IRS denies exemption to a fee-based paratransit organization

Plain-English summary

The IRS issued a final adverse determination denying section 501(c)(3) exemption to an organization that planned to provide paratransit services for elderly and disabled people through healthcare organizations and institutions. The organization’s proposed rates were based on passenger, mileage, and waiting fees, and it expected to rely on service fees rather than contributions. The IRS concluded that the organization did not directly serve a charitable class, had not shown that its rates were below cost or based on riders’ ability to pay, and operated in a commercial manner. The determination also stated that contributions to the organization were not deductible under section 170.

Ruling snapshot

• Question: Did the fee-based paratransit organization operate exclusively for charitable purposes under section 501(c)(3)?
• Outcome: Denied
• Key authorities: IRC §§ 501(c)(3), 170, 6104(c), 6110, and 7428(b)(2); Treas. Reg. §§ 1.501(c)(3)-1(a)(1), 1.501(c)(3)-1(c)(1), and 1.501(c)(3)-1(d)(2); Rev. Ruls. 72-124, 76-244, and 77-246; Rev. Proc. 2010-9

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Release Number: 201041045 Contact Person:
Release Date: 10/15/10
Date: 7/19/10 Identification Number:
UIL Code: 501.35-00

504.50-00 Contact Number:

Employer Identification Number:
Form Required To Be Filed:

Tax Years:
All

Dear

This is our final determination that you do not qualify for exemption from Federal income tax as
an organization described in Internal Revenue Code section 501(c)(3). Recently, we sent you a
letter in response to your application that proposed an adverse determination. The letter
explained the facts, law and rationale, and gave you 30 days to file a protest. Since we did not
receive a protest within the requisite 30 days, the proposed adverse determination is now final.

Since you do not qualify for exemption as an organization described in Code section 501(c)(3),
donors may not deduct contributions to you under Code section 170. You must file Federal
income tax returns on the form and for the years listed above within 30 days of this letter, unless
you request an extension of time to file.

We will make this letter and our proposed adverse determination letter available for public
inspection under Code section 6110, after deleting certain identifying information. Please read
the enclosed Notice 437, Notice of Intention to Disclose, and review the two attached letters that
show our proposed deletions. If you disagree with our proposed deletions, you should follow
the instructions in Notice 437. If you agree with our deletions, you do not need to take any
further action.

In accordance with Code section 6104(c), we will notify the appropriate State officials of our
determination by sending them a copy of this final letter and the proposed adverse letter. You
should contact your State officials if you have any questions about how this determination may
affect your State responsibilities and requirements.

Letter 4038(CG) (11-2005)
Catalog Number 47632S

2

If you have any questions about this letter, please contact the person whose name and
telephone number are shown in the heading of this letter. If you have any questions about your
Federal income tax status and responsibilities, please contact IRS Customer Service at
1-800-829-1040 or the IRS Customer Service number for businesses, 1-800-829-4933. The
IRS Customer Service number for people with hearing impairments is 1-800-829-4059.

Sincerely,

Rob Choi
Director, Exempt Organizations
Rulings & Agreements

Enclosure
Notice 437
Redacted Proposed Adverse Determination Letter
Redacted Final Adverse Determination Letter

Letter 4038(CG) (11-2005)
Catalog Number 476328

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION
Date: July 3, 2007 Contact Person:
Identification Number:
Contact Number:
FAX Number:
Employer Identification Number:
Legend: UIL Codes: 501.35-00
A= Date of Incorporation 504.50-00

B= State of Incorporation
C = Date of Amended Articles of Incorporation

Dear

We have considered your application for recognition of exemption from Federal income tax
under Internal Revenue Code section 501(a) and your protest. Based on the information
provided, we have concluded that you do not qualify for exemption under Code section
501(c)(3). The basis for our conclusion is set forth below. This letter supersedes our letter
dated July 6, 2009.

ISSUE
Do you qualify for exemption under section 501(c)(3) of the Code?
FACTS

You were incorporated in the B on date A. Your Articles of Incorporation initially stated that you
provide ambulances and wheel chair vans to organizations that provide transportation services
to the elderly and handicapped. Your Articles of Incorporation were amended on date C to state
that you are organized exclusively for charitable, religious, educational and scientific purposes.

Although you were incorporated on date A, you were not operational in the first two years of
your formation.

You state that you will work with organizations to develop a comprehensive, coordinated and
accessible system of transportation responsive to the needs of the aging population within the
community and institutional setting. Your purpose as stated on Forms 990 is to provide safe
and low cost transportation to the general public.

You state, “Each program has a scope of practice and these vary widely. Actual pricing will be
determined as we examine each program’s requirements. ... Since these programs are all very
mature, the administrators have a history of data for comparison.”

Your staff will meet the necessary qualifications to transport elderly and disabled persons. They
will receive training in cardio pulmonary resuscitation. They must have completed an
emergency vehicle operators course and pass a Federal Commercial Drivers License
equivalency test. You will conduct criminal background checks and motor vehicle driving record
checks on all employees. Drivers must also undergo physical, drug and alcohol screening as
well. You will provide tuition assistance to your employees.

Your financial support will come from the organizations that hire you to provide paratransit
services to their clients. Your rates will be $ per passenger per one-way transport plus $
per loaded mile for every mile after six miles. You will also charge a Waiting Fee of $
per hour or fraction thereof. Your expenditures include wages for drivers, support staff,
fuel, insurance, and continuing education and tuition assistance expenses.

LAW:

Section 501(c)(3) of the Code provides for the exemption from Federal income tax of
organizations organized and operated exclusively for charitable purposes.

Section 1.501(c)(3)-1(a)(1) of the Income Tax Regulations states that, in order to be exempt as
an organization described in section 501(c)(3) of the Code, 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.

Section 1.501(c)(3)-1(c)(1) of the regulations provides that an organization will be regarded as
“operated exclusively” for one or more exempt purposes only if it engages primarily in activities
that 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.

Section 1.501(c)(3)-1(d)(2) of the regulations provides that the term ‘charitable’ is used in
section 501(c)(3) of the Code in its generally accepted legal sense. Such term includes relief of
the distressed.

Revenue Ruling 72-124, 1972-1 C.B. 145, describes an organization that operated a home for
the elderly. It qualified for exemption under 501(c)(3) as a charitable organization because it
met the special needs of the elderly for housing, healthcare and financial security.

Revenue Ruling 76-244, 1976-1 C.B. 155, describes a charitable organization that provided
home delivered meals to elderly and disabled persons. Volunteers delivered the meals. A
nominal fee that was insufficient to cover the costs of the meals and delivery was charged. In
some cases, no fees were charged depending on the recipients’ abilities to pay. The
organization qualified for exemption under section 501(c)(3) of the Code.

Revenue Ruling 77-246, 1977-2 C.B. 190, describes an organization that was formed to provide
low cost bus transportation for senior citizens and disabled persons in a community where
public transportation was unavailable or inadequate. Although the organization charged a
nominal fee, it was dependent upon contributions and Federal and local governmental grants in
order to meet its operating expenses. The organization qualified for exemption under section
501(c)(3) of the Code.

B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352, 356-7 (1978), describes an organization
whose sole activity was to provide consulting services for a fee to nonprofit organizations. It
provided qualified persons to perform research projects for its clients. The fees charged by the
organization were set at or close to cost but were not less than the organization’s full cost of
providing its service. The organization was denied exemption because it operated in a
commercial, nonexempt manner. The provision of managerial and consulting services on a
regular basis for a fee is a trade or business ordinarily carried on for profit. The Court held that
the organization was not operated exclusively for charitable, educational or scientific purposes
within the meaning of section 501(c)(3) of the Code.

APPLICATION OF LAW:

You are not described in section 501(c)(3) because you are not organized and operated
exclusively for charitable, educational or religious purposes.

You do not comply with section 1.501(c)(3)-1(a)(1) of the regulations because you are not
organized or operated exclusively for one or more exempt purposes.

You are not described in section 1.501(c)(3)-1(c)(1) of the regulations because more than an
insubstantial part of your activities is devoted to non-exempt purposes. The provision of
paratransit or transportation services is not a charitable, educational or religious activity within
the meaning of section 501(c)(3) of the Code. You have not demonstrated that the services you
provide are offered in a noncommercial manner. You have not demonstrated that your fees for
service arrangement are distinguishable from those of your commercial counterpart.

You are not described in section 1.501(c)(3)-1(d)(2) of the regulations because you do not
directly provide services to a charitable class. Your clientele consists of healthcare
organizations and institutions that hire you to provide paratransit for their clients.

You are not like the organization described in Revenue Ruling 72-124. Although you require
special training of your drivers to meet the physical needs of your riders, you do not meet other
special needs, such as financial security, of the elderly and the disabled. You are contracted for
services by organizations, institutions and publicly funded programs that provide services to
elderly and disabled persons. You are not providing your services directly to the elderly and
disabled; therefore, you do not consider their ability to pay. Payments are expected from the
health care organizations or institutions, which hire you. You charge the rate of $ per
passenger, one way. In addition, you charge $ for every mile after the first six miles and a
waiting fee of $ per hour. You have no provisions for basing your fees on the rider’s ability
to pay.

You are not like the organization described in Revenue Ruling 76-244. You are dependent on
the service fees you bill your clientele in order to operate. Your fees cannot be described as
nominal. No provision has been made for those riders, who are unable to pay. You operate in a
commercial manner like any transportation service. You determine your costs and set your
fees to meet your financial obligations.

You are not like the organization described in Revenue Ruling 77-246 because the rates you
plan to charge organizations and institutions are not below cost. You do not take into
consideration the riders’ ability to pay. Furthermore, you do not charge the riders; you bill the
organizations that hire you to provide transportation services. You are dependent on the
transportation fees you charge to cover your expenses. The majority of your expenses are
salaries and wages.

You are similar to the organization described in the B.S.W. Group, supra. Your sole purpose is
to provide transportation services for your clients that request non-emergency transportation for
their clients. You are dependent solely on the fees you charge to operate. The provision of
transportation services on a regular basis for a fee is a trade or business ordinarily carried on for
profit. The fees you charge lack the donative element necessary to establish your activities as
charitable. Your fees are also set above cost in order to allow for the tuition assistance program
you offer your employees. You do not qualify for exemption because you operate in a
commercial manner rather than exclusively for charitable purposes.

APPLICANT’S POSITION:

You state that you have considered many pricing situations and the ability of riders to pay. You
state that you would provide a sliding fee schedule if necessary.

In response to our request for additional information, your officer states, “I am not aware that we
have supplied you with any such information. The Public Utilities Commission (PUC) requires
that paratransit services submit maximum rates for approval. The rates provided in our April

letter are those rates.”

You subsequent state that you will offer discounts from the PUC rates for private pay situations
and will be based on the specific needs of the individuals. Your rates charged to organizations
will be determined based on each organization’s requirements and the level of services they are
requiring. You state, “It is typical to supply a ‘cost build up’ analysis for each request for
proposal.”

SERVICE RESPONSE TO APPLICANT’S POSITION:

Although you state that you have considered many pricing situations and the ability of riders to
pay, you have not substantiated your claim. You have not provided a sliding scale fee schedule
to demonstrate that your fee is based on the ability to pay of the riders. You have not

demonstrated that you do not operate in a commercial manner. There is no evidence that your
transportation rates are below cost. Furthermore, you have not demonstrated that your rates
address the financial needs of your riders, including the elderly and the disabled.

Your riders are not your direct customers; therefore, you do not have an obligation to provide
them a below-market rate. Your direct customers are the organizations that hire you for the
provision of transportation to their clients.

You state you will offer discounts for private pay situations based on the specific needs of the
individuals. However, you have not submitted data to substantiate the determination of ability to
pay of your riders.

You rely solely on fees for transportation services you provide to health care organizations and
institutions, which are your direct clients. You do not directly charge the elderly and disabled
persons for the services you provide; therefore, you do not consider the riders’ abilities to pay.
The fact that you intend to provide tuition assistance to your employees indicates that your fees
are set above your operating costs.

CONCLUSION:

Based on the information provided, you do not qualify for exemption under section 501(c)(3) of
the Code. You are not organized and operated exclusively for charitable purposes within the
meaning of section 501(c)(3) of the Code because you operate in a commercial manner. You
have not demonstrated that you directly serve a charitable class nor have you demonstrated
that the rates you charge meet the financial needs of the charitable class.

You have the right to file a protest if you believe this determination is incorrect. To protest, you
must submit a statement of your views and fully explain your reasoning. You must submit the
statement, signed by one of your officers, within 30 days from the date of this letter. We will
consider your statement and decide if the information affects our determination. If your
statement does not provide a basis to reconsider our determination, we will forward your case to
our Appeals Office. You can find more information about the role of the Appeals Office in
Publication 892, Exempt Organization Appeal Procedures for Unagreed Issues.

An attorney, certified public accountant, or an individual enrolled to practice before the Internal
Revenue Service may represent you during the appeal process. If you want representation
during the appeal process, you must file a proper power of attorney, Form 2848, Power of
Attorney and Declaration of Representative, if you have not already done so. You can find more
information about representation in Publication 947, Practice Before the IRS and Power of
Attorney. All forms and publications mentioned in this letter can be found at www.irs.gov, Forms
and Publications.

If you do not file a protest within 30 days, you will not be able to file a suit for declaratory
judgment in court because the Internal Revenue Service (IRS) will consider the failure to appeal
as a failure to exhaust available administrative remedies. Code section 7428(b)(2) provides, in
part, that a declaratory judgment or decree shall not be issued in any proceeding unless the Tax
Court, the United States Court of Federal Claims, or the District Court of the United States for
the District of Columbia determines that the organization involved has exhausted all of the
administrative remedies available to it within the IRS.

If you do not intend to protest this determination, you do not need to take any further action. If
we do not hear from you within 30 days, we will issue a final adverse determination letter. That
letter will provide information about filing tax returns and other matters.

Please send your protest statement, Form 2848, and any supporting documents to the
applicable address:

Mail to: Deliver to:
Internal Revenue Service Internal Revenue Service
EO Determinations Quality Assurance EO Determinations Quality Assurance
Room 7-008 550 Main Street, Room 7-008
P.O. Box 2508 Cincinnati, OH 45202

Cincinnati, OH 45201

You may fax your statement using the fax number shown in the heading of this letter. If you fax
your statement, please call the person identified in the heading of this letter to confirm that he or
she received your fax.

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

Sincerely,
Robert Choi
Director, Exempt Organizations

Rulings & Agreements

Enclosure:
Publication 892