Determination 1040034: IRS revokes a fraternal organization's exemption

Plain-English summary

The IRS revoked an organization's exemption under IRC § 501(c)(10), effective September 1, 20XX. The organization operated a bar and claimed to be a subordinate of a fraternal parent organization, but the IRS found no common bond among members, no lodge-system features, and no rituals, ceremonies, or regalia. The organization was open to the public to recruit members, and the IRS concluded that its primary activity was commercial operation of the bar rather than an exempt fraternal purpose. The organization was required to file Form 1120 for tax periods ending on and after June 30, 20XX.

Ruling snapshot

• Question: Was the organization operated exclusively for exempt purposes under IRC § 501(c)(10)?
• Outcome: Revocation
• Key authorities: IRC §§ 501(c)(8) and 501(c)(10); Treas. Reg. § 1.501(c)(10)-1

Full text (IRS public release)

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 MAR 01 2010
Number: 201040034 Taxpayer Identification Number
Release Date: 10/8/2010
Form:
ORG
ADDRESS Tax Year(s) Ended:
Person to Contact/ID Number:
Contact Numbers:
Telephone:
UIL: 501.10-00 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
Name of Taxpayer Year/Period
ORG Ended
EIN: EIN June 30, 20XX
LEGEND
ORG = Organization name XX = Date EIN = EIN City = city
State = state President = president BM-1 = 1st BM CO-1 = 1st CO
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 EIN, was
incorporated on September 20, 20XX. ORG was recognized as an organization
exempt from federal income tax as described in IRC Section 501(c)(10) under the
group ruling number 9470. ORG maintained liquor license to sell liquor by the drink
for a tax exempt entity.

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 created by President. Several customers asked about the bar being open
on Sunday prior to the organization becoming ORG. As an S-corporation the bar
could not be open on Sunday. In the state of State, only an exempt organization is
allowed to be open on Sunday. Therefore, the organization contacted the CO-1 in
City, State, and inquired about information on how to become a ORG subordinate.
President received an information packet which included basic information on how to
form a corporation and applications to apply for a ORG subordinate. The
organization became a ORG subordinate in September 20XX.

The parent organization's Constitution and Bylaws state that ORG 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

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

Name of Taxpayer Year/Period

ORG Ended

EIN: EIN June 30, 20XX

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 ORG’s subordinate are as follows:

1. 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.

2. Donate $$ to other approved non-profit entities. All donations must be verified
   by providing the CO-1 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.

3. Conduct monthly meeting

Article III, part 4 of the Articles of Incorporation states that, each ORG USA
post/lodge will be committed to contribute $$ each year to charity(s) of the post/lodge
choice. These charities may be within the post’s own community. Verification of
donations must be submitted to the CO-1 monthly to be placed in each post/lodge
file. During the year under the examination, ORG had benefits for local charities by
having fundraising events and participating in a Food Drive.

Since President's inception with the ORG, his business has been able to be open on
Sunday, because of his organization’s exemption from Federal income tax under IRC
501(c)(10) as a subordinate ORG. From September of 20XX to August 20XX, ORG
was open to the general public to recruit new members. Currently, the organization
has a 3 visit maximum policy. Guest can come to the bar 3 times then must apply for
membership. During the course of the examination, the organization posted a sign in
the organization that stated restricted to members only. The organization did this to
be exempt from state sales tax, because ORG is not recognized as an exempt
organization with the State Department of Revenue.

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

Name of Taxpayer Year/Period

ORG Ended

EIN: EIN June 30, 20XX

The organization must be restricted to members only in order to be exempt from
sales tax.

There is a complete lack of regalia or memorabilia specific to the ORG either inside
or outside the organization. The organization is devoid of any rites or rituals specific
to the ORG culture when the meetings are held or when new members are recruited.
Any individual who pays the $$ for membership can join the organization. There is
no common bond among interest and demonstrated in the open membership. ORG
has only one class of membership and there are approximately 100 members.

LAW

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

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

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

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

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

Name of Taxpayer Year/Period

ORG Ended

EIN: EIN June 30, 20XX

either the fraternal features or the insurance features predominate so long as both
features are present.

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

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

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

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

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

Name of Taxpayer Year/Period

ORG Ended

EIN: EIN June 30, 20XX

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’s 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 fraternal purposes. The
current officer, BM-1, created ORG and purchased the facility with the intent to profit
on the investment. 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 annual membership
dues are paid by ORG, not the members. 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
officer is not selected or elected by the membership.

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

ORG Ended

EIN: EIN June 30, 20XX

During the year under audit, although ORG had a fundraising to raise money to help
local charities, that does not continue to qualify ORG for exemption 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 September 1, 20XX.

Forms 1120 should be filed for the tax periods ending on and after June 30, 20XX.

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