Determination 1039038: IRS revoked a fraternal organization’s exemption for operating a commercial bar

Plain-English summary

The IRS revoked an organization’s tax-exempt status under IRC § 501(c)(10), effective April 1, 20XX. The organization operated a commercial bar, and its officer acknowledged that the organization was created to obtain a liquor license and generate profits. The organization had no common fraternal bond, lodge-system features, rites, or regalia, and its members received sales-tax-free drinks. The organization consented to the revocation and was required to file Form 1120 for the affected tax periods.

Ruling snapshot

• Question: Did the organization qualify for exemption under IRC § 501(c)(10) as a domestic fraternal society operating under the lodge system?
• Outcome: Revocation
• Key authorities: IRC §§ 501(c)(8) and 501(c)(10); Treas. Reg. § 1.501(c)(10)-1; Rev. Ruls. 73-165 and 81-117

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE

Attn: Mandatory Review, MC 4920 DAL

1100 Commerce St. 501.10-00
TAX EXEMPT AND Dallas, TX 75242
GOVERNMENT ENTITIES
DIVISION

Date: June 9, 2010
Release Number: 201039038
Release Date: 10/1/10

LEGEND

ORG = Organization name Employer Identification Number:

XX = Date Address = address Person to Contact/ID Number:
Contact Numbers:

ORG Voice:

ADDRESS Fax:

CERTIFIED MAIL — RETURN RECEIPT REQUESTED
Dear

This is a final adverse determination letter with regard to your status under
section 501(c)(10) of the Internal Revenue Code.

You are a subordinate organization included in group exemption number 9470.
The parent organization was granted tax exempt status as an organization
described in section 501(c)(10) of the Code in May 19XX.

The primary activity of ORG (ORG) is the operation a commercial bar open to the
general public. The current officer and owner, , created ORG with
the intent to generate profits. All assets and net earnings of ORG belong to

. Members of ORG do not have a common fraternal bond.

ORG is not a domestic fraternal society operating under the lodge system, the
net earnings of which are devoted exclusively to religious, charitable, scientific,
literary, educational, and fraternal purposes.

The organization does not qualify for exemption under section 501(c)(10) of the
Internal Revenue Code. Consequently, the organization’s exempt status is
revoked effective April 1, 20XX. You have agreed to the revocation of your
exempt status by signing Form 6018-A.

You are required to file Forms 1120 with the appropriate Service Center for the
tax periods beginning on and after April 1, 20XX.

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: (314) 612-4610 (not toll-free).

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

Sincerely,

Nanette M. Downing
Director, EO Examinations

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
TE/GE EO Examinations
MS:4957:DAL

1100 Commerce Street

TX 75242
TAX EXEMPT AND Dallas

GOVERNMENT ENTITIES

DIVISION
Taxpayer Identification Number
ORG Form:
ADDRESS

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

If you accept our findings, please sign and return the enclosed Form 6018-A, Consent to
Proposed Action. We will then send you a final letter revoking your 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 the event of revocation, you will be required to file
Federal income tax returns for the tax period(s) shown above. If you have not yet filed
these returns, please file them with the examiner as soon as possible, unless a report of
income tax liability was issued to you with other instructions. File returns for later tax
years with the appropriate service center indicated in the instructions for those returns.

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. Please note that Fast Tract
Mediation Services referred to in Publication 3498, do not apply to Exempt
Organizations.

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 the
United States Tax Court, the United States Court of Federal Claims, or the United States
District Court, after satisfying procedural and jurisdictional requirements as described in
Publication 3498.

You may also request that we refer this matter for technical advice as explained in
Publication 892, Exempt Organizations Appeal Procedures for Unagreed Issues. If a
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.

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,

Director, EO Examinations

Enclosures:

Publication 892

Publication 3498

Form 6018-A Report of Examination
Envelope

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

Explanation of Items Exhibit

Year/Period Ended
March 31, 20XX

Name of Taxpayer
ORG
EIN: #

LEGEND
ORG = Organization name XX = Date State = state President =
president CEO = CEO CO-1 = CO-1

ISSUE

Whether ORG is operated exclusively for exempt purposes described within Internal
Revenue Code section 501(c)(10).

FACTS

ORG (hereinafter “ORG”) whose Employer Identification Number is #, was incorporated
in the State of State. ORG was recognized as an organization exempt from federal
income tax as described in IRC Section 501(c)(10) under the group ruling number

ORG operated a bar named CO.

In Chapter 311, Section 311.090 of the State Revised Statutes, Liquor Control Law, “in
order for a licensee to sell intoxicating liquor outside city limits, a licensee must meet
certain provisions such as having obtained an exemption from the payment of federal
income taxes as provided in IRC sections 501(c)(3), 501(c)(4), 501(c)(5), 501(c)(7),
501(c)(8), 501(c)(10), 501(c)(19), or 501(d) of the United States Internal Revenue Code
of 1954, as amended in any incorporated city having a population of less than 19,500
inhabitants as determined by the last decennial census under the provisions and methods
set out in this chapter.” Also, in Chapter 311, Section 311.097 of the State Revised
Statutes, Liquor Control Law states “that an organization can obtain a license to sell
liquor by the drink if at least 50% of the gross income of which is derived from the sale
of prepared meals or food consumed on such premises or which has an annual gross
income of at least $ from the sale of prepared meals or food consumed on such premises.

Before forming ORG, the officer, President had operated the bar that was able to sell beer
only. To attract more customers, President would like to obtain liquor license for her bar.
The officer was sure that her bar was unable to meet food sale requirements, so the only
option she had to obtain the liquor license is to become a tax exempt organization. She
knew about CO-1 from the bars around that were CO-1 subordinates. The officer got the
CO-1 National Headquarters’ contact information from the bar where her son worked.
The officer called CO-1 National Headquarters to ask about the information on how to
apply, requirements to become a CO-1 subordinate, and how to maintain the status of
CO-1 subordinate.

The parent organization's Constitution and Bylaws state that CO-1 purpose is “to promote
fellowship among all living beings, respectfully; to encourage the elimination of
prejudice and help unify divergent groups in the overall interest of American democracy;
to orientate our youth with full knowledge of responsibilities as well as privileges of

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

Explanation of Items Exhibit
Year/Period Ended
Name of Taxpayer March 31. 20XX
ORG
EIN: #

citizenship through the wisdom of our seniors; to assist the underprivileged and well
deserving by maintenance of sponsoring educational opportunities and by providing
monetary grants and awards toward their wellbeing overall; to fully support the effort of
“Drug Free America;” to encourage compassion for every fellow man, woman and child
in distress and/ or deserving; to provide social clubs for members and guests for the
purpose of fellowship and entertainment of its members; to create and initiate new
programs to assist the homeless, battered and abandoned children, the mentally retarded,
and the needy and well deserving for the purpose of their well-being.”

Requirements to become a CO-1’s subordinate are as follows:

l.

3.

Start the chapter with 25 members at annual dues of $ each. By the seventh year
of incorporation the subordinate is required to have 32 members. The dues will
be split 50/50 between the parent organization and subordinate for each
membership sold after 32.

Donate $ to other approved non-profit entities. All donations must be verified by
providing the CO-1 National Headquarters copies of canceled checks submitted
for donations. If donations are given to needy individuals, subordinate must
submit the name of the individual, social security number, date of birth, address,
the reason for the donation, and the amount of the donation.

Conduct monthly meeting

After President contacted the CO-1 Headquarters to ask for steps and the information to
become a CO-1 subordinate, she received the package including the following material
from the CO-1 Headquarters:

Constitution and Bylaws of CO-1
Membership requirements
Instructions on how to prepare Articles of Incorporation
State Liquor Control Checklist prepared by CO-1 National Headquarters to help
the organization prepare all necessary Forms filed with Division of Liquor
Control to obtain liquor license. The following information listed on the
checklist:

1. Certificate of Incorporation

2. Articles of Incorporation (copy) after filed with the State Secretary of
   States Office
   Property/Dwelling Lease Agreement
   Bill of Sales of Inventory & Fixtures
   Managing Officers Appointment Form
   Subordinate Group Authorized Form
   2 page Tax Exemption Letter (receivable on payment of charter fees and
   membership dues).

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

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

Year/Period Ended

Name of Taxpayer March 31, 20XX

ORG
EIN: #

Article III, part 4 of the Articles of Incorporation states that, each CO-1 post/lodge will
be committed to contribute $ each year to charity(s) of the post/lodge choice. These
charities may be within the post’s own community. Verification of donations must be
submitted to the CO-1 National Headquarters monthly to be placed in each post/lodge
file.

The officer did not change anything inside or outside of the bar when the bar was
operated under ORG. The old name of the bar, CO, was still used by the organization.
The bar was open the general public.

To meet the membership requirement, the officer invited her customers to become
members. Members were required to pay membership dues. Members were not required
to pay sales taxes for their drinks.

There is a complete lack of regalia or memorabilia specific to the CO-1 either inside or
outside the organization. The organization is devoid of any rites or rituals specific to the
CO-1 culture when the meetings are held or when new members are recruited. ORG has
only one class of membership.

LAW

Internal Revenue Code subsection 501(c)(10) provides an exemption for domestic
fraternal societies, orders, or associations, operating under the lodge system, the net
earnings of which are devoted exclusively to religious, charitable, scientific, literary,
educational, and fraternal purposes, and which do not provide for the payment of life,
sick, accident, or other benefits.

Income Tax Regulation section 1.501(c)(10)-1 provides that an organization will qualify
for exemption under section 501(c)(10) if it is a domestic fraternal beneficiary society
order, or association, described in section 501(c)(8) and the regulations thereunder except
that it does not provide for the payment of life, sick, accident, or other benefits to its
members, and devotes its net earnings exclusively to religious, charitable, scientific,
literary, educational, and fraternal purposes.

Internal Revenue Code section 501(c)(8) provides an exemption from taxation for
fraternal beneficiary societies, orders, or associations operating under the lodge system or
for the exclusive benefit of the members of a fraternity itself operating under the lodge
system and providing for the payment of life, sick, accident, or other benefits to the
members of such society, order, or association or their dependents.

Rev. Rul. 81-117, 1981-1 C.B. 346 states that an organization that does not conduct any
fraternal activities or operate under the lodge system, but does operate exclusively for the

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

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

Year/Period Ended

Name of Taxpayer March 31, 20XX
ORG
EIN: #

benefit of members of certain related domestic fraternal societies operating under the
lodge system, does not qualify for exemption under section 501(c)(10) of the Code.

Rev. Rul. 73-165, 1973-1 C.B. 224A defines a fraternal beneficiary society, order, or
association exempt under section 501(c)(8) as one that, in addition to being operated in
furtherance of fraternal purposes, (1) is so operated under the lodge system or for the
exclusive benefit of the members of a fraternity that is so operated under the lodge
system, and (2) has an established system for the payment to its members or their
dependents of life, sick, accident, or other benefits. There is no requirement that either the
fraternal features or the insurance features predominate so long as both features are
present.

In National Union v. Marlow 374 F. 775, 778 (1896) a fraternal beneficial society was
defined as one whose members have adopted the same, or a very similar calling,
avocation, or profession, or who are working in union to accomplish some worthy object,
and who for that reason have banded themselves together as an association or society to
aid and assist one another, and to promote the common cause. The term "fraternal" can
properly be applied to such an association, for the reason that the pursuit of a common
object, calling, or profession usually has a tendency to create a brotherly feeling among
those who are thus engaged. The National Union did not fit this definition, because it
was an association of individuals who were associated for the purpose of obtaining
insurance. The court concluded that: “In its practical operations, therefore, the
defendant company cultivates fraternity and confers benefits in the same manner that
every insurance company doing business on the mutual plan cultivates feelings of
fraternity, and confers benefits upon its members. Or, in other words, when the defendant
is stripped of all disguises, and judged by the standard of what it is engaged in doing,
and what it was most likely organized to do, it is simply an insurance company which
carries on an extensive business on the assessment plan.”

The court in Polish Army Veterans Post 147 v. Commissioner , 24 T.C. 891, reversed on
other grounds, 236 F.2d 509 (3rd Cir. 1956) concluded that an organization had not
established its exemption as a fraternal beneficiary society because members lacked a
common tie: to qualify for the exemption an organization must be fraternal .... Here only
the active members, comprising less than 10 per cent of the total membership of the Post,
had a common tie. They, of course had the bond of having formerly served in the Polish
Army. But approximately 90 percent of the total membership of the Post was social
members who were not ex-members of the Polish Armed Forces and who ... had nothing
in common with the active members or with each other. An organization cannot be
classed as fraternal where the only common bond between the majority of the members is
their membership in that organization.

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

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

Year/Period Ended

Name of Taxpayer March 31, 20XX
ORG
EIN: #

Fraternal Order of Civitans v. Commissioner , 19 T.C. 240 (1952) provided that the
requirement of common ties and objectives is not satisfied merely by a recitation of such
purposes in the association's constitution or bylaws. It is necessary that the stated
purposes be implemented or accomplished by specific acts. The Tax Court denied
exemption to an organization whose constitution called for, among other things, the
promotion of civic enterprises in the community. It engaged in no civic or charitable
activities during the period under review.

The court in Western Funeral Benefit Association v. Hellmich , 2 F.2d 367 (E.D. Mo.
1924), stated that "by the 'lodge system’ is generally understood as an organization which
holds regular meetings at a designated place, adopts a representative form of government,
and performs its work according to ritual."

Philadelphia and Reading Relief Association, 4 B.T.A. 713 (1926), held that where the
sole motive in joining an organization is to receive insurance benefits, and there are no
lodges, rituals, ceremonies or regalia, then there is no fraternal element present.

Knights of Columbus Building Association of Stamford, Conn., Inc. v. United States, 61
AFTR 2d 88-1212 (DC Conn. 1988), held that an organization that operated a bar and
buffet that was utilized by nonmember community organizations was not operating with the
exemption provisions and therefore was not exempt under IRC §501(c)(8).

TAXPAYER’S POSITION

ORG consents to the proposed revocation.

GOVERNMENT’S POSITION

ORG is not a domestic fraternal society because the members do not have a common tie
or objective. The only common bond between the members is their membership in ORG.
Members of ORG do not have a common fraternal bond. The members do not possess a
similar calling, avocation, or profession, and are not working in unison to accomplish any
worthy objective or common cause. Rituals, ceremonies, and regalia that are evidence of
fraternal activities are not found in ORG. ORG has not been neither operating for
religious, charitable, scientific, literary, educational and fraternal purposes, nor devoting
its net earnings exclusively to religious, charitable, scientific, literary, educational, and
fraternal purposes. The current officer, President, created ORG with the intent to
generate profits. All assets and net earnings of ORG belong to the owner, President.

ORG is not operating under the lodge system. ORG is a member of the parent

organization through the payment of dues and a charter fee. The term “membership
dues” implies that each member pays a fee for membership because they place a value on

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenuc Service Schedule No. or
Explanation of Items Exhibit

Year/Period Ended

Name of Taxpayer March 31, 20XX

ORG
EIN: #

their association with the organization and that there are rights, privileges or benefits
associated with membership. The organization does not have a set meeting schedule and
there are no rituals associated with the meetings. The organization does not have a
representative form of government because the members have no voice or voting rights in
the business operation of the organization or the net earnings. The officers are not
selected or elected by the membership.

During the year under audit, although ORG donated $/month to some charities, that does
not make ORG meet the 501(c)(10) requirements. ORG is operating in a commercial
manner which is not an exempt activity described under Internal Revenue Code section

501(c)(10).

CONCLUSION

In the case of ORG, it is held that, where the primary purpose or activity of the
organization is the commercial manner in which the bar operates. ORG is not a domestic
fraternal society operating under the lodge system, the net earnings of which are devoted
exclusively to religious, charitable, scientific, literary, educational, and fraternal
purposes. The organization does not qualify for exemption under section 501(c)(10) of
the Internal Revenue Code. Consequently, the organization’s exempt status is revoked
effective April 1, 20XX.

Forms 1120 should be filed for the tax periods ending on and after March 31, 20XX.

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