordingly, it
is not exempt under Section 501(c)(4) of the Code.

Rev. Rul. 59-95, 1959-1 C.B. 627, concerns an exempt organization that was requested to
produce a financial statement and statement of its operations for a certain year. However, its
records were so incomplete that the organization was unable to furnish such statements. The
Service held that the 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 tt,
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 tts exempt status.

Taxpayer's Position

Government’s Position and Conclusions

Form 886-Acrey.4-68) Department of the Treasury - Internal Revenue Service

Page: -16-

Form 886A Department of the ‘Treasury - [nternal Revenue Service Schedule No. or Lxhibit:

Explanation of Items Exhibit 1, lexhibir 2,
Iexhibic 3, [xhibic 4,

Exhibit A, Exhibit B,

Lixhibic C,Form 6018-A

Year/ Period Ended
12/31/20XX

Name of Taxpayer
ORG
DBA ORG, Address, City, State

Issue 1. ORG has not established that it operates exclusively for exempt purposes listed in
Treas. Reg. § 1.501(c)(19)-1(c).

An organization described in I.R.C. § 501(c)(19) carries out activities in furtherance of its
exempt purposes only when such activities are carried out exclusively in furtherance of the
purposes listed in Treas. Reg. § 1.501(c)(19)-1(c). Among these purposes is the provision of
social and recreational activities for its members. If an organization makes its facilities available
to the general public to a substantial degree, and/or a significant amount of the organization’s
income is received from the general public, the organization may lose its tax exemption. In the
instant case, very few documents were produced during the examination that demonstrated the
exempt activities in which ORG engaged during the years at issue. ORG was unable to provide
records that demonstrated the amount of income for members, their families, guests, auxiliary
members, and nonveterans. Nor did the organization provide records to demonstrate who used
the facilities (i.e., members, members’ families, guests, non-veterans, etc.) on a daily basis.

According to information that ORG's President, President, provided during the initial interview,
and based on the records that the organization provided for review, it has been determined that
more than 50% of the organization’s gross receipts were derived from the general public’s use
of the organization's facilities (i.e., drinks) in 20XX and 20XX, respectively. This determination
is further supported by comparing the average amount each of the 15 members of the
organization, and/or their families, would have had to spend each year in order to reach the
organization’s total gross receipts for 20XX and 20XX. For 20XX, the average amount a
member and/or their family would have had to spend at the organization would have been $.
For 20XX, the average amount would have been $. Given the fact that ORG had only 15
members and 100 customers per night and because it lacks the records to substantiate the
source of its gross receipts, we have determined that ORG is operating a business that is open
to the public and it is not operating exclusively to provide social and recreational activities to its
members.

Based on the evidence that has been produced to date, it appears that the organization's
exempt activities are insignificant in comparison to ORG’s operation of the business. Moreover,
ORG failed to substantiate what purpose was served by the donations.

Issue 2. ORG's net income inured to the benefit of its President, President, during 20XX and
20XX, respectively.

In the mortgage note for the business, the loan document states the borrowers are: President,
President; Vice-President, Vice President; and RA-1, Vice President's wife. This loan appears
to benefit the three partners as the contract does not mention the tax exempt organization
anywhere in it. The contract also states that this is “A General Partnership”. (See Exhibit C.)

There is a contract between President, President, and RA-2, spouse; that states that
entitled to half of the profits for the weekend sales from the business. It states that the
maximum amount to be paid to her is $, and this is to be paid every Monday. (See Exhibit B.)

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

Page: -17-

: A Department of the Treasury - Internal Revenue Service Sche iN exhibit:
Form 886A | sur g e Schedule No, or Exhibit:

Explanation of Items lExhibie 1, Exhibit 2,
Exhibit 3, Exhibit 4,

Exhibit A, lexhibic B,

Exhibit C.Form 6018-A

Year/Period Ended
12/31/20XNX

Name of Taxpayer
ORG
DBA ORG, Address, City, State

An organization does not qualify for exemption from federal income tax under section
501(c)(19) of the Code if any of its assets or earnings inure to the benefit of any insiders. See
Treas. Reg. § 1.501(c)(19)-1(a)(1). Although stated in terms of the "net earnings” of an
organization, the inurement doctrine applies to any transfer of an organization's assets. See
People of God Community v. Commissioner, 75 T.C. 127, 133 (1980).

The prohibition on inurement in I.R.C. § 501(c)(19) is absolute even if the amount involved is
considered to be de minimus. The Internal Revenue Service has the authority to revoke an
organization's exempt status for inurement regardless of the amount of inurement. See
Spokane Motorcycle Club v. U.S., 222 F. Supp. 151 (E.D. Wash. 1963);

Based on the foregoing, the reported income that the organization paid to the President's
spouse in 20XX and 20XX, respectively, constitutes inurement. See Treas. Reg. §
1.501(c)(19)-1(a)(1)

Issue 3. ORG has failed to satisfy the recordkeeping and reporting requirements provided by
I.R.C. §§ 6001 and 6033.

As is discussed more fully above, in order to qualify for exemption under I.R.C. § 501(c)(19), an
organization must keep accurate books and records to determine the nature of the
organization's income and records of its exempt and non exempt activities.

During the years under examination, ORG failed to maintain records which distinguished the
income that it derived from "veteran" members, the members' families, bona fide guests,
auxiliary members, and non-veterans in connection with the organization's operation of its bar
and/or lounge. Also, the organization produced very few records that substantiated the
activities that it claimed were engaged in for exempt purposes. Additionally, the organization’s
Forms 990 for 20XX and 20XX do not accurately reflect the organization's activities, the nature
of its income and/or expenses, or the amounts of its income and expenses as required under
I.R.C. §§ 6001 and 6033, and the regulations promulgated under those sections.

Issue 4. ORG does not qualify for exemption under I.R.C. § 501(c)(19), and therefore its tax
exempt status should be revoked for the following reasons:

1. ORG does not operate exclusively for exempt purposes, as required, because it
   primarily operates a bar and more than a substantial amount of sales are to the general
   public.

2. ORG’s net income inured to the benefit to its founder and President during the years
   under examination.

3. ORG failed to meet the recordkeeping and reporting requirements required by I.R.C. §§
   6001 and 6033.

As indicated above, the operational test is not satisfied where any part of the organization's
earnings inures to the benefit of private shareholders or individuals. ORG has operated in the

Form 886-A (Rev.4-68 Department of the Treasury - Internal Revenue Service
) P ry
Page: -18-

Form 886A ia Department of the ‘Treasury - Internal Revenue Service Schedule No. or Lxhibit:

Explanation of Items Exhibit 1, Exhibit 2,
Exhibit 3, exhibit 4,

Exhibit A, Exhibit B,

Exhibit C.Form 6018-A

Year/ Period Ended
12/31/20XX

Name of Taxpayer
ORG
DBA ORG, Address, City, State

same manner since it was included in ORG's group exemption in April of 20XX. Accordingly,
we have determined that recognition of exemption as an organization described in section
501(c)(3) is revoked effective as of April 1, 20XX. ORG is required to file Form 1120 returns for
all open tax years ending after April 1, 20XX.

Issue 5. Alternatively, if ORG’s exemption under I.R.C. § 501(a), as an organization described
in RC. § 501(c)(19), is not revoked, it is the government's position that, effective January 1,
20XX, the income that ORG received from its bar operations, vending machines, Keno, and
gaming activities is unrelated business income under I.R.C. § 512, which is subject to tax
pursuant to I.R.C. §511. In determining whether an income-producing activity is an unrelated
trade or business, it must be shown that (1) there is a trade or business; (2) the trade or
business is regularly carried on; and (3) the conduct of the trade or business is not substantially
related to the organization’s exempt purpose or function. See Treas. Reg. § 1.513-1(a).

As is discussed more fully above, gross income is derived from an unrelated trade or business
if the trade or business is not substantially related (other than through production of funds) to
the purposes for which exemption is granted. See Treas. Reg. § 1.513-1(d)(1). To escape
taxation as unrelated business income, the organization's activities, which give rise to the
income, must contribute directly and importantly to the accomplishment of one or more of the
organizations exempt purposes. See Treas. Reg. § 1.513-1(d)(2).

In this case, ORG was actively engaged in the operation of a bar which was open to the general
public. ORG’s bar was open 7 days a week, and the bar was operated by the organization in
direct competition with similar non-exempt commercial enterprises. Thus, ORG's bar activities
constituted a regularly carried on trade or business. ORG has failed to demonstrate that its bar
activities were conducted in a non-commercial manner or that the frequency of its operations
were irregular compared with similar non-exempt enterprises. ORG did not maintain any
records which specify the amounts of income that the bar generated from members and non
members, and it failed to provide any basis for determining how much of its income came from
members and non members. Since no reasonable method exists for determining which part of
the organization’s bar income was derived from the general public as opposed to the
organization's members, it is the government's position that all of the income that was
generated by the bar including, but not limited, to the bar operations, vending machines, Keno
and gaming activities should be treated as unrelated business income.

Since the organization's bar income that was derived from the general public is unrelated to the
organization's exempt purposes, and the organization failed to maintain records that delineated
between the income that it derived from members and non members, and because it was
unable to establish which part of the income was related to and/or generated by members of
the organization as opposed to nonmembers, such income should be considered to be
unrelated trade or business income and it is therefore subject to income tax. No reasonable
basis was provided to explain how such income was determined. Accordingly, the organization
is liable for $12,694.20 in Federal income tax for the year ending December 31, 20XX, and
$6,477.36 in Federal income tax for the year ending December 31, 20XX. The organization is

Form 886-Acrev.4-8) Department of the Treasury - Internal Revenue Service
Page: -19-

Form 886A

Department of the ‘Treasury - Internal Revenue Service

Explanation of Items

Schedule No. or Lxhibit:
Exhibit 1, Ixhibit 2,
Exhibit 3, Exhibit 4,
Exhibit A, Exhibit B,
Exhibit C,Form 6018-A

Name of Taxpayer
ORG

DBA ORG, Address, City, State

Year/Period Ended
12/31/20XX

required to file Form 990-T returns for all subsequent tax years. See Exhibit B for a list of
taxable income & deductible expenses determined during the audit and form 4549 for
computations of the Federal income tax owed.

If you accept our findings, please sign the enclosed Form 6018-A, Consent to Proposed
Action-Non Declaratory Judgment. Please return it to the following address within 30
days of the date of this letter:

Internal Revenue Service

Form 886-Aev.4-68)

Department of the Treasury - Internal Revenue Service

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