IRS determination 1039044: Supporting organization reclassified as a private foundation

View official IRS release (PDF)

Plain-English summary

The IRS issued a final adverse determination revoking an organization’s recognition under IRC § 501(c)(3) as a supporting organization. The document states that the organization operated substantially for a nonexempt purpose, its earnings inured to private individuals, and it did not establish the relationships, responsiveness, integral-part, attentiveness, and control requirements for classification under IRC § 509(a)(3). The IRS concluded that the organization should instead be treated as a private foundation under section 509(a), effective on a redacted date. Contributions were no longer deductible under IRC § 170, and the organization was instructed to file Form 1120 for later years. The determination also describes declaratory-judgment and Taxpayer Advocate procedures.

Ruling snapshot

• Question: Did the organization qualify as a section 509(a)(3) supporting organization, or should it be reclassified as a private foundation?
• Outcome: Revocation
• Key authorities: IRC §§ 170, 501(c)(3), 509(a)(3), 6104(c), and 7428; Treas. Reg. §§ 1.501(c)(3)-1 and 1.509(a)-4

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
1100 Commerce Street
Dallas, TX 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Release Number: 201039044
Release Date: 10/1/10
Date: June 13, 2007

A=Name of organization

UIL:501.03-01

Last Date for Filing a Petition
With the Tax Court - Date 1

Certified Mail Return - Receipt Requested

Dear
This is a Final Adverse Determination Letter as to A Organization’s exempt status

under IRC §501(c)(3).
Our adverse determination was made for the following reasons:

The organization has not been operating exclusively for exempt purposes within

the meaning of IRC §501(c)(3) and Treas. Reg. §1.501(c)(3)-1(d). It is not an
organization which operates exclusively for one or more of the exempt purposes

which would qualify it as an exempt organization. It has been operating
substantially for a non-exempt purpose and its earnings inure to the benefit of

private individuals.

Based upon these reasons, we are retroactively revoking the organization’s IRC
§501(c)(3) tax exempt status for all years beginning on or after Date 2

Contributions to your organization are no longer deductible under IRC §170.

A Organization is required to file federal income tax returns on Form 1120, U.S.
Corporation Income Tax Return, with the appropriate Service Center immediately and by

the due date of Form 1120 for all subsequent years.

Page 2 of 2

Processing of income tax returns and assessment of any taxes due will not be
delayed should a petition for declaratory judgment be filed under IRC §7428.

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 Claim
Court 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 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.

We will notify the appropriate state officials of this action, as required by IRC
§6104(c).

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

Sincerely,

Marsha A. Ramirez
Director, EO Examinations

Enclosure:
Publication 892

DEPARTMENT OF THE TREASURY

Internal Revenue Service

300 N. Los Angeles Street, MS7300
Los Angeles, CA 90012

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

October 10, 2006

Taxpayer Identification Number:

Form:
Tax Year(s) Ended:

Person to Contact/ID Number:

Contact Numbers:
Telephone’
Fax:

Certified Mail - Return Receipt Requested

Dear

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

(Code) is necessary.

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

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

applicable law, and arguments in support of your position.

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

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

was the subject of the technical advice.

Letter 3618 (04-2002)
Catalog Number 34809F

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:

300 North Los Angeles Street

Room 5109, Stop 6710

Los Angeles, CA 90012

(213) 576-3140
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,

Marsha A. Ramirez
Director EO Examinations

Enclosures:
Publication 892
Publication 3498

Form 886-A, Parts | & II

Letter 3618 (04-2002)
Catalog Number 34809F

Schedule oc!

Form 886-A EXPLANATION OF ITEMS Exhibit No.
Part 1
Name of Taxpayer | Year Ended
A (B) Year of Exam
A=Supporting K=Organization 4 W=Organization 7
L=Organization § X=Organization 8

Y=Organization 9
Z=Organization 10
AA=notation of check
BB=Investment firm 1
CC=Investment firm 2

Organization
B=Employer M=Organization 6
identification Number N=Board member of A
C=Founder and Trustee O=Board member of A
of A and spouse of D P=Investment advisory
D=Founder of A and firm of C

spouse of C Q=law firm in which C is DD=Investment firm 3
E=City and State where partner EE=Grandson of
C and D reside R=Board member of A board member N
F=Organization 1 S=Board member of A ****=Dates

G=Board member of A T=Law firm partner of C X=Amounts

H=Board member of A U=Organization
l=Organization 2 V=Name of financial plan

J=Organization 3 sold by P

ISSUE #1

Should the A’s tax exempt status under Internal Revenue Code 501(c)(3) be revoked
because it has not established that it is operated exclusively for tax exempt purposes and
because the funds of the organization have inured to C?

ISSUE #2
Should the A be reclassified as a private foundation?

FACTS:

Organizing Documents
The A’s Declaration of Trust was entered into in the State of on **** by C and D

(as Founder or Donor) and C (as Trustee) both of whom resided in E when the Trust was
formed. According to the Declaration, the Trust’s purpose is the establishment of an
organization which is described in Section 501(c)(3) and Section 509(a)(3) of the Internal
Revenue Code of 1986. The Declaration provides that it will be “organized and at all times
thereafter will be operated exclusively to support or benefit, as defined by Treasury Regulation
Section 1.509(a)-4(b)(1), one or more publicly supported organizations and shall comply with
all other requirements of Section 509(a)(3) of the Code. No part of the net earnings of this
Trust shall inure to the benefit of any individual... Notwithstanding any other provision hereof,
‘his Trust shall not conduct or carry on any activities not permitted to be conducted or carried
on by an organization which is tax exempt or by an organization that receives donations which
are deductible from taxable income to the extent allowed by the provisions of the Code and
»ther applicable legislation and regulations as they now exist or may hereafter be amended. »
Page 1 of 2§

Form 886-A

Department of the Treasury - Internal Revenue Service

7 q i Schedule or
Form 886-A EXPLANATION OF ITEMS | Exhibit No.
| Part 1
Name of Taxpayer | Year Ended
A (B; | Year of Exam

The Declaration of Trust states that the Trust is irrevocable and the Founder “waives
the right and power to alter, amend, revoke, or terminate the Trust or any of the terms of this
Declaration” and also “Founder hereby renounces any power to determine or control, by

alteration, amendment, revocation, termination, or otherwise, and the Founder renounces any
interest in, either vested or contingent, including reversionary interest or possibility or reverter,

the income or principal of the trust estate.”

The Declaration of Trust also states that, “A// donations so received, together with the
income therefrom (hereinafter referred to as the “Trust Fund”) shall be held, managed
administered and paid out by the Trustee pursuant to the terms and conditions of this

Agreement.”

The Declaration of Trust provides that each year the “Trustee shall distribute
percent‘ %) of the net income of this Trust to F (hereinafter referred to as the “Primary
Charity’), a charitable organization qualified under section 501(c)(3) of the Code”. The
Declaration of Trust also provides, “It is intended that the distributions to the Primary Charity
will help such charitable organization perform its functions and carry out its purposes. In order
to insure that this happens, the Board shall meet with a representative of the Primary Charity
.. determine the use of such distributions. It is intended that the distributions will be used in a
similar fashion each year.” (Note: Amendments were made to the primary charity, see below)

The Declaration of Trust goes on to state, “/n addition to the distribution to be made
pursuant to Section 2.2.1 above, each year the Trustee shall distribute a totalof _ percent
( %) of the net income of this Trust to one or more of the organizations listed on Schedule A,
which by this reference is made a part hereof, or to the Primary Charity as directed by a
majority of the Board in writing...Each such distribution shall be made on or before the end of
the fourth (4") month immediately following the year in which the income was earned. If,
seven (7) business days before the expiration of the above-referred-to time to make such
distribution for a particular taxable year, the Trustee has not received directions from the Board
to make such distribution, then the Trustee shall distribute such of the above amount as has
not been distributed to such of the organizations listed on Schedule A as the Trustee, in
Trustee’s sole and absolute discretion, shall determine, provided that each such distribution
shall be a distribution which can be made by an organization described in section 509(a)(3) of

the Code.”

Section 2.11 of the Declaration provides that the Trustee shall render at least annually
an account of income and principal, including statement of receipts, disbursements and capital
changes to the Board and to F. (Note: Amendments made to the primary charity, see below)

The Declaration provides that the Board may consist of up to five (5) members and no
less than three (3) members. One Board member shall be appointed by the Primary Charity

Page 2 of 25
Form 886-A

Department of the Treasury - Internal Revenue Service

i Schedule o:

• X £ we

Form 886-A EXPLANATION OF ITEM | Exhibit No.
| Part 1

Name of Taxpayer | Year Ended

A (B) _Year of Exam

or its designated agent. Two Board members shall be from the class consisting of C and D
their descendants (the “C/D Family”). The other members of the Board shall be G and H.

The Declaration provides that the membership of the Board shall at all times be such
that the original Founder, Donor, or other Disqualified Persons, as defined in section 4946 of

the Code, do not control the Board.
Schedule A of the Declaration of Trust listed four (4) organizations that may receive
payments as follows: 1) I, 2) J, 3) K, 4) L.
The Declaration of Trust was signed (undated) by C and D as Founder/Donor and C as

Trustee. The witnesses section was

Amendments to the Declaration of Trust
Amendments made were as follows:

****_ Amended Purpose clause

**** _ Changed primary charity to K; amended Purpose clause

* _ Amended Dissolution clause to delete last sentence
e *- Changed primary charity to M.
All Amendments were signed by C.

Application for Recognition of Exemption (Form 1023)
The A filed Form 1023, Application for Recognition of Exemption, with the IRS on or

around *. Based on the application, the IRS recognized A as exempt from federal income
tax under section 501(a) of the Internal Revenue Code as an organization described in section
501(c)(3) and Letter number 947 from the IRS, dated ", was issued to the organization. The
letter also stated that the organization was not a private foundation within the meaning of
section 509(a) because it was an organization described in section 509(a)(3).

Primary Supported Organization
The Declaration of Trust provided that the primary supported organization was initially

F. Subsequent amendments changed the primary supported organization to K and finally to

M.

Activities
The current Governing Board members listed on the Form 990 were as follows:

C, State 1
D, State 1
G, State 1

H, State 1
N, State 2 (the Form 1023 listed O, F, State 1)
Page 3 of 25

Form 886-A

Department of the Treasury - Internal Revenue Service

7 “ni | Schedule or
Form 886-A EXPLANATION OF ITEMS | Exhibit No.
| Part 1
Name of Taxpayer | Year Ended
A (EB) | Year of Exam

G from State 1 is the investment advisor for the C and D.
The grandson of N, received $. | as a scholarship from M during 2003, based on the
Form 990 of M.

As part of the examination, the IRS requested information on Form 4564 (Information

Document Request #2 & #2a) from the A regarding its activities to determine if the
organization was qualified for tax exemption under IRC section 501(c)(3). The following

information was requested:

1) Biography and relationships (including business) of all board members
2) Information on the supported organizations (primary charities)

3) Minutes of all Board/Trustee meetings
4) All correspondence and communications with the supported organizations

5) Contracts & agreements with P (see discussion below)
6) Explanation of the discrepancies between reported payments on the Form

990 and the organizations accounting records (see Financial Information

section below)
Evidence that payments made were exclusively for tax exempt purposes (see

Financial Information section below)
Evidence that the assets of the organization exists (see Financial Information

section below)

7)

8)

To date, the A has not provided any response or documents to the items requested on
Information Document Request #2 and 2a.

C, a lawyer by trade and has the law firm Q, was expecting a large sum of money from

settlements on lawsuit against pharmaceutical companies. Based on the information, an
amount up to $ was estimated to be received from these pharmaceutical

company lawsuit settlements.

Information obtained by the IRS indicates that C and D’s intent for creating A was not
exclusively for charitable purposes but rather for tax avoidance purposes under the direction of
P. Documents obtained by the IRS include an application completed by C and D that provides
personal information required by P. The application to P includes Personal History, Goals &
Objectives, Personal Assets, Personal Liabilities, Personal Annual Income Statement,

Personal Expenses, Business History, Advisors. In the Goals & Objectives section, question

number Il. 2. asks:

“What was your objective in contacting P?”
Page 4 of 25

Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A EXPLANATION OF ITEMS | Schedule or

| Exhibit No.

| Part 4
Name of Taxpayer Year Ended
Ae | Year of Exam

C and D’s written response was, “Reduce Taxes’.

Question number VI asks:

“Are there worthy causes or objectives that you feel strongly about?”
C and D’s response was “Any interests that my wife or girls have are my interests”

Question VII asks:

“Are there any significant economic events going to take place in the next few years?”
C and D responded with, “Many cases that we have that could be settling bringing in

tremendous amount in fees”

This answer pertains to the pharmaceutical company lawsuits that C’s law partnership were
involved in. In the Advisor section of the application, C listed R as his investment advisor.
Documents obtained by the IRS also include an Agreement for Implementation of Master
Financial Plan dated Date 4. The agreement is between S, an entity related to P, and Q a C-

Corporation law practice with 30 employees. The agreement was signed by C (*), T (),
and the U (***). The agreement includes a “secrecy” clause that states, “You agree not to

disclose any information or documents obtained from us, including but not limited to all

information and documents contained in your Plan as well as all contracts, entity,
organizational and/or other legal documents necessary to implement and maintain your Plan.”

Schedule A of the master financial plan agreement lists the products and services to be

provided as follows:

Domestic
Two Support Organizations — Preparation of documents to complete the

e
organization, filing with governmental agencies for approval, and preparation of
documents as needed for the transfer of assets & filing

e One Loss of Income Policy

e One VEBA

e Equity Management Mortgage

Two Limited Liability Companies (LLC)
e Two Estate Planning/Living Trusts
Two Irrevocable Life Insurance Trusts

Foreign
e Two Foreign Variable Annuities
e Two Hybrid Guarantee Companies
Page 5 of 2&
Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A EXPLANATION OF ITEMS Schedule or
Exhibit No.
| Part 1
Name of Taxpayer | Year Ended
ALP) | Year of Exam

Two International Business Corporations (IBC)

The “Two Support Organizations” listed in Schedule A are presumably for the creation of a tax
exempt organization for C & D (A) and one for T, the law firm partner of C. Schedule A was
signed by C (*) and T (*) affirming to the implementation of the master financial plan.
Schedule B, Implementation and Maintenance Fees and Expenses, is also an attachment to

the agreement to implement the master financial plan.

Documents obtained by the IRS also include a V Development Agreement between P and Q
This document was signed by C (*) and T (), P (), and U (*).

P and Related Entities
Pisa corporation and P is the parent company. P offers services to
clients that are designed to reduce taxes and protect assets through creation of offshore and

use of “offshore” entities.

The Securities and Exchange Commission (SEC) filed a complaint against P and other
related entities on ****. The SEC complaint states that P is engaged in an ongoing scheme in
which it has obtained investments from clients to whom it provides offshore tax planning and

asset protection services. The complaint describes P as follows:

“P provides its services in the form of a “V’ it sells to clients and implements on their
behalf. The implementation of the plan involves the establishment of offshore entities
and the execution of transactions through which its clients invest funds, securities and
other assets P promises its clients that, through the implementation of the V, the clients
will reduce their taxes by significant percentages, have their investments grow offshore
in a tax free environment, and will be able to protect their assets from unwanted

liabilities and encumbrances.”
The SEC complaint describes the use of supporting organizations (SO) by P as follows:

“P describes SO’s as charitable organizations established for the benefit of an individual
client. Among the stated benefits of an investor establishing an SO over using a domestic
charitable organization is the investment funds transferred to the investors personal SO can
grow tax free. These investments gains are available to the donor/investor through access to

the offshore corporations that manage the investment of the SO.”

Poffered the Vs to clients and in promoting these plans makes claims to clients that P utilizes
“loopholes” in the Internal Revenue Code to enable clients to minimize tax obligations and
protect assets. P also provided a means to repatriate clients assets through transactions that

Page 6 of 25
Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A EXPLANATION OF ITEMS | Schedule or
Exhibit No.
Fart 14

Name of Taxpayer | Year Ended

A | Year of Exam

hide actual ownership of the assets, thereby enabling the clients to utilize the untaxed funds
without paying tax obligations.

Financial Information
Form 990 for the years ending December 20 through 20 ~~ reported revenue

and expenses as follows:

Revenue: 200: 200° 200 200.
Contributions $XXX,000 $ XX,XXX $ XX,XXX $ XX,XXX
Expenses:
Grants & Allocations
K $ X,XXX $ XX,XXX $ XX,XXX -
F $ X,XXX - -
Ww - $ XX,XXX -
M - - $ XX,XXX $ XX,XXX
4 - - - $ XX,XXX
L - - - $ XX, XXX
Y - - - $ XX,XXX
2 - : - $ XX,XXX
Miscll $ X,XXX - - -
GSI $ X,XXX S - -
Accounting Fees - - - $ XXX
Bank Charges - $ XX - $ XX
$ XXX,XXX ($§ XXX) 3 X,XXX ($ XXX)

Excess or Deficit:

Year 2000 Transactions
During the year 20 ‘the C and D opened an account at Bank (#XXXXXXXxX) for the A.
The following transactions occurred in the bank account as follows:

* _ Deposit of $X,XXX (not reported on Form 990)
* — Check in the amount of $X,XXX payable to K (not reported on Form 990)

* _ Deposit (transfer) of $X,XXX
x _ A miscellaneous debit of $X,XXX from the account

* _ Deposit (transfer) of $XXX,XXX
* —_ Check #X for $XXX,XXX payable to Bank. Noted on
check is “Investment Contract”
Check #X for $ payable to Bank. Noted on

check is “AA”
Deposit (transfer) of $X,XXX**** — Check #XXX for $X,XXXpayable to K

wa

Page 7 of 25
Form 886-A

Department of the Treasury - Internal Revenue Service

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

| Part 1
Name of Taxpayer | Year Ended
A (B; | Year of Exam

The A has not provided documentation supporting the purpose and disposition of
payments made during 20 Specifically, no supporting documentation has been provided tc
substantiate the reported payment, purportedly for investment purposes, of the $XXX,XXX
(reported as Savings & Temp Cash Investments on Form 990). Based on the information
provided by the A to date, the asset is described as located at * . The CSO
has not provided evidence that this asset exists and is being used to serve charitable
purposes. This asset was contributed to the CSO by the C and D who may have claimed a
charitable tax deduction on their Form 1040 in connection with this contribution. The A has not
reported any interest or earnings from the investment of the $XXX,XXX. It is possible that

these funds were returned to the C and D via BB, CC, and ultimately to Q.

Year Transactions
The general ledger provided by the A for the year 20 —_ did not support the reported

expenses on the 2001 Form 990. The A general ledger showed the following expenses for the

year 20
K (2 payments) $ X,XXX
DD (5 payments) $ X,XXX
Individual 1 (wire transfer) $ XX, XXX
Individual 2 & 3 (wire transfer) $ XX,XXX
Bank Service Charge $ XX
Total $ XX,XXX

The payees who received payments per the general ledger did not support the reported
payees on the Form 990. Also, the reported expense/payment of $X,XXX to the F was never

made. A voided this payment (check) during ****.

In addition, the A has not proven that all payments were made exclusively for charitable
purposes. The documents provided to the IRS indicate that payments made by the A served
private purposes rather than for public or charitable purposes as discussed below:

1) Two (2) payments were made to K totaling $X,XXX during 2C_| which included a
payment of $X,XXX during September. The description of this $X,XXX payment in the A's
records was, “Full & Final Settlement for and behalf of K’ and the check was made payable to

Individual 4 and 3 Ltr acronym. This payment appears to be a payment in settlement of an
obligation (possible legal matter) rather than for an exclusive charitable purpose. This payment

to K occurred on or around * and on or around * the A’s Declaration of Trust was
amended to change the primary charity from K to M

In addition, the IRS does not have any evidence that the organization, K, is recognized
by the IRS as an organization that is tax exempt under section 501(c)(3) of the Internal

Page & of 25
Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A EXPLANATION OF ITEMS | Schedule or

| Exhibit No.

| Part 1
Name of Taxpayer | Year Ended
A(B. | Year of Exam

Revenue Code.

2) Five (5) payments were made to DD totaling ¢ during 2C A’s general
ledger describes the payments to DD as “ " It cannot be determined if these
expenditures served exclusively charitable purposes because the A has not provided

supporting information for these payments.

3) A wire transfer of $ was made to Individual 1 on or around ****. The A’S
general ledger describes the wire transfer to Individual 1 as “Dance Instruction”. This
payment appears to have not been made exclusively for charitable purposes but rather for the
dance instruction of an individual, a purpose that serves a personal and private benefit.

4) A wire transfer of $. was made to Individuals 2 and 3 on or around ****. A’S
general ledger describes the wire transfer to Individuals 2 and 3 as “Dance Instruction’. This
payment appears to have not been made exclusively for charitable purposes but rather for the
dance instruction of an individual, a purpose that serves a personal and private benefit. A
review of M Form 990 for the year 20 _ shows that a scholarship was given to (Individual 4
having same first and last name as Individual 3 with middle name added) in the amount

of $.

Year 2002 Transactions
The A has not provided books and records for the year 20 however the IRS has —
obtained bank statements for the Bank account (ZXXXXXXXxX) and used this information in its

examination of the payments made from the A and are as follows:

“ae - Check XXX for $ " payable to “W”. Noted on the check was “Trip

**** _ Check XXX for $. payable to DD. Noted
on the check was “Nov, Dec, Jan”

“ - Check XXX for ¢ © payable to M.
Noted on the check was (Dec, Jan, Feb)
™ _ Check XXX for $ _ payable to C.

payable to DD. Noted on the check is

**** _ Check XXX for $.
payable to A. Noted on the check is “close acct”

**** - Check XXX for $.

The reported payments on Form 990 did not reconcile with payments from the Bank
account. In addition, the reported income on the Form 990 did not reconcile with the deposits

in the Bank account.

As with the payments during 20 _— there are payments to DD which have not been

xplained to the IRS as to the purposes served and there are payments to the dance

Page 9 of 25
Form 886-A

Department of the Treasury - Internal Revenue Service

. Schedule or
LL ¢
Form 886-A EXPLANATION OF ITEMS Exhibit No.
Part 1
Name of Taxpayer | Year Ended
A (B) | Year of Exam

organization which may be for payments for individual dance instruction. In addition, there are
and $ ) which indicate that funds from the A

direct payments to the C & D ($
inured to the benefit of the C and D.

Year20 Transactions
The A did not provide books and records for the year 2C_ However a review of the

Form 990 shows reported payments were made to organizations other than the supported
organization (i.e. M). Payments to organizations included: 1) K (the CSO changed their

primary charity to M on ****); 2) W; 3) X; 4) L; 5) Y.; and 6) Zl.

The A has not provided an explanation of why payments to other than the supported
organization were made nor to the charitable purposes for these payments. Based on the
names of the organizations to which payments were made it appears that some of the entities
are not tax exempt organizations such as X, Y, and Z.

The grandson of N (Board Member), EE, received §. as a scholarship from M

during 20 based on the Form 990 of M

ISSUE
Should A’s tax exempt status under Internal Revenue Code 501(c)(3) be revoked
because it has not established that it qualifies for tax exempt status and has not established

that it is operated exclusively for tax exempt purposes.

LAW:

IRC § 501(c)(3) exempts from Federal income tax: corporations, and any community
chest, fund, or foundation, organized and operated exclusively for religious, charitable,
scientific, testing for public safety, literary, or educational purposes, or for the prevention of
cruelty to children or animals, no part of the net earnings of which inures to the benefit of any
private shareholder or individual, no substantial part of the activities of which is carrying on
propaganda, or otherwise attempting to influence legislation and which does not participate in,
or intervene in (including the publishing or distributing of statements), any political campaign

on behalf of any candidate for public office.

Regulation section 1.501(c)(3)-1(a)(1), Organizational and operational tests, provides
that in order to be exempt as an organization described in section 501(c)(3), an organization
must be both organized and operated exclusively for one or more of the purposes specified
in such section. If an organization fails to meet either the organizational test or the

operational test, it is not exempt.

Regulation section 1.501(c)(3)-1(c)(1) provides that an organization will be regarded as

"operated exclusively" for one or more exempt purposes only if it engages primarily in activities

Page 10 of 25
Form 886-A

Department of the Treasury - Internal Revenue Service

• Schedule o!

Form &86-4 EXPLANATION OF ITEM Exhibit Nc.
Part 14

Name of Taxpayer | Year Ended

A (B} | Year of Exam

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.

Regulation section 1.501(c)(3)-1(c)(2) provides that an organization is not operated
exclusively for one or more exempt purposes if its net earnings inure in whole or in part to
the benefit of private shareholders or individuals. The words "private shareholder or
individual" refer to persons having a personal and private interest in the activities of the
organization. The term “private shareholder or individual” is defined in regulation section

1.501(a)-1(c).

Regulation section 1.501(c)(3)-1(d)(1)(ii) 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, to meet the requirement of this subdivision, it is necessary for an

organization to establish that it is not organized or operated for the benefit of private
interests such as the creator or his family, shareholders of the organization, or persons

controlled, directly or indirectly, by such private interests.

In Better Business Bureau v. United States, 326 U.S. 279 (1945) the court held that
regardless of the number of truly exempt purposes, the presence of a single substantial non
exempt purpose will preclude exemption under section 501(c)(3) of the Code. See also
American Campaign Academy v. Commissioner, 92 T.C. 1053, 1065-66 (1989) (when an
organization operates for the benefit of private interests, such as designated individuals, the
creator or his family, or persons directly or indirectly controlled by such private interests, the
organization by definition does not operate exclusively for exempt purposes); Old Dominion
Box Co., Inc. v. United States, 477 F2d 340 (4" Cir. 1973) (operating for the benefit of private
parties who are not members of a charitable class constitutes a substantial nonexempt

purpose).

In Church of World Peace, Inc. v. Commissioner, T.C. Memo. 1994-87, affd, 75 A.F.T.R.2d
(RIA) 2082 (10" Cir. 1995), the Tax Court held that a church did not operate exclusively for
religious purposes because the church facilitated a circular tax-avoidance scheme. The facts
showed that individuals made contributions to the church and claimed charitable contribution
deductions. The court found that the church then returned the money to the individuals
claiming that the payments were for housing allowances and reimbursement of expenses. The
court further found that such payments were in fact unrelated to the church’s operations.

In Spokane Motorcycle Club v. U.S., 222 F. Supp. 151, net profits were found to inure
to private individuals where refreshments, goods and services amounting to $825
(representing some 8% of gross revenues) were furnished to members.

Page 11 of 25 =
Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A EXPLANATION OF ITEMS | Schedule or
Exhibit Nc.
Part 1
Name of Taxpayer | Year Ended
A (B) | Year of Exam

In Revenue Ruling 67-5, 1967-1 C.B. 123, it was held that a foundation controlled by the
creator's family was operated to enable the creator and his family to engage in financial
activities which were beneficial to them, but detrimental to the foundation. It was further held
that the foundation was operated for a substantial non-exempt purpose and served the private
interests of the creator and his family. Therefore, the foundation was not entitled to exemption

from Federal income tax under section 501(c)(3).

Regulation section 1.6033-2(i)(2) states, “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.”

Regulation section 1.6001-1(a) states in part that organizations, “..shall keep such
permanent books of account or records, including inventories, as are sufficient to establish the
amount of gross income, deductions, credits, or other matters required to be shown by such

persons in any return of such tax or information.”

Revenue Ruling 59-95 provides that a failure to file required information return or
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 an exempt status

In Church of Gospel Ministry v. United States, 640 F. Supp 96, the court ruled that a
failure to keep and present accurate and adequate records prevented the Church from meeting
its burden of showing that its operations were primarily for charitable purposes and did not
inure to the private benefit of its officers. The court also stated that, “...the lack of adequate
records or receipts... makes it impossible for CGM to establish that it is not being operated for
the private benefit of its members and provides independent grounds for rejecting its claim to

tax-exempt status.”

GOVERNMENT POSITION:
A has not shown that it has/is operated exclusively for tax exempt purposes and the

funds of the A has inured to or for the benefit of private individuals in violation of regulation
1.501(c)(3)-1(c)(2) and regulation 1.501(c)(3)-1(d)(1)(ii).

when a payment of

Funds of the A have inured to the benefit C during the year 20
$. (check XXXX) was made directly to C. Also during 2C_ =a payment of $

Page 12 of 25

Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A EXPLANATION OF ITEMS | Serene
| Exhibit No.
| Part 1
Name of Taxpayer | Year Ended
ae Year of Exam

(check ) was made to C when the Bank was closed and the remaining funds in the

account were distributed to C. In addition, the A has not provided evidence as to the
disposition of the $ reportedly invested during the year 20_. (check #XXXX) and

reported on the Forms 990 as such. The A has not established that the asset still exists and if
such asset is being used for tax exempt purposes. It is possible that these funds were
returned to the C and D via BB, CC, and ultimately to Q.

During 20( payments of and $. . were made for the dance instruction

of Individuals 2 and 3 and Individual 1which serves private interests rather than for
charitable purposes. Payments to K appear to be payments for dance instruction and/or

obligations connected with the providing of dance instruction.

The listed A board member, N, purportedly from the supported organization, M,
received a private benefit indirectly from the A when her grandson received a $ payment
from M during 20 M was apparently used also to facilitate the wire transfer during 20 to
Individuals 2 and 3 for dance instruction, a transaction that served private interests.
Subsequent to the wire transfer of $ intended for the benefit of Individuals 2 and 3,

the M provided a §. scholarship to Individual 4 during 20

Payments made during the years 20| and20 were made to organizations that are
either not named supported organizations and/or not tax exempt organizations. These
to Z.

payments include §$. ‘to K; $ to X., $ to Y., and $

The payments to “DD” have not been explained by the A and appear to be payments
for the rental of a warehouse. The IRS does not see the need for renting a warehouse since
the A does not have any reported inventory, furniture, equipment, or supplies belonging the A.

Tax exemption is a matter of legislative grace and not a right. Taxpayers have the

burden of establishing entitlement to tax exemption. As required per Regulation section
1.6033-2(i)(2) and Revenue Ruling 59-95 it is incumbent upon an organization to submit
information as may be required by the Internal Revenue Service for the purpose of inquiring
into its exempt status. A has failed to provide all information requested during the

examination.

An organization is described in section 501(c)(3) only if no part of its net earnings
nures to the benefit of any private shareholder or if it serves a public rather than a private
nterest. The inurement and private benefit prohibition is designed to insure that charitable

assets are dedicated to exclusively furthering public purposes. An organization is not
perated exclusively for exempt purposes if its net earnings inure to the benefit of private

hareholders and individuals or serves a private interest.

Page 13 of 25

Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A EXPLANATION OF ITEMS Schedule or

| Exhibit No.

| Part 1
Name of Taxpayer | Year Ended
A (B) | Year of Exam

A charity’s assets are required to be irrevocably dedicated to charitable purposes.
Treas. Reg. § 1.501(c)(3)-1(b)(4). The inurement and private benefit prohibition serves to
prevent the individuals who operate the charity from siphoning off any of a charity's income or
assets for personal use. If a charity's investments are decided in part by the needs of private
interests, this may indicate the charity may not be operated exclusively for exempt purposes.

Western Catholic Church v. Commissioner, 73 T.C. 196, 214 (1979).

A has not established that it primarily engages in activities that accomplish exempt
purposes. Moreover, a substantial part, if not all, of its activities appear to serve private
interests. A is operated as part of a tax avoidance scheme. Tax avoidance schemes do not
further an exempt purpose. Freedom Church of Revelation, 588 F. Supp 693, 696 (D.D.C.

1984).

A has not met the burden of showing that it operations and funds were primarily used
for charitable purposes and did not inure to private benefit of individuals (see Church of Gospel

Ministry v. United States, 640 F. Supp 96 (D DC 1986).

Therefore, based on the information, the A’s tax exempt status under section 501(c)(3)
of the Code should be revoked because it has not established that is operated exclusively for
tax-exempt purposes and or that its net earnings did not inure to the private benefit of the C
and D or private individuals.

CONCLUSION:
Accordingly, the A’s recognition as an organization described under section 501(c)(3)
should be revoked, effective September 28,20 . because it did not operate exclusively for
exempt purposes. Form 1041 U.S. Income Tax Return for Estates and Trusts should be filed
20

for tax years ending December 31,20 20 ,20:.,20 20: and December
Subsequent returns are due no later than the 15" day of the 4'" month following the close of

the trusts accounting period.
Returns should be sent to the following mailing address:

ISSUE #2
Should the A be reclassified as a private foundation?

LAW:
Page 14 of 25
Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A EXPLANATION OF ITEMS Schedule or

| Exhibit No.

| Part 14
Name of Taxpayer | Year Ended
A (B) | Year of Exam

income Tax Regulations section 1.509(a)-4(c) regarding the organizational test a

509(a)(3) organization must meet provides:

(1) in general. —An organization is organized exclusively for one or more of the purposes specified in
section 509(a)(3)(A) only if its articles of organization (as defined in §1.501(c)(3)-1(b)(2)):

(i) Limit the purposes of such organization to one or more of the purposes set forth in section

509(a)(3)(A),
(ii) Do not expressly empower the organization to engage in activities which are not in furtherance

of the purposes referred to in subdivision (i) of this subparagraph;
(iii) State the specified publicly supported organizations on whose behalf such organization is to

be operated (within the meaning of paragraph (d) of this section); and ;
(iv) Do not expressly empower the organization to operate to support or benefit any organization
other than the specified publicly supported organizations referred to in subdivision (iii) of this

subparagraph.
Income Tax Regulations section 1.509(a)-4(e) regarding the operational test a 509(a)(3)

organization must meet provides:

(1) Permissible beneficiaries. —A supporting organization will be regarded as “operated exclusively” to
support one or more specified publicly supported organizations (hereinafter referred to as the “operational
test”) only if it engages solely in activities which support or benefit the specified publicly supported
organizations. Such activities may include making payments to or for the use of, or providing services or
facilities for, individual members of the charitable class benefited by the specified publicly supported
organization. A supporting organization may also, for example, make a payment indirectly through another
unrelated organization to a member of a charitable class benefited by a specified publicly supported
organization, but only if such a payment constitutes a grant to an individual rather than a grant to an
organization. In determining whether a grant is indirectly to an individual rather than to an organization the
same standard shall be applied as in §53.4945-4(a)(4) of this chapter. Similarly, an organization will be
regarded as “operated exclusively” to support or benefit one or more specified publicly supported
organizations even if it supports or benefits an organization, other than a private foundation, which is
described in section 501(c)(3) and is operated, supervised, or controlled directly by or in connection with
such publicly supported organizations, or which is described in section 511(a)(2)(B). However, an
organization will not be regarded as operated exclusively if any part of its activities is in furtherance of a
purpose other than supporting or benefiting one or more specified publicly supported organizations.

(2) Permissible activities. —A supporting organization is not required to pay over its income to the publicly
supported organizations in order to meet the operational test. It may satisfy the test by using its income to
carry on an independent activity or program which supports or benefits the specified publicly supported
organizations. All such support must, however, be limited to permissible beneficiaries in accordance with
subparagraph (1) of this paragraph. The supporting organization may also engage in fund raising activities,
such as solicitations, fund raising dinners, and unrelated trade or business to raise funds for the publicly

supported organizations, or for the permissible beneficiaries.

Income Tax Regulations section 1.509(a)-4(f) regarding the nature of relationships
required for section 509(a)(3) organizations provides:

Page 15 of 25

Form 886-A

Department of the Treasury - Internal Revenue Service

| Schedule or
-£ ¢
Form 886-A EXPLANATION OF ITEMS Exhibit No.
| Part 1
Name of Taxpayer | Year Ended
A (B) | Year of Exam

(1) in general. —Section 509(a)(3)(B) describes the nature of the relationship required between é
section 501(c)(3) organization and one or more publicly supported organizations in order for such section
501(c)(3) organization to qualify under the provisions of section 509(a)(3). To meet the requirements of
section 509(a)(3), an organization must be operated, supervised, or controlled by or in connection with

one or more publicly supported organizations. If an organization does not stand in one of such
relationships (as provided in this paragraph) to one or more publicly supported organizations, it is not an

organization described in section 509(a)(3).

(2) Types of relationships. —Section 509(a)(3)(B) sets forth three different types of relationships, one
of which must be met in order to meet the requirements of subparagraph (1) of this paragraph. Thus, a

supporting organization may be:

(i) Operated, supervised, or controlled by,

(ii) Supervised or controlled in connection with, or
(iil) Operated in connection with, one or more publicly supported organizations.

(3) Requirements of relationships. —Although more than one type of relationship may exist in any one
case, any relationship described in section 509(a)(3)(B) must insure that:

(i!) The supporting organization will be responsive to the needs or demands of one or more publicly

supported organizations; and
(ii) The supporting organization will constitute an integral part of, or maintain a significant involvement
in, the operations of one or more publicly supported organizations.

(4) General description of relationships. —In the case of supporting organizations which are “operated,
supervised, or controlled by” one or more publicly supported organizations, the distinguishing feature of
this type of relationship is the presence of a substantial degree of direction by the publicly supported
organizations over the conduct of the supporting organization, as described in paragraph (g) of this
section. In the case of supporting organizations which are “supervised or controlled in connection with”
one or more publicly supported organizations, the distinguishing feature is the presence of common
supervision or control among the governing bodies of all organizations involved, such as the presence of
common directors, as described in paragraph (h) of this section. In the case of a supporting organization
which is “operated in connection with” one or more publicly supported organizations, the distinguishing
feature is that the supporting organization is responsive to, and significantly involved in the operations of,

the publicly supported organization, as described in paragraph (i) of this section.

Income Tax Regulations section 1.509(a)-4(g) provides guidance on the meaning of
“operated, supervised, or controlled by” as follows:

(1)
(i) Each of the items “operated by’, “supervised by”, and “controlled by”, as used in section
509(a)(3)(B), presupposes a substantial degree of direction over the policies, programs, and activities of a
supporting organization by one or more publicly supported organizations. The relationship required under
any one of these terms is comparable to that of a parent and subsidiary, where the subsidiary is under the
direction of, and accountable or responsible to, the parent organization. This relationship is established by
the fact that a majority of the officers, directors, or trustees of the supporting organization are appointed

Page 16 of 25
Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A EXPLANATION OF ITEMS | Schedule or
| Exhibit No.
_Part 1
Name of Taxpayer | Year Ended
A (8) | Year of Exam

or elected by the governing body, members of the governing body, officers acting in their official capacity,
or the membership of one or more publicly supported organizations.

(ii) A supporting organization may be “operated, supervised or controlled by” one or more publicly
supported organizations within the meaning of section 509(a)(3)(B) even though its governing body is not
comprised of representatives of the specified publicly supported organizations for whose benefit it is
operated within the meaning of section 509(a)(3)(A). A supporting organization may be “operated,
supervised, or controlled by" one or more publicly supported organizations (within the meaning of section
509(a)(3)(B)) and be operated “for the benefit of’ one or more different publicly supported organizations
(within the meaning of section 509(a)(3)(A)) only if it can be demonstrated that the purposes of the former

organizations are carried out by benefiting the latter organizations.

Income Tax Regulations section 1.509(a)-4(h) provides guidance on the meaning of
“supervised or controlled in connection with” as follows:

(1) In order for a supporting organization to be “supervised or controlled in connection with” one or more
publicly supported organizations, there must be common supervision or control by the persons supervising
or controlling both the supporting organization and the publicly supported organizations to insure that the
supporting organization will be responsive to the needs and requirements of the publicly supported
organizations. Therefore, in order to meet such requirement, the control or management of the supporting

organization must be vested in the same persons that control or manage the publicly supported

organizations.

(2) A supporting organization will not be considered to be “supervised or controlled in connection with”
one or more publicly supported organizations if such organization merely makes payments (mandatory or
discretionary) to one or more named publicly supported organizations, even if the obligation to make
payments to the named beneficiaries is enforceable under state law by such beneficiaries and the
supporting organization's governing instrument contains provisions whose effect is described in section
508(e)(1)(A) and (B). Such arrangements do not provide a sufficient “connection” between the payor
organization and the needs and requirements of the publicly supported organization to constitute
supervisions or control in connection with such organizations.

Income Tax Regulations section 1.509(a)-4(i) provides guidance on the meaning of
“operated in connection with” as follows:

(1) General rule
(i) Except as provided in subdivisions (ii) and (iii) of this subparagraph and subparagraph (4) of
this paragraph, a supporting organization will be considered as being operated in connection with one or

more publicly supported organizations only if it meets the “responsiveness test” which is defined in
subparagraph (2) of this paragraph and the “integral part test” which is defined in subparagraph (3) of this

paragraph.

(2) Responsiveness test
(i) For purposes of this paragraph, a supporting organization will be considered to meet the

“responsiveness test” if the organization is responsive to the needs or demands of the publicly supported
organizations within the meaning of this subparagraph. In order to meet this test, either subdivision (ii) or

subdivision (iil) of this subparagraph must be satisfied.

(ii)
Page 17 of 25
Form 886-A

Department of the Treasury - Internal Revenue Service

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

| Part 1
Name of Taxpayer | Year Ended
A (B) | Year of Exam

(a) One or more officers, directors, or trustees of the supporting organization are elected or
appointed by the officers, directors, trustees, or membership of the publicly supported

organizations;

(b) One or more members of the governing bodies of the publicly supported organizations are
also officers, directors or trustees of, or hold other important offices in, the supporting

organizations; or

(c) The officers, directors or trustees of the supporting organization maintain a close and
continuous working relationship with the officers, directors or trustees of the publicly supported

organizations; and

(d) By reason of (a), (b), or (c) of this subdivision, the officers, directors or trustees of the publicly
supported organizations have a significant voice in the investment policies of the supporting
organization, the timing of grants, the manner of making them, and the selection of recipients of
such supporting organization, and in otherwise directing the use of the income or assets of such

supporting organization.

(iii)
(a) The supporting organization is a charitable trust under State law:
(b) Each specified publicly supported organization is a named beneficiary under such charitable

trust's governing instrument; and
(c) The beneficiary organization has the power to enforce the trust and compel an accounting

under State law.

(3) integral part test; general rule
(i) For purposes of this paragraph, a supporting organization will be considered to meet the

“integral part test” if it maintains a significant involvement in the operations of one or more publicly
supported organizations and such publicly supported organizations are in turn dependent upon
the supporting organization for the type of support which it provides. In order to meet this test,
either subdivision (ii) or subdivision (iii) of this subparagraph must be satisfied.

(ii) The activities engaged in for or on behalf of the publicly supported organizations are activities
to perform the functions of, or to carry out the purposes of, such organizations, and, but for the
involvement of the supporting organization, would normally be engaged in by the publicly

supported organizations themselves.

(iii)
(a) The supporting organization makes payments of substantially all of its income to or for the use
of one or more publicly supported organizations, and the amount of support received by one or
more of such publicly supported organizations is sufficient to insure the attentiveness of such
organizations to the operations of the supporting organization. In addition, a substantial amount of
the total support of the supporting organization must go to those publicly supported organizations
which meet the attentiveness requirement of this subdivision with respect to such supporting
organization. Except as provided in (b) of this subdivision, the amount of support received by a
publicly supported organization must represent a sufficient part of the organization's total support
So as to insure such attentiveness. In applying the preceding sentence, if such supporting

organization makes payments to, or for the use of, a particular department or school of a
university, hospital or church, the total support of the department or school shall be substituted for

the total support of the beneficiary organization.
Page 18 of 25

Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A EXPLANATION OF ITEMS SONI Oh
| Exhibit No.
Part 1
Name of Taxpayer | Year Ended
A (B) | Year of Exam

(b) Even where the amount of support received by 4 publicly supported beneficiary organization
does not represent a sufficient part of the beneficiary organization's total support, the amount of
support received from a supporting organization may be sufficient to meet the requirements of
this subdivision if it can be demonstrated that in order to avoid the interruption of the carrying on
of a particular function or activity, the beneficiary organization will be sufficiently attentive to the
operations of the supporting organization. This may be the case where either the supporting
organization or the beneficiary organization earmarks the support received from the supporting
organization for a particular program or activity, even if such program or activity is not the
beneficiary organization's primary program or activity so long as such program or activity is a

substantial one.

(d) All pertinent factors, including the number of beneficiaries, the length and nature of the
relationship between the beneficiary and supporting organization and the purpose to which the
funds are put (as illustrated by subdivision (iii)(b) and (c) of this subparagraph), will be considered
in determining whether the amount of support received by a publicly supported beneficiary
organization is sufficient to insure the attentiveness of such organization to the operations of the
supporting organization. Normally the attentiveness of a beneficiary organization is motivated by
reason of the amounts received from the supporting organization. Thus, the more substantial the
amount involved, in terms of a percentage of the publicly supported organization's total support
the greater the likelihood that the required degree of attentiveness will be present. However, in
determining whether the amount received from the supporting organization is sufficient to insure
the attentiveness of the beneficiary organization to the operations of the supporting organization
(including attentiveness to the nature and yield of such supporting organization's investments),
evidence of actual attentiveness by the beneficiary organization is of almost equal importance. An
example of acceptable evidence of actual attentiveness is the imposition of a requirement that the
supporting organization furnish reports at least annually for taxable years beginning after
December 31, 1971, to the beneficiary organization to assist such beneficiary organization in
insuring that the supporting organization has invested its endowment in assets productive of a
reasonable rate of return (taking appreciation into account) and has not engaged in any activity
which would give rise to liability for a tax imposed under sections 4941, 4943, 4944, or 4945 if
such organization were a private foundation. The imposition of such requirement within 120 days
after October 16, 1972, will be deemed to have retroactive effect to January 1, 1970, for purposes
of determining whether a supporting organization has met the requirements of this subdivision for
its first two taxable years beginning after December 31, 1969. The imposition of such requirement
is, however, merely one of the factors in determining whether a supporting organization is
complying with this subdivision and the absence of such requirement will not preclude an
organization from classification as a supporting organization based on other factors.

(e) However, where none of the beneficiary organizations is dependent upon the supporting
organization for a sufficient amount of the beneficiary organization's support within the meaning
of this subdivision, the requirements of this subparagraph will not be satisfied, even though such
beneficiary organizations have enforceable rights against such organization under State law.

Revenue Ruling 76-32, 1976-1 C.B. 160, held, even though the reports are voluntarily submitted, so long
as the agreement is observed it will be considered evidence of actual attentiveness within the meaning of section
1.509(a)-4-(i)(3)(iii)(d) of the Regulations for purposes of determining whether the attentiveness requirement of
he integral part test of section 1.509(a)-4(i)(3)(iii) is satisfied. However, while the agreement will be considered
svidence of actual attentiveness under section 1.509(a)-4(i)(3)(iii)(d), it will not, in itself, satisfy the attentiveness

Page 19 of 25
Form 886-A

Department of the Treasury - Internal Revenue Service

. | Schedule or

• S
  Form 886-A EXPLANATION OF ITEMS _ Exhibit No.
  | Part 1
  Name of Taxpayer | Year Ended
  A (B) | Year of Exam

Rather, in order to satisfy that requirement, all

requirement of the integral part test of section 1.509(a)-4(i)(3) (iii).
ideration.

of the factors mentioned in the regulations must be taken into cons

Income Tax Regulations section 1.509(a)-4(j) regarding control by disqualified persons

provides:

(1) /n general. —Under the provisions of section 509(a)(3)(C) a supporting organization may not be
controlled directly or indirectly by one or more disqualified persons (as defined in section 4946) other than

foundation managers and other than one or more publicly supported organizations. If a person who is a
as a substantial contributor to the

disqualified person with respect to a supporting organization, such

supporting organization, is appointed or designated as a foundation manager of the supporting organization

by a publicly supported beneficiary organization to serve as the representative of such publicly supported
be regarded as a disqualified person,

organization, then for purposes of this Paragraph such person will

rather than as a representative of the publicly supported organization. An organization will be considered
“controlled”, for purposes of section 509(a)(3)(C), if the disqualified persons, by aggregating their votes or
positions of authority, may require such organization to perform any act which significantly affects its
performing such act. This includes, but is not limited to,

operations or may prevent such organization from

the right of any substantial contributor or his spouse to designate annually the recipients, from among the

publicly supported organizations of the income attributable to his contribution to the supporting organization.

Except as provided in subparagraph (2) of this paragraph, a supporting organization will be considered to be
€ disqualified persons if the voting power of such persons is 50

controlled directly or indirectly by one or mor
percent or more of the total voting power of the organization's governing body or if one or more of the total!

voting power of the organization's governing body or if one or more of such persons have the right to
exercise veto power over the actions of the organization. Thus, if the governing body of a foundation is
composed of five trustees, none of whom has a veto power over the actions of the foundation, and no more
than two trustees are at any time disqualified persons, such foundation will not be considered to be
controlled directly or indirectly by one or more disqualified persons by reason of this fact alone. However, all
pertinent facts and circumstances including the nature, diversity, and income yield of an organization's
holdings, the length of time particular stocks, securities, or other assets are retained, and its manner of
exercising its voting rights with respect to stocks in which members of its governing body also have some
interest, will be taken into consideration in determining whether a disqualified person does in fact indirectly

control an organization.

GOVERNMENT POSITION:
It is the government's position that the A’s tax exempt status should be revoked (Issue
ation.

1). In addition, it should be reclassified as a private found

Due to Congressional concerns about wide-spread abuses of their tax-exempt status by
drivate foundations, private foundations were defined and subjected to significant regulations
ind controls by the Tax Reform Act of 1969. The definition of a private foundation was
itentionally inclusive so that all organizations exempted from tax by section 501(c)(3) are
ivate foundations except for those specified in section 509(a)(1) through(4), Roe Foundation
‘haritable Trust v. Commissioner, T.C. Memo. 1989-566, 58 T.C.M. (CCH) 402, 404 (1989);
juarrie Charitable Fund v. Commissioner, 603 F.2d 1274, 1277 (7" Cir. 1979). A seeks to
scape private foundation status and its associated controls of Chapter 42 by fitting under

section 509(a)(3) which defines supporting organizations.

Page 20 of 26

Form 886-A

Jepartment of the Treasury - Internal Revenue Service

Form 886-A EXPLANATION OF ITEMS | Schedule or
| Exhibit No.
| Part 1
Name of Taxpayer Year Ended
A (B) | Year of Exam

Publicly supported organizations as defined in sections 509(a)(1) and (2) are excepted
from private foundation status on the theory that their exposure to public scrutiny and their
dependence on public support keep them from the abuses to which private foundations are
subject. Supporting organizations are similarly excepted from private foundation status.
Supporting organizations are excepted because Congress believed the public charities which
they support would provide sufficient oversight and keep supporting organizations from the
types of abuses to which private foundations are prone. Quarrie Charitable Fund, 603 F.2d at

1277-78.
IRC § 509(a)(3) organizations must meet all three of the following tests:

1) Organizational and Operational Tests under IRC § 509(a)(3)(A).

2) Relationship Test under IRC § 509(a)(3)(B).
3) Lack of Disqualified Person Control Test under IRC § 509(a)(3)(C).

Overall, these tests are meant to ensure that a supporting organization is responsive to the

needs of a public charity and intimately involved in its operations and that the public charity (or
publicly supported organization) is motivated to be attentive to the operations of the supporting
organization and that it is not controlled, directly or indirectly, by disqualified persons. None of

these tests were met by the A.

Organizational and Operational Test
A is not organized to benefit one or more specified publicly supported organizations.

Pursuant to Treas. Reg. § 1.509(a)-4(c)(1)(iii) and (iv), an organization’s governing instrument
must state the specified publicly supported organization(s) on whose behalf the organization is
to be operated and cannot expressly empower the organization to support or benefit any
organizations other than the specified publicly supported organizations(s). A dissolution
clause allows distributions to organizations other than the specified publicly supported
organizations upon termination of the A. The possible beneficiaries are not limited to the M or
to the organizations specified on Schedule A. Therefore, the organizational test is not met.
See Quarrie Charitable Fund v. Commissioner, 603 F.2d 1274 (7" Cir. 1979) (the court held
the organizational test was not satisfied where the trustee had the power to determine the
charitable use was unnecessary or impracticable and to distribute the income to any charitable

corporation he selected).

In addition, the operational test set forth in Treas. Reg. § 1.509(a)-4(e)(1) is not
satisfied. A supporting organization will be regarded as “operated exclusively” to support a
specified publicly supported organization(s) only if it engages in activities which support or
benefit the specified publicly supported organizations(s). As was discussed under Issue
iumber 1 above, the A has served private interests by making expenditures for dance lessons

Paae 21 of 25

Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A EXPLANATION OF ITEMS Schedule or

| Exhibit No.

| Part 1
Name of Taxpayer | Year Ended
A (B) | Year of Exam

of specific individuals and other expenditures that have not been shown to serve charitable
interests. In addition, the funds of the A has inured to the benefit of C via the payment of $
( ‘check XXX) and$ . (check XXX) during 20 Also, the A has not provided
evidence that the reported asset of $. still exists for charitable purposes. Therefore,

the A has not established that it operates exclusively for the benefit of the publicly supported

organization(s).

Relationship Test

As set forth in Treas. Reg. § 1.509(a)-4(f)(2), there are three permissible relationships:
(a) operated, supervised, or controlled by; (b) supervised or controlled in connection with; and
(c) operated in connection with one or more publicly supported organizations.

The relationships “operated, supervised or controlled by” and “supervised or controlled
in connection with’ presuppose a substantial degree of direction over the policies, programs
and activities of the supporting organization by a publicly supported organization. The
“operated, supervised or controlled by” relationship is established by the fact that a majority of
the officers, directors, or trustees of the supporting organization are appointed or elected by
the governing body, members of the governing body, officers acting in their official capacity or

the membership of the publicly supported organization. The “supervised or controlled in
connection with” relationship is established by the fact that there is common supervision or
control by the persons supervising or controlling both the supporting and the publicly supported

organizations, i.e., that control or management of the supporting organization is vested in the
same persons that control or manage the publicly supported organization.

In the present case, the majority of the A’s governance was not appointed or elected by
the specified publicly supported organization. Furthermore, there was no common supervision
or control by the same persons over the A and the specified publicly supported charity.
Accordingly, the facts indicate that there was no substantial control or direction over the
policies or activities of the A by the supported organization. In fact, the majority of the
members of the governing body (Board or Trustees) consisted of the C and D and their
financial advisor R. A has not shown that the purported board member(s) from the primary
charity (supported organization) attended any board meetings or participated in the investment

decisions of the A.

Thus, the requirements to be one of the first two types of relationships; i.e. supervised or
controlled by and supervised and controlled in connection with relationships, are not met.

The 3 and final relationship possible for section 509(a)(3) organizations is the
“operated in connection with” relationship which requires that the supporting organization be
responsive to the needs or demands of the publicly supported organization and constitute an
integral part of, or maintain a significant involvement in the affairs of the publicly supported

Page 22 of 25
Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A EXPLANATION OF ITEMS Schedule or

| Exhibit No.

| Part 1
Name of Taxpayer | Year Ended
A (B) | Year of Exam

organization. This relationship is satisfied where the supporting organization meets both the
“responsiveness” and “integral part” tests. The integral part test has not been met in this case.

While the responsiveness test guarantees that the publicly supported organization can
influence the activities of the supporting organization, the integral part test ensures that the
publicly supported organization will be motivated to attend to the operations of the supporting
organization. The integral part test is considered to have been satisfied if the supporting
organization maintains a significant involvement in the operations of one or more publicly
supported organizations and the publicly supported organizations are in turn dependent upon
the supporting organization for the type of support which it provides. Treas. Reg § 1.509(a)-
4(i)(3)(i). In order to meet the integral part test, either Treas. Reg. § 1.509-4(i)(3)(ii) or (iii)

must be satisfied.

Treas. Reg. § 1.509(a)-4(i)(3)(ii) provides that the activities engaged in for or on behalf
of the publicly supported organizations must be activities to perform the functions of, or to carry
out the purposes of, such organizations and, but for, the involvement of the supporting
organization, would normally be engaged in by the publicly supported organizations
themselves. Thus, this part of the integral part test applies in those situations in which the
supporting organization actually engages in activities which benefit the publicly supported
organizations as opposed to simply making grants to support the publicly supported
organizations. See Roe Foundation, 58 T.C.M. at 408; Cuddeback Foundation v.
Commissioner, T.C. Memo. 2002-300. A does not meet this test because it does not perform

any activities the publicly supported organization conduct themselves.

Treas. Reg. § 1.509(a)-4(i)(3)(iii) has 3 basic requirements and they are: 1) payment of
substantially all of its income to publicly supported organizations; 2) the amount received by
one publicly supported organization must be sufficient to motivate it to pay attention to the
operations of the supporting organization; and 3) a substantial amount of the total support of
the organization must go to those publicly supported organizations that meet the attentiveness

requirement.
In the present situation, the first requirement is not met. There was -0- reported income

(not including contributions from the C and D) so, technically, there was -0- required
distributions (Note, the A did not report any interest income earned despite the reported
"in Savings & Temporary Cash Investments). Therefore, there was no requirement

$.
per the A’s Declaration of Trust to distribute any income to any named supported
20 .and20- but

organizations, however the A did make payments to K and M during 26
it appears these payments were made for the dance instruction of specific individuals which

serves a private and personal purpose rather than a charitable purpose. In addition, the A
made distributions to organizations during 20 __ that are not specifically named supported

organizations in the A Declaration of Trust. Some of these organizations that received
Page 23 of 25

Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A EXPLANATION OF ITEMS Schedule or

| Exhibit No.

| Part 1
Name of Taxpayer | Year Ended
A(B | Year of Exam

distributions do not appear to be organizations described in IRC 509(a)(3) nor IRC 501(c)(3).
Therefore, requirement number 1 of the Attentiveness test is not met. A has not provided any
evidence to show that the supported organization(s) were attentive or involved with the
operations and investment decisions of the A and, therefore, it has not proven that it has met

the second and third requirement of the Attentiveness test.

Treas. Reg. § 1.509(a)-4(i)(3)(iii)(a) provides that the amount of support received by a
publicly supported organization must represent a sufficient part of the organizations total
support so as to insure such attentiveness. As a rule of thumb, an organization that supplies
less than 10 percent of the publicly supported organization’s total support would, in the usual
case, be insufficient to insure the publicly supported organization's attentiveness. Treas. Reg.
§ 1.509(a)-4(i)(3)(iii)(b) provides that a supporting organization can meet the attentiveness
requirement, even where the amount of support received by the publicly supported
organization does not represent a sufficient part of the publicly supported organization’s total
support, if it can be demonstrated that support is earmarked for a substantial program of the
publicly supported organization that would be interrupted without the supporting organization’s
support. And finally, Treas. Reg. § 1.509(a)-4(i)(3)(d) provides that “all pertinent factors. . .
will be considered in determining whether the amount of support received by a publicly
supported organization is sufficient to insure the attentiveness of such organization to the
operations of the supporting organization. It goes on to note the importance of the percentage
of the income received from the supporting organization is in determining if the publicly
supported organization will have the requisite degree of attentiveness and concludes that

evidence of actual attentiveness is almost as important.

Control Test
Internal Revenue Code § 509(a)(3)(C) and Treas. Reg. § 1.509(a)-4(j)(1) provides that
a supporting organization may not be controlled, directly or indirectly by disqualified persons.
Treas. Reg. § 1.509(a)-4(j)(1) provides that for purposes of section 509(a)(3)(C), an
organization will be considered “controlled” if the person, by reason of his position or authority,
may require the organization to perform any act which significantly affects its operations or
prevents such organization from performing such act. All facts and circumstances are taken
into consideration in determining whether a disqualified person controls an organization. Id.

As founders, substantial contributors, and officers of the A, C and D are disqualified persons.
Although three other individuals were listed as board members, there is no evidence indicating
that these other board members were involved in any way with the investment policies and
activities of the A. In addition, if the board consists of four members, C and D would have veto

power over actions proposed by the board because they would have % of the votes.

CONCLUSION:

Page 24 of 25

Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A EXPLANATION OF ITEMS | Schedule or

| Exhibit No.

| Part 1
Name of Taxpayer | Year Ended
A (B) | Year of Exam

Therefore, A should be reclassified as an organization that is a private foundation

defined in section 509(a). A cannot be classified as a supporting organization because it has

not established that it has met the requirements set forth in Treas. Reg. § 1.509(a)-4(c)

through (j). This determination is effective beginning January 1, 2000. Form 990 PF Return
20

of Private Foundation should be filed for tax years ending December 20! = 20.
20 20 — and December 20: Subsequent returns are due no later than the 15" day of

the 5" month following the close of the foundation’s accounting period.

Send your returns to the following mailing address:

Note:
‘1. 990 PF is required for each tax year until Private Foundation status is terminated under

Page 25 of 25
Form 886-A

Department of the Treasury - Internal Revenue Service