IRS denies section 501(c)(3) exemption to a reciprocal service exchange

Plain-English summary

The IRS issued a final adverse determination denying exemption under IRC § 501(c)(3) to an organization that coordinated reciprocal exchanges of personal services among members. The organization used service credits, a membership directory, and a database to match members who provided and received services. The IRS concluded that the organization was organized and operated primarily for the private benefit of its members rather than for the general public, and that its purposes and dissolution clause also failed the organizational test. Because the organization did not qualify for exemption, donors could not deduct contributions under § 170, and the organization was required to file the listed federal income tax returns.

Ruling snapshot

• Question: Did the reciprocal service exchange satisfy the organizational and operational requirements for exemption 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(b)(1)(i), 1.501(c)(3)-1(b)(4), 1.501(c)(3)-1(c)(1), and 1.501(c)(3)-1(d)(1)(ii); Rev. Ruls. 61-170, 69-175, and 78-132

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Release Number: 201041048 Contact Person:
Release Date: 10/15/10
Date: 5/19/10 Identification Number:
UIL Code: 501.03-30
501.33-00 Contact Number:
501.35-00
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

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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 47632S

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

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Date: May 20, 2010 Contact Person:
Identification Number:
Contact Number:
FAX Number:

Employer Identification Number:

LEGEND: UIL #’s:

A = State of Incorporation 501.03-30
B = Date of Incorporation 501.33-00
C = Name of Organization 501.35-00

D = Applicant’s County

Dear

We have considered your application for recognition of exemption from Federal income tax
under Internal Revenue Code section 501(a). 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.

Issue 1:

Do you, C, pass the organizational test of section 501(c)(3) of the Internal Revenue Code?

Issue 2:

Do you, C, pass the operational test of section 501(c)(3) of the Internal Revenue Code?

Facts:

You, C, were incorporated under the laws of the State of A on date B. Your Articles of
Incorporation provides, in part, that your purposes are the following:

C is an all-ages, skills-sharing program. Our mission is to create caring community, value
every individual equally, and share our time, our services and community.

The Bylaws, Articles 2.2 and 2.1 state, in part, respectively:

C is a charitable organization as defined by Section 501c3 of the Internal Revenue Code, or
correspondence section of any future code.

In the event of dissolution of this organization, and after discharge of all its liabilities, the
remaining assets shall be given to a non-profit organization which qualifies for tax exempt
status under Section 501c3 of the Internal Revenue Code...Such organization shall have as
its purpose a purpose similar to or consistent with C.

Your Bylaws state that application for membership is open to any community member in the D
area and surrounding towns. Your membership application gathers basic personal
information plus requests the prospective members to indicate five services they would be
willing to provide to existing members as well as five services they wish to receive from existing
members. Each membership application is processed by the coordinator, whose duties will be
further described below. The coordinator meets with each prospective member to clarify any
issues that need clarifying and conducts an orientation for the new member. Results of a
background check would be the determining factor in denying membership. You state that no
applicant has been turned down to date and that you currently have about 0 members. An
effort is made by the coordinator to connect each new member immediately with someone who
can provide a service that the new members want. You state that no voting rights are afforded
to members but members may address issues by contacting your coordinator or any board
member. Your Bylaws state that all members are invited to attend the annual meeting but are
silent on whether members can vote on any matters discussed at the annual meeting.

Your Form 1023 indicates that you provide services to members. You coordinate various
services amongst your members based on the needs of your members. Members may conduct
services on personal property or at other arranged locations. Examples of services exchanged
between members are transportation, minor home repair, raking, snow shoveling, tutoring,
massage, data entry, helping with a move, computer assistance, cooking, yard work, mending,
painting, teaching a class, making phone calls, meal preparation and various others. Services
are exchanged between members on a volunteer basis and are based on a time sharing
program. One hour of exchange service performed equals one hour of exchange service to be
received. Members may deem it necessary to cover overhead and other miscellaneous
expenses incurred from any services rendered to other members. For example, the receiver of a
service will voluntarily offer to pay the provider for gas, but not to pay for the transportation
service itself.

Your flyer also states, “C is a network of people who help each other while earning credits
towards services for themselves. Once you are a member, for every hour of service you provide
to another member, you earn one “share” which is “banked”, or credited to your account on the
C computer. The account of the person who received the service is debited. Then each of you
continue to earn or spend with other members. An hour of service is equal to an hour of
service.”

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In your response to our information request you stated that members will be the primary
beneficiaries of all services rendered. You occasionally participate in community wide activities
that may involve your members and other members of your community. You further stated that
members can refer and network amongst each other and can access information about services
provided by other members via a membership directory. The membership directory lists all
services that members can provide to existing members. You indicated that you will conduct
quarterly potluck dinners to provide members with the opportunity to interact with each other
and arrange for the reciprocal exchange of member services. You maintain a database that
tracks credit hours earned for the reciprocal exchange of services amongst your members.
Members may log into their accounts to update and view records and account for services
rendered to and received from other members.

Your response further indicated that the majority of your financial resources were spent on
hiring a consultant to act as your coordinator. Duties of the coordinator include processing
membership applications, helping members make connections where necessary and being
responsible for infrastructure tasks such as financial management, data entry, reports,
fundraising, membership recruitment, public relations and community networking among
organizations.

You do not have membership fees. You are supported by gifts, grants and contributions from
the general public. Your expenses are used for fundraising, miscellaneous expenses and
professional fees. Professional fees account for over % of your budget and will be paid to a
consultant who will act as the coordinator. You state that the hired consultant is a professional
social worker. You state that you would hire the consultant for more time if there is more
income.

Law:

Section 501(c)(3) of the Code provides, in part, for the exemption from Federal income tax of
organizations organized and operated exclusively for charitable, religious or educational
purposes, no part of the net earnings of which inures to the benefit of any private shareholder or
individual.

Section 1.501(c)(3)-1(a)(1) of the Regulations states that in order to qualify under section
501(c)(3) of the Code, an organization must be both organized and operated exclusively for one
or more exempt purposes. If an organization fails to meet either the organizational or
operational test, it is not exempt.

Section 1.501(c)(3)-1(b)(1)(i) of the Regulations states that an organization is organized
exclusively for one or more exempt purposes only if its articles of organization:

(a) Limit the purposes of such organization to one or more exempt purposes; and

(b) Do not expressly empower the organization to engage otherwise than as an insubstantial
part of its activities, in activities which in themselves are not in furtherance of one or more
exempt purposes.

Section 1.501(c)(3)-1(b)(4) of the Regulations states that an organization is not organized
exclusively for one or more exempt purposes unless its asset are dedicated to an exempt
purpose. An organization’s assets will be considered dedicated to an exempt purpose, if upon
dissolution, such assets would by reason of a provision in the organization’s articles of
organization or by operation of law, be distributed for one or more exempt purposes.

Section 1.501(c)(3)-1(c)(1) of the regulations provides that an organization operates exclusively
for exempt purposes only if it engages primarily in activities that accomplish exempt purposes
specified in section 501(c)(3) of the Code. An organization must not engage in substantial
activities that fail to further an exempt purpose.

Section 1.501(c)(3)-1(d)(1)(ii) of the regulations provides that an organization is not operated
exclusively for any of the purposes specified in section 501(c)(3) unless it serves public rather
than private interests. 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 designated individuals, the creator or his family, shareholders of the organization, or
persons controlled director or indirectly, by such private interests.

Revenue Ruling 61-170, 1961-1 C.B. 112, held that an association composed of professional
private duty nurses and practical nurses which supported and operated a nurses’ registry
primarily to afford greater employment opportunities for its members was not entitled to
exemption under section 501(c)(3) of the Code. Although the public received some benefit from
the organization’s activities, the primary benefit of these activities was to the organization’s
members.

Revenue Ruling 69-175, 1969-1 C.B. 149, held that a nonprofit organization, formed by parents
of pupils attending a private school to provide school bus transportation for its members’
children served a private rather than a public interest and did not qualify for exemption under
section 501(c)(3) of the Code.

Revenue Ruling 78-132, 1978-1 C.B. 157, held that a community cooperative organization
formed to facilitate the exchange of personal services among members was operating primarily
for the private benefit of its members and was not exempt from tax as a social welfare
organization.

In Better Business Bureau v. United States, 326 U.S. 279 (1945), the Supreme Court stated that
the presence of a single nonexempt purpose, if substantial in nature, will preclude exemption
under section 501(c)(3) of the Code, regardless of the number or importance of statutorily
exempt purposes. Thus, the operational test standard prohibiting a substantial non-exempt
purpose is broad enough to include inurement, private benefit, and operations that further
nonprofit goals outside the scope of section 501(c)(3).

In Old Dominion Box Co. v. United States, 477 F2d 344 (4th Cir. 1973) cert. denied 413 U.S.
910 (1973), the court held that operating for the benefit of private parties constitutes a
substantial non-exempt purpose.

Application of law:

You are not described in section 501(c)(3) of the Code because you are not organized and
operated exclusively for charitable, educational, or other exempt 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.

Issue 1:

You do not comply with section 1.501(c)(3)-1(b)(1)(i) of the Regulations because the purposes
as stated a broader than described in the regulations. Your Articles of Incorporation state, “Our
mission is to create (a) caring community, value every individual equally, and share our time,
our services and community.”

You do not comply with section 1.501(c)(3)-1(b)(4) of the regulations because your Articles of
Incorporation do not contain an adequate dissolution clause. Therefore, your assets are not
dedicated for exempt purposes and.

Issue 2:

You are not as 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.

You are not described in section 1.501(c)(3)-1(d)(1)(ii) of the regulations because you are a
bartering exchange that coordinates the bartering services of your membership. Therefore, you
are operated for the private benefits of your members only. Your activities do not serve the
general public.

You are similar to the organization described in Revenue Ruling 61-170 because substantially
all of your resources, purposes and activities are used to offer your members a reciprocal
exchange of services amongst each other through the use of your membership directory.

You are similar to the organization described in Revenue Ruling 69-175 because you are
formed and operated for the reciprocal exchange of services amongst your members similar to
a barter exchange. Therefore, you are similarly structured to the organization in the above ruling
in that a substantial part of your activities serves the private interests of your members rather
than the public.

You are similar to the organization described in Revenue Ruling 78-132 because like it you are
a community cooperative organization formed to facilitate the exchange of personal services
among members. This describes the activities of your bartering exchange.

You are similar to the organization described in Better Business Bureau v. United States, supra,
because like it you too were formed for a nonexempt purpose. Your main activity is to
coordinate various services amongst your members based on their needs. The main
beneficiaries of your operation are your members rather than the general public. Any community

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services that you may have are insubstantial and secondary to your main purpose that is to
provide a medium for members to barter services.

You are similar to the organization described in Old Dominion Box Co., Inc. v. United States,
supra, because you too operate for a substantial non-exempt purpose. You provide an
opportunity for your members to exchange services without exchange money. The fair market
value of services received in exchange for services would have been considered income to your
members.

Applicant’s Position:

You state that you are a charitable organization. You do not charge for services. All services are
done on a volunteer basis by members on a reciprocal basis.

Service Position:

Providing a medium for members to exchange services that they would otherwise have to pay
or to report income does not equate to charitable within the meaning of section 501(c)(3) even if
you do not charge for services.

Conclusion:

You are formed to operate a barter exchange that serves private interests of your members.
Therefore, based on the information submitted, we have concluded that you are not an
organization described in section 501(c)(3) of the Code because you are not organized and
operated exclusively for one or more exempt purposes set forth in section 501(c)(3) of the Code
or the Regulations pertaining thereto.

Appeal Rights:

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

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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:

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