Determination 1039034: IRS revoked an airport operator’s exemption for commercial activity and private benefit

Plain-English summary

The IRS revoked an airport operator’s exemption under IRC § 501(c)(3), retroactive to January 1, 20XX. The organization owned and operated a private airport, earned rental and license-fee income from airport property, and made interest payments on loans controlled by an insider. The IRS concluded that the organization operated a commercial business, failed to establish a charitable purpose or a lessening of government burdens, and provided private benefits through above-market interest payments and insider control. Contributions were no longer deductible under IRC § 170, and the organization was required to file Form 1120.

Ruling snapshot

• Question: Did the airport operator satisfy the operational and private-benefit requirements for exemption under IRC § 501(c)(3)?
• Outcome: Revocation
• Key authorities: IRC §§ 170, 501(a), 501(c)(3), 501(c)(4), 4958, 6104(c), and 7428; Treas. Reg. §§ 1.501(c)(3)-1(a)(1), 1.501(c)(3)-1(c)(1), 1.501(c)(3)-1(d)(1)(ii), and 1.501(c)(3)-1(d)(2)

Full text (IRS public release)

DEPARTMENT OF THE TREASURY

Internal Revenue Service
TE/GE EO Examinations

MC:4957:DAL:0S
1100 Commerce St.

GOVERNMENT ENTITIES
DIVISION
Release Number: 201039034 May 06, 2010
Release Date: 10/1/10
LEGEND
ORG = Organization name XX = Date Address = address

Form Number:
ORG Tax Year Ended: December 31, 20XX
ADDRESS Taxpayer Identification Number:
Person to Contact:
Employee Identification Number:
Contact Telephone Number:
(Phone)
(Fax)
In Reply Refer to: TE/GE Review Staff

LAST DATE FOR FILING A PETITION WITH TAX
COURT, THE UNITED STATES COURT OF FEDERAL
CLAIMS OR THE DISTRICT COURT OF THE UNITED
STATES FOR THE DISTRICT OF COLUMBIA:

August 04, 20XX

Dear

This is a Final Adverse Determination Letter as to your exempt status under section 501(c)(3) of the
Internal Revenue Code. Your exemption from Federal income tax under section 501(c)(3) of the code
is hereby revoked effective January 1, 20XX.

Our adverse determination was made for the following reasons:

1. You have failed to demonstrate that you are operated exclusively for an exempt
   purpose and that your net income did not inure to the private benefit of individuals.

2. Your operations of the CO constitutes engaging in an activity not in furtherance of an
   exempt purpose to an extent that is more than insubstantial.

Based upon these reasons, we are retroactively revoking your IRC §501(c)(3) tax exempt status effective
for all years beginning on or after January 1, 20XX.

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

You are required to file federal income tax returns on Form 1120, U.S. Corporation Income Tax
Return, for the years ended December 31, 20XX, and for all years thereafter with the appropriate
Service Center immediately and by the due date of Form 1120 for all subsequent years.

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

If you decide to contest this determination in court, you must initiate a suit for declaratory judgment in
the United States Tax Court, the United States Court of Federal Claims or the District Court of the
United States for the District of Columbia before the 91st day after the date this determination was
mailed to you. Contact the clerk of the appropriate court for the rules for initiating suits for declaratory
judgment.

You also have the right to contact the office of the Taxpayer Advocate. However, you should first
contact the person whose name and telephone number are shown above since this person can access
your tax information and can help you get answers.

You can call 1-877-777-4778 and ask for Taxpayer Advocate assistance or you can contact the Taxpayer
Advocate from the site where the tax deficiency was determined by calling (214) 413-6500 or writing to:

Taxpayer Advocate assistance cannot be used as a substitute for established IRS procedures, formal
appeals processes, etc. The Taxpayer Advocate is not able to reverse legal or technically correct tax
determinations, nor extend the time fixed by law that you have to file a petition in the United States
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 have any questions, please contact the person whose name and telephone number are shown in

the heading of this letter.

Sincerely yours,

Nanette M. Downing
Director, EO Examinations

Attachment:
Publication 892

DEPARTMENT OF THE TREASURY
Internal Revenue Service

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION
January 8, 2010
Taxpayer Identification Number:
ORG
ADDRESS Form:

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

Contact Numbers:
Telephone:
Fax:

Certified Mail - Return Receipt Requested

Dear

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

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

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

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

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

Letter 3618 (04-2002)
Catalog Number 34809F

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

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

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

Thank you for your cooperation.

Sincerely,

Nanette M. Downing
Acting Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Report of Examination

Letter 3618 (04-2002)
Catalog Number 34809F

Form 886-A EXPLANATION OF ITEMS Schedule or Exhibit No.

Name of Taxpayer Years Ended

ORG December 31, 20XX

December 31, 20XX

LEGEND
ORG = Organization name City = city State = state RA-1 = 18" RA
DIR-1 = 1st DIRECTOR CO-1, CO-2, CO-3 & CO-4 = 1st, 2nd, 3rd & 4th COMPANIES
ISSUES

Whether the tax-exempt status of ORG under 501(c)(3) be revoked?
BRIEF EXPLANATION OF FACTS

ORG (hereafter “ORG”) is a State non-profit corporation domiciled at City, State. ORG organized
exclusively for charitable purposes within the meaning of IRC 501(c)(3). ORG was recognized as
exempt from Federal income tax under IRC 501(a) as an organization described in IRC 501(c)(3) by
the Internal Revenue Service in a letter dated July 17, 19XX. In that same letter, the Service also
ruled ORG was reasonably expected to be a publicly supported organization described in IRC section
509(a)(1) & 170(b)(1)(A)(vi).

ORG’s primary activity is to own and operate CO-1 located in City. The airport’s website states CO-1
is “the largest privately owned airport home to over 550 aircraft. State. CO-1 is located three miles
Northwest of City. The airport is a small airfield, with two runways. ORG owns 22 rental hangers,
which are combined together in two separate buildings, and are owned and maintained by ORG. All
other hangers, planes, and buildings on the premises are individually owned, and are not part of the
organization. ORG is under no obligation to maintain the privately owned hangers. In a conversation
with RA-1 of the CO-1 the Secretary/Treasurer of ORG stated “the airport is used almost exclusively
for general aviation purposes by aircraft based at the airport”. The airport operators estimated less
than 1% of the traffic was from transient aircraft.

In 20XX and 20XX, the Internal Revenue Service (herein referred to as “Service”) conducted an
examination of ORG’s Form 990 for the tax period ending December 31, 20XX, but expanded the
examination to include 20XX. The examination also expanded to Forms 990-T for the same tax
years. ORG is either unable to or refuses to completely respond to the following document requests
which raise questions arising from responses from previous document requests, and which are
relevant to ORG’s exempt status: EO-05, 28, 35, 37, 39, 43, 44, 45, 46, 47, and 48.

DIR-1 is one of the founders of ORG. DIR-1 and his Wife, RA-1 operate and control ORG. DIR-1 is
listed as Director, and RA-1 is the Secretary/Treasurer. DIR-1 also controls CO-2, a taxable
entity. CO-2 is a related organization with respect to ORG by common officers and directors. CO-2
received payments from ORG for loans lent to ORG to purchase the Airport assets.

CO-1 is privately owned and operated by ORG. The organization has two board members, DIR-1 and
RA-1, who control ORG. DIR-1 and RA-1 are related individuals.

No governmental body was found to have any relation with ORG or its management, and ORG
receives no governmental support. Income received by ORG is primarily from rental revenue from the
hangers, license fees from airport property owners. The organization also receives a small amount of
revenue from interest and contributions. Income is expended for permanent improvements to the
airport, maintenance, daily operations and payment on debt.

Forms 990 for the period ending December 31, 20XX indicated the following:

Form 886-A EXPLANATION OF ITEMS Schedule or Exhibit No.

Name of Taxpayer Years Ended

ORG December 31, 20XX
December 31, 20XX

• There was $ of Mortgages and Notes Payable according to Parts IV of the Form 990

• There was $ of Other Liabilities reported as Long Term Interest Payable (Accrued Negative
  Amort) according to Part IV, Balance Sheet.

• There was $ of Interest Expense according to Part II Statement of Function Expenses Line 41.

Forms 990 for the period ending December 31, 20XX indicated the following:

• There was $ of Mortgages and Notes Payable according to Parts IV of the Form 990

• There was $ of Other Liabilities reported as Long Term Interest Payable (Accrued Negative
  Amort) according to Part IV, Balance Sheet.

• There was $ of Interest Expense according to Part II Statement of Function Expenses Line 41.

The following information/documents were provided for our examination of this issue:

1. Promissory Note for loan payable to CO-2.dated 12/31/XX. The Principal amount was
   for $, had an interest rate of 12%. Principal will be paid in total on demand at the end of
   a period of time when the interest paid + principal equals the stated $ or on December
   31, 20XX, as may be elected at the discretion of ORG, Inc.

At the end of the 3-year period, the 12% interest rate will be adjusted to offset any
negative amortization and a new interest rate schedule will be established.

DIR-1 signed the promissory note.

2. Promissory Note for loan payable to CO-2.dated 12/31/XX. The Principal amount was
   for $, had an interest rate of 12%. Principal will be paid in total on demand at the end of
   a period of time when the interest paid + principal equals the stated $ or on December
   31, 20XX, as may be elected at the discretion of ORG, Inc.

At the end of the 3-year period, the 12% interest rate will be adjusted to offset any
negative amortization and a new interest rate schedule will be established.

DIR-1 signed the promissory note.

3. Promissory Note for loan payable to CO-2.dated 12/31/XX. The Principal amount was
   for $, had an interest rate of 12%. Principal will be paid in total on demand at the end of
   a period of time when the interest paid + principal equals the stated $ or on December
   31, 20XX, as may be elected at the discretion of ORG, Inc.

At the end of the 3-year period, the 12% interest rate will be adjusted to offset any
negative amortization and a new interest rate schedule will be established.

DIR-1 signed the promissory note

ORG’s Form 990 included an attachment schedule (Mortgages Schedule, Page 4, Part IV, Line
64b) listed the amounts of loans outstanding of the following:

Notes Payable O/S (1) Total Payable to Related Parties
20XX 20XX 20XX 20XX

Form 886-A EXPLANATION OF ITEMS Schedule or Exhibit No.
Name of Taxpayer Years Ended
ORG December 31, 20XX
December 31, 20XX

CO-2

CO-2 $

CO-2 $

DIR-1 $

Total $ $$

Note (1): Total Payable to Related Parties include Notes Payable outstanding plus accrued negative
amortization on interest on the Notes Payable. The unpaid interest is added to the notes payable
balance.

Loan Payments Made by ORG
Per review of CO-3 (Account #) records, the following was paid to CO-2.

CHECK# DATE AMOUNT CHECK # DATE AMOUNT
675 01/26/XX ) 746 01/31/20XX
678 01/24/XX $ 754 02/28/20XX
676 01/31/XX S) 765 03/31/20XX
682 02/28/XX S 772 04/30/20XX
689 03/31/XX $ 778 04/30/20XX
693 04/30/XX $ 789 05/31/20XX
700 05/31/XX $ 798 06/19/20XX
704 06/30/XX $ 800 06/30/20XX
709 07/31/XX S 806 07/10/20XX
715 08/31/XX $ 810 07/19/20XX
719 09/30/XX $ 811 07/20/20XX
724 10/11/XX $ 812 07/31/20XX
726 10/31/XX $ 817 08/31/20XX
731 11/30/XX $ 825 09/11/20XX
741 12/31/XX $ 826 09/17/20XX
828 09/26/20XX
829 09/30/20XX
839 10/31/20XX
846 11/30/20XX
850 12/19/20XX
853 12/31/20XX

Sub Total: $ Sub Total:

Form 886-A EXPLANATION OF ITEMS Schedule or Exhibit No.

Name of Taxpayer Years Ended

ORG December 31, 20XX
December 31, 20XX
TOTAL 20XX & 20XX CO-2: $
Per review of CO-3 (Account #) records, the following was paid
to DIR-1
677 01/31/XX $ 744 01/05/XX $
683 02/28/XX 3 747 01/31/XX $
690 03/31/XX $ 752 02/28/XX $
694 04/30/XX $ 755 02/28/XX $
701 05/31/XX $ 760 03/14/XX $
705 06/30/XX $ 758 03/12/XX $
710 07/31/XX S 766 03/30/XX $
716 08/02/XX $ 770 04/05/XX $
720 09/30/XX $ 771 04/09/XX $
727 10/31/XX $ 773 04/10/XX $
732 11/30/XX $ 777 04/19/XX $
742 12/31/XX $ 779 04/30/XX $
782 05/09/XX $
787 05/21/XX $
788 05/24/XX $
790 05/31/XX $
793 06/11/XX $
798 06/19/XX $
799 06/22/XX $
802 06/30/XX $
804 07/03/XX $
807 07/10/XX $
809 07/16/XX )
819 08/31/XX $
820 08/31/XX $
822 09/27/XX $
824 09/11/XX $
827 09/25/XX $
830 09/30/XX $
831 10/05/XX $
832 10/XX/XX $
834 10/09/XX $
835 10/23/XX $
840 10/31/XX $
847 11/30/XX $
851 12/19/XX $
852 12/22/XX $
12/31/XX $
Sub Total: Sub Total:
TOTAL 20XX: $U.S.

LAW

Form 886-A EXPLANATION OF ITEMS Schedule or Exhibit No.

Name of Taxpayer Years Ended

ORG December 31, 20XX
December 31, 20XX

Section 501(c)(3) of the Code exempts from federal income tax organizations organized and operated
exclusively for charitable, educational, and other exempt purposes, provided no part of the
organization's net earnings inures to the benefit of any private shareholder or individual.

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

Section 1.501(c)(3)-1(c)(1) of the regulations provides an organization will not be regarded as
operated exclusively for exempt purposes if more than an insubstantial part of its activities is not in
furtherance of exempt purposes.

Section 1.501(c)(3)-1(d)(ii) of the regulations provides an organization is not organized or operated
exclusively for one or more exempt purposes unless it serves a public rather than a private interest.
Thus, it is necessary for an organization to establish 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.

Section 1.501(c)(3)-1(d)(2) of the regulations provides the term "charitable" is used in section
501(c)(3) of the Code in its generally accepted legal sense, and includes the promotion of education.

Primary Purpose: Substantial Nonexempt Purpose

In Better Business Bureau of Washington, D.C. v. United States, 326 U.S. 279, 283 (1945), the
United States Supreme Court stated that "the presence of a single . . . [non-exempt] purpose, if
substantial in nature, will destroy the exemption regardless of the number or importance of truly .. .
[exempt] purposes."

In making the appropriate analysis, it is necessary to focus on the purpose rather than the nature of
the organization's activities. Est of Hawaii v. Commissioner, 71 T.C. 1067 (1979); B.S.W. Group, Inc.
v. Commissioner, 70 T.C. 352 (1978); Golden Rule Church Association v. Commissioner, 41 T.C. 719
(1964); see Trinidad v. Sagrada Orden de Predicadores, 263 U.S. 578 (1924); San Francisco Infant
School v. Commissioner, 69 T.C. 957 (1978). An organization whose activities constitute a trade or
business or generate a profit may still be exempt, provided that those activities accomplish an exempt
purpose. Sec. 1.501(c)(3)-1(e)(1), Income Tax Regs.; B.S.W. Group, Inc. v. Commissioner, supra.
Compare Randall Foundation v. Riddell, 244 F.2d 803 (9th Cir. 1957), [**11] with Passaic United
Hebrew Burial Association v. United States, 216 F. Supp. 500 (D. N.J. 1963).

However, in Living Faith Inc. v. Commissioner, 950 F.2d 365, 372 (7th Cir. 19XX), affg. T.C. Memo.
1990-484, an organization's purposes may be inferred from its manner of operations; its "activities
provide a useful indicia of the organization's purpose or purposes."

In B.S.W. Group, Inc. v. Commissioner, 70 T.C. 358 (1978), the Court states that “Factors such as
the particular manner in which an organization's activities are conducted, the commercial hue of
those activities, and the existence and amount of annual or accumulated profits are relevant evidence
of a forbidden predominant purpose.”

KJ's Fund Raisers v. Commissioner, T.C. Memo 19XX-424, affd 166 F.3d 1200 (2nd Cir. 19XX),
petitioner also operated for the substantial private benefit of KJ's Place and its owners. A substantial
nonexempt purpose thus characterizes its operation, disqualifying it from exemption under sections

501(a) and 501(c)(3). Citing Better Business Bureau v. United States, 326 U.S. at 283; Copyright
Clearance Center, Inc. v. Commissioner, 79 T.C. at 803.

In Church by Mail v. Commissioner, 765 F.2d 1387 (9th Cir. 1985) affg TCM 1984-349 (1984), the
Court noted that Church by Mail, Inc. (‘Church’) paid Twentieth Century Advertising Agency
(‘Twentieth’) for services provided. Twentieth was owned and controlled by the two individuals who
ran Church. The Tax Court had found it unnecessary to consider the reasonableness of payments
made by the applicant to a business owned by its officers. In addressing whether Church operated for
a substantial non-exempt purpose the 9th Circuit Court of Appeals, in affirming the Tax Court's
decision, stated: “... The critical inquiry is not whether particular contractual payments to a related for-
profit organization are reasonable or excessive, but instead whether the entire enterprise is carried on
in such a manner that the for-profit organization benefits substantially from the operation of the
Church. Est of Hawaii v. Commissioner, 71 T.C. at 1080-81; see also Presbyterian & Reformed
Publishing Co. v. Commissioner, 743 F.2d 148, 155 (3d Cir. 1984) (courts must look to all objective
indicia from which a corporate actor's intent may be discerned); United States v. Dykema, 666 F.2d
1096, 1100 (7th Cir. 1981), cert. denied, 456 U.S. 983, 72 L. Ed. 2d 861, 102 S. Ct. 2257 (1982) (it is
necessary and proper for the I.R.S. to survey all of the activities of an organization to determine
whether a non-exempt purpose is furthered).

In American Campaign Academy v. Commissioner, 92 T.C. 1053, 1065-1066 (1989), the court stated
that when an organization operates for the benefit of private interests...the organization by definition
does not operate exclusively for exempt purposes. Prohibited private benefits may include an
“advantage; profit, fruit; privilege; gain; [or] interest.”. Occasional economic benefits flowing to
persons, as an incidental consequence of an organization pursuing exempt charitable purposes will
not generally constitute prohibited private benefits. Thus, should [the organization] be shown to
benefit private interests, it will be deemed to further a nonexempt purpose under section 1.501(c)(3)-
1(d)(1)(ii)... This nonexempt purpose will prevent [the organization] from operating primarily for
exempt purposes absent a showing that no more than insubstantial part of its activities further private
interests or any other nonexempt purposes.

In Housing Pioneers v. Commissioner, 65 T.C.M. (CCH) 2191 (19XX), aff'd, 49 F.3d 1395 (9th Cir.
19XX), amended 58 F.3d 401 (9th Cir. 1985) ("Housing Pioneers"), the Tax Court concluded that an
organization did not qualify as a section 501(c)(3) organization. The organization could describe only
a vague charitable function of surveying tenant needs.

Inurement and Private Benefit

In American Campaign Academy v. Commissioner, 92 T.C. 1053, (1989), the Court addressed the
operational test and illuminates the difference between private benefit, derived by private interests
where such private benefit is adverse to exemption under Section 501(c)(3), from inurement, derived
by insiders, which also is adverse to exemption under Section 501(c)(3). It states:

...To establish that it operates primarily in activities which accomplish exempt
purposes, petitioner must establish that no more than an insubstantial part of its
activities does not further an exempt purpose. Sec. 1.501(c)(3)-1(c)(1), Income
Tax Regs. The presence of a single substantial nonexempt purpose destroys the
exemption regardless of the number or importance of the exempt purposes.
Better Business Bureau v. United States, 326 U.S. 279, 283 (1945); Copyright
Clearance Center v. Commissioner, 79 T.C. 793, 804 (1982).

Form 886-A EXPLANATION OF ITEMS Schedule or Exhibit No.

Name of Taxpayer Years Ended

ORG December 31, 20XX
December 31, 20XX

... We have consistently recognized that while the prohibitions against private inurement and
private benefits share common and often overlapping elements, Church of Ethereal Joy v.
Commissioner, 83 T.C. 20, 21 (1984), Goldsboro Art League, Inc. v. Commissioner, 75 T.C.
337, 345 n. 10 (19XX), the two are distinct requirements which must independently be
satisfied. Canada v. Commissioner, 82 T.C. 973, 981 (1984); Aid to Artisans, Inc. v.
Commissioner, 71 T.C. at 215. Nonetheless, we have often observed that the prohibition
against private inurement of net earnings appears redundant, since the inurement of earnings
to an interested person or insider would constitute the conferral of a benefit inconsistent with
operating exclusively for an exempt purpose. Western Catholic Church v. Commissioner, 73
T.C. 196, 209 n. 27 (1979), affd. in an unpublished opinion 631 F.2d 736 (7th Cir. 1980). See
also sec. 1.501(c)(3)-1(c)(2), Income Tax Regs. In other words, when an organization permits
its net earnings to inure to the benefit of a private shareholder or individual, it transgresses the
private inurement prohibition and operates for a nonexempt private purpose.

... The absence of private inurement of earnings to the benefit of a private shareholder or
individual does not, however, establish that the organization is operated exclusively for
exempt purposes. Therefore, while the private inurement prohibition may arguably be
subsumed within the private benefit analysis of the operational test, the reverse is not true.
Accordingly, when the Court concludes that no prohibited inurement of earnings exists, it
cannot stop there but must inquire further and determine whether a prohibited private benefit
is conferred. See Aid to Artisans, Inc. v. Commissioner, 71 T.C. at 215; Retired Teachers
Legal Fund v. Commissioner, 78 T.C. 280, 287 (1982).

In People of God Community v. Commissioner, 75 T.C. 127 (1980) the Court, in examining the
compensation arrangement of an insider, noted that it is an established principle that the organization
is entitled to pay reasonable compensation to an insider but the burden of establishing the
reasonableness of the compensation fell upon the organization.

In Founding Church of Scientology v. United States, 412 F. 2d 1197 (Ct. Cl. 1969), cert. den., 397
U.S. 1009 (1970). The Court determined that the different arrangements between the organization and
its founder, such as payment of ten percent or gross revenues, lending of money to him and his family,
payment of expenses on their behalf, rental of property at inflated prices, resulted in inurement. The
Court rejected the reasonable compensation defense. It stated: If in fact a loan or other payment in
addition to salary is a disguised distribution or benefit from the net earnings, the character of the
payment is not changed by the fact that the recipient's salary, if increased by the amount of the
distribution or benefit, would still have been reasonable.

Section 4958 of the Code, effective September 14, 1995, was added to the Internal Revenue Code by
the Taxpayer Bill of Rights 2 bill in 1996 (P.L. 104-168, enacted July 30, 19XX). In Caracci v.
Commissioner, 118 T.C. No. 25 (2002), the Court noted: “With the enactment of section 4958,
however, the issue whether the tax-exempt status of ... tax-exempt entities should be revoked now
must be considered in the context of the ‘intermediate sanction’ provisions. ... the intermediate
sanction regime was enacted in order to provide a less drastic deterrent to the misuse of a charity
than revocation of that charity's exempt status. The legislative history explains that ‘the intermediate
sanctions for ‘excess benefit transactions’ may be imposed by the IRS in lieu of (or in addition to)
revocation of an organization's tax-exempt status.’ H. Rept. 104-506, supra at 59, 19XX-3 C.B. at

107. A footnote to this statement explains: ‘In general, the intermediate sanctions are the sole
     sanction imposed in those cases in which the excess benefit does not rise to a level where it calls into
     question whether, on the whole, the organization functions as a charitable or other tax-exempt
     organization’. Id. n. 15, 19XX-3 C.B. at 107. Although the imposition of section 4958 excise taxes as a

Form 886-A EXPLANATION OF ITEMS Schedule or Exhibit No.

Name of Taxpayer Years Ended

ORG December 31, 20XX
December 31, 20XX

result of an excess benefit transaction does not preclude revocation of the organization's tax-exempt
status, the legislative history indicates that both a revocation and the imposition of intermediate
sanctions will be an unusual case.” (emphasis added)

Net earnings may inure to the benefit of private individuals in ways other than by the actual
distribution of dividends or payment of excessive salaries. General Contractors' Ass'n v. United
States, 202 F. 2d 633 (7th Cir. 1953) - reports and surveys furnished to members; Chattanooga Auto.
Club v. Commissioner, 182 F. 2d 551 (6th Cir. 1950) - services to members; Underwriters’
Laboratories, Inc. v. Commissioner, 135 F. 2d 371 (7th Cir.), cert. denied, 320 U.S. 756 (1943) -
reports and studies furnished; Spokane Motorcycle Club v. United States, 222 F. Supp. 151 (E.D.
Wash. 1963) - goods, services, and refreshments given. That the benefit conveyed may be relatively
small does not change the basic fact of inurement. Spokane Motorcycle Club v. United States, supra.

In Est of Hawaii v. Commissioner, 71 T.C. 1067 (1979), aff'd in unpublished opinion 647 F.2d 170
(9th Cir. 1981) ("Est of Hawaii"), several for-profit Est organizations exerted significant indirect control
over Est of Hawaii, a non-profit entity, through contractual arrangements. The Tax Court concluded
that the for-profits were able to use the non-profit as an “instrument to further their for-profit
purposes. The fact that amounts paid to the for-profit organizations under the contracts were
reasonable did not affect the court's conclusion. Consequently, Est of Hawaii did not qualify as an
organization described in section 501(c)(3).

Section 501(c)(4) of the Code provides for exemption from federal income tax of civic leagues or
organizations not organized for profit but operated exclusively for the promotion of social welfare.

Section 1.501(c)(4)-1(a)(2)(i) of the Income Tax Regulations provides that an organization is operated
exclusively for the primarily engaged in welfare if it is primarily engaged in promoting in some way the
common good and general welfare of the people of the community. An organization embraced within

this section is one which is operated primarily for the purpose of bringing about civic betterments and

social improvements

Section 1.501(c)(4)-1(a)(2)(ii) of the regulations provides that an organization is not operated primarily
for the promotion of social welfare if its primary activity is carrying on a business with the general
public in a manner similar to organizations which are operated for profit.

TAXPAYER’S POSITION
Unknown at this time
GOVERNMENT’S POSITION

The government's position is that ORG does not qualify for exemption under section 501(c)(3) of the
Internal Revenue Code, as it does not meet the operational test. The operational test outlined in
section 1.501(c)(3)-1(c) of the Regulations states that an organization will not meet the operational
test if more than an insubstantial part of its activities are not in furtherance of an exempt purpose.

ORG activities does not appear to meet the definition of social welfare under section 501(c)(4) of the
Internal Revenue Code. Social welfare can also be considered a charitable activity under Treasury
Regulation 1.501(c)(3)-1(d)(2).

Form 886-A EXPLANATION OF ITEMS Schedule or Exhibit No.

Name of Taxpayer Years Ended

ORG December 31, 20XX
December 31, 20XX

Pertinent to this case, we are specifically concerned whether the organization meets the
compliance tests listed below:

• Operational Test: Charitable Activity

• Operational Test: Primary Purpose, Substantial Nonexempt Purpose

• Operational Test: Inurement (Private Benefit)

• Effect on Section 4958 of the Code

Primary Purpose, Substantial Nonexempt Purpose

The presence of a single substantial nonexempt purpose can destroy the exemption regardless of the
number or importance of exempt purposes. Better Business Bureau v. United States, 326 U.S. 279,
283 (1945).

ORG's primary activity is to own and operate CO-1 located in City. The airport’s website states CO-1
is “ . State. CO-1 is located three miles
Northwest of City. The airport is a small airfield, with two runways. ORG owns 22 rental hangers,
which are combined together in two separate buildings, and are owned and maintained by ORG. All
other hangers, planes, and buildings on the premises are individually owned, and are not part of the
organization. ORG is under no obligation to maintain the privately owned hangers.

DIR-1 is one of the founders of ORG. DIR-1 and his Wife, RA-1 operate and control ORG. DIR-1 is
listed as Director, and RA-1 is the Secretary/Treasurer. DIR-1 also controls CO-2, a taxable entity.
CO-2 is a related organization with respect to ORG by common officers and directors. CO-2 received
payments from ORG for loans lent to ORG to purchase the Airport assets.

No governmental body was found to have any relation with ORG or its management, and ORG
receives no governmental support. Income received by ORG is primarily from rental revenue from the
hangers, license fees from airport property owners. The organization also receives a small amount of
revenue from interest and contributions. Income is expended for permanent improvements to the
airport, maintenance, daily operations and payment on debt. The organization is carrying on a
business with the general public in a manner similar to organizations operated for profit.

Operating an airport in a commercial manner is inherently an exempt activity. An organization must
be both organized and operated exclusively for one or more of the purposes specified in section
501(c)(3) of the Code. Whether an organization has satisfied the operational test is a question of fact;
See Harding Hospital Inc., supra. The main reason why the organization does not qualify for
exemption under 501(c)(3) is it fails to operate for a charitable non-exempt purpose.

Section 501(c)(3) of the Code provides for the exemption from federal income tax of organizations
organized and operated exclusively for charitable purposes. The requirement an organization operate
exclusively for charitable purposes is further amplified in section 1.501(c)(3)-1(c)(1) of the regulations.
This section provides an organization will be regarded as “operated exclusively” for one or more
exempt purposes only if it engages primarily in activities which accomplish one or more of such
exempt purposes specified in section 501(c)(3). An organization will not be so regarded if more than
an insubstantial part of its activities is not in furtherance of an exempt purpose. In the fundamental
case of Better Business Bureau of Washington, D.C., Inc. v. United States, supra, the Court
concluded the presence of a single nonexempt purpose, if substantial in nature, would preclude
exemption regardless of the number of important of statutorily exempt purposes.

Inurement (and Private Benefit)

Form 886-A EXPLANATION OF ITEMS Schedule or Exhibit No.

Name of Taxpayer Years Ended

ORG December 31, 20XX
December 31, 20XX

DIR-1 controls ORG's operations and financial affairs. He was a founding member of the
organization, and he makes decisions for ORG. He also exerts substantial influence over the
organization for purposes of the excess benefits tax under section 4958 of the Code.

We have determined that the interest rate on the loans payable by ORG to DIR-1 and CO-2, a for-
profit controlled by DIR-1, were above market rate. During 20XX and 20XX the interest rate paid by
ORG for the loans originated in 19XX was 8.0%, 7.0% for the loan originated in 19XX (which paid off
in 20XX) and 8.0% for the loan originated in 20XX. The interest rate on the loans originated in 19XX
and 19XX both were originally 12% and were adjusted yearly ranging between 7% and 12%.

Year 19XX Loans 19XX Loan
19XX 12% 7%
19XX 12% 7%
19XX 12% 7%
19XX 7% 7%
19XX 7% 7%
19XX 7% 7%
19XX 12% 7%
20XX 12% 7%
20XX 12% 7%
20XX 7% 7%
20XX 7% 7%
20XX 7% 7%
20XX 8% 7%
20XX 8% 7%

The applicable federal rate for long term loans originated in 19XX was 7.07%, originated in 19XX
6.36, and originated in 20XX was 4.64%. Since the rates were above market DIR-1 is treated as
having received an economic benefit from the organization equal to the amount of interest received
that exceeded market value. See schedule below for a comparison of actual interest payments with
those using the applicable federal rate.

CO-4
Note Payable to CO-2/DIR-1
Cost - Actual vs current applicable federal rate (AFR)

CO-2 (Origination Date 19XX)
Days Int @

December-XX o/s Actual AFR % Int@8% Act% Difference
January-XX 8.000% 7.070%
February-XX 8.000% 7.070%
March-XX 8.000% 7.070%
April-XX 8.000% 7.070%
May-XX 8.000% 7.070%
June-XX 8.000% 7.070%
July-XX 8.000% 7.070%
August-XX 8.000% 7.070%
September-XX 8.000% 7.070%
October-XX 8.000% 7.070%
November-XX 8.000% 7.070%
December-XX 8.000% 7.070%

CO-2
(Origination Date 19XX)
Days
o/s Actual AFR %
31.00 7.000% 6.360%
28.00 7.000% 6.360%
31.00 7.000% 6.360%
30.00 7.000% 6.360%
31.00 7.000% 6.360%
30.00 7.000% 6.360%
31.00 7.000% 6.360%
31.00 7.000% 6.360%
30.00 7.000% 6.360%
31.00 7.000% 6.360%
30.00 7.000% 6.360%
31.00 7.000% 6.360%
Total CO-2 (20XX)

DIR-1
(Origination Date 19XX)
Days
o/s Actual AFR %
31.00 8.000% 7.070%
28.00 8.000% 7.070%

Int @
Int@8% Act% Difference
Int @
Int@ 8% Act% Difference

Form 886-A EXPLANATION OF ITEMS Schedule or Exhibit No.

Name of Taxpayer

ORG

Years Ended
December 31, 20XX
December 31, 20XX

March-XX 31.00 8.000% 7.070%
April-XX 30.00 8.000% 7.070%
May-XX 31.00 8.000% 7.070%
June-XX 30.00 8.000% 7.070%
July-XX 31.00 8.000% 7.070%
August-XX 31.00 8.000% 7.070%
September-XX 30.00 8.000% 7.070%
October-XX 31.00 8.000% 7.070%
November-XX 30.00 8.000% 7.070%
December-XX 31.00 8.000% 7.070%

Total DIR-1 (20XX)
Total

Note Payable to CO-2
Cost - Actual vs current applicable federal rate (AFR)

CO-2
(Origination Date 19XX)
Days
o/s Actual AFR %
31.00 8.000% 7.070%
28.00 8.000% 7.070%
31.00 8.000% 7.070%
30.00 8.000% 7.070%
31.00 8.000% 7.070%
30.00 8.000% 7.070%
31.00 8.000% 7.070%
31.00 8.000% 7.070%
30.00 8.000% 7.070%
31.00 8.000% 7.070%
30.00 8.000% 7.070%
31.00 8.000% 7.070%
(Origination Date 19XX)
Days
o/s Actual AFR %
31.00 8.000% 7.070%
28.00 8.000% 7.070%
31.00 8.000% 7.070%
30.00 8.000% 7.070%
31.00 8.000% 7.070%
30.00 8.000% 7.070%
31.00 8.000% 7.070%
31.00 8.000% 7.070%
30.00 8.000% 7.070%
31.00 8.000% 7.070%
30.00 8.000% 7.070%
31.00 8.000% 7.070%
Total CO-2 (20XX)

(Origination Date 20XX)
Days
o/s Actual AFR %
31.00 8.000% 4.640%
28.00 8.000% 4.640%
31.00 8.000% 4.640%
30.00 8.000% 4.640%
31.00 8.000% 4.640%
30.00 8.000% 4.640%
31.00 8.000% 4.640%
31.00 8.000% 4.640%
30.00 8.000% 4.640%
31.00 8.000% 4.640%
30.00 8.000% 4.640%
31.00 8.000% 4.640%
Total CO-2 (20XX)

(Origination Date 19XX)
Days
o/s Actual AFR %
31.00 8.000% 7.070%
28.00 8.000% 7.070%
31.00 8.000% 7.070%
30.00 8.000% 7.070%
31.00 8.000% 7.070%
30.00 8.000% 7.070%
31.00 8.000% 7.070%
31.00 8.000% 7.070%
30.00 8.000% 7.070%
31.00 8.000% 7.070%
30.00 8.000% 7.070%
31.00 8.000% 7.070%
Total DIR-1 (20XX)
Total

Int @
Int@8% Act% Difference
Int @
Int@8% Act% Difference

Form 886-A EXPLANATION OF ITEMS Schedule or Exhibit No.

Name of Taxpayer Years Ended

ORG December 31, 20XX
December 31, 20XX

The Service has sufficient information to establish a pattern of control on the part of some insiders
has resulted in continuing inurement to the insiders. Apart from the inurement concerns, there
continues to be primary purpose, substantial nonexempt purpose, and primary activity concerns
which disqualify ORG from exemption.

GOVERNMENT’S POSITION:

Based on the above, we propose to revoke CO-4 tax-exempt status. This proposed revocation would
become effective January 1, 20XX. Any contributions to CO-4 are no longer deductible as charitable
contributions. Any contributions to this organization by those who were in part responsible for, or
were aware of, the activities or deficiencies on the part of the organization that gave rise to loss of
exempt status will not be allowed as a deduction effective the date of revocation. ORG will be
required to file Form 1120 for all tax years since 20XX, inclusive.

CONCLUSION

Based on the foregoing reasons, the organization does not qualify for exemption under section
501(c)(3) and its tax exempt status should be revoked as of the fiscal year ended December 31,
20XX,

Forms 1120, U.S. Corporation Income Tax Return should be obtained for the fiscal years December
31, 20XX to the present.

If this proposed revocation becomes final, appropriate State officials will be advised of the
action in accordance with Internal Revenue Code Section 6104(c) and applicable regulations.

The organization may re-apply for tax exemption under 501(c)(3) or 501(c)(4), as long as it can be
determined their activities further their exempt purpose.