Determination 1039039: 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 July 1, 20XX. The organization operated a commercial bar open to the general public, had no common fraternal bond among its members, and did not operate under a lodge system. The IRS concluded that the organization was not devoted exclusively to religious, charitable, scientific, literary, educational, or fraternal purposes. The organization was required to file Form 1120 for tax periods beginning on and after the effective date.

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.
TAX EXEMPT AND Dallas, TX 75242 501-10.00
GOVERNMENT ENTITIES
Date: June 9, 2010
Release Number: 201039039
Release Date: 10/1/10
LEGEND Employer Identification Number:
ORG = Organization name Person to Contact/ID Number:
XX = Date Address = address Contact Numbers:
Voice:
ORG Fax:
ADDRESS

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. All assets and net earnings of ORG belong to the owner,
PRESIDENT. 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 July 1, 20XX.

You are required to file Forms 1120 with the appropriate Service Center for the
tax periods beginning on and after July 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

Dallas, TX 75242
TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION
ORG Taxpayer Identification Number
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 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 modifying or 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.

In lieu of Letter 3610

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,

Nanette M. Downing
Acting Director, EO Examinations
Enclosures:
Publication 892
Publication 3498
Form 6018-A
Report of Examination
Envelope

In lieu of Letter 3610

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

Year/Period Ended

Name of Taxpayer June 30, 20XX

ORG
EIN: #

LEGEND
ORG = Organization name SS = Date State = state MGR = MGR
President = president CEO = CEO CO-1 & CO-2 = 1%* & 2"? COMPANIES

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 Reforms Only Bar.

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.

ORG was examined on September 9, 20XX. MGR, the Manager, was present for the
examination. MGR was designated to represent President on September 7, 20XX. The
organization did not provide any financial information at the examination and President,
the only officer, did not attend. Financial information was also requested on November 3,
20XX. To date financial information has not been provided to the Service. The following
information was obtained.

The organization was established in July of 20XX. The bar used to be named CO-1,
which was a CO-2 subordinate. President, officer, purchased the organization and called
the CO-2 headquarters to inquire about remaining a CO-2 subordinate. Subsequently, the
organization remained a CO-2 and the chapter number changed. It was stated in the
interview that the only reason the organization became a CO-2 is to obtain a liquor
license. In the interview, the taxpayer could not explain or describe the organization’s
purpose. The organization does not have a clear purpose other than to operate a bar. The

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 June 30, 20XX

ORG
EIN: #

bar is open to the general public. Individuals do not have to be a member frequent the
bar. Currently the organization has 26 members and one class of membership. As stated
in the interview, the requirements for membership are as follows:

Anyone who can pay for membership dues can become a member
New members give their name and address for membership cards

There is no common bond, avocation or profession among members. The organization
recruits new members by putting up a sign at the bar. The benefits of being a CO-2
member are members receive free food and drinks sometimes.

The parent organization's Constitution and Bylaws state that CO-2 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
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-2’s subordinate are as follows:

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-2 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-2 Headquarters to ask for steps and the information to
remain a CO-2 subordinate, he was told it would be a $ transfer fee and he also
received a package including the following material from the CO-2 Headquarters:

. Constitution and Bylaws of CO-2
. Membership requirements
C. Instructions on how to prepare Articles of Incorporation
D. State Liquor Control Checklist prepared by CO-2 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:

Certificate of Incorporation

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).

Article III, part 4 of the Articles of Incorporation states that, each CO-2 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-2 National Headquarters monthly to be placed in each post/lodge
file.

There is a complete lack of regalia or memorabilia specific to the CO-2 either inside or
outside the organization. The organization is devoid of any rites or rituals specific to the
CO-2 culture when the meetings are held or when new members are recruited. ORG only
exist to operate a bar.

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 June 30, 20XX

ORG
EIN: #

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

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 June 30, 20XX

ORG
EIN: #

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
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

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 June 30, 20XX
ORG
EIN: #

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.

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

The taxpayer position is unknown at this time.

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

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

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
June 30, 20XX
ORG
EIN: #

fraternal purposes. The current officer, CEO, 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
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 made contributions to some charities, that
does not qualify ORG exempt status under 501(c)(10). 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 July 1, 20XX.

Forms 1120 should be filed for the tax periods ending on and after July 1, 20XX.

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