IRS revokes exemption of a fraternal beneficiary society

Plain-English summary

The IRS revoked a fraternal beneficiary society's exemption under IRC § 501(c)(8). The organization did not follow its bylaws, held no regular general membership meetings, admitted members without enforcing its membership requirements, and conducted video lottery gaming as its primary activity. Its parent organization did not supervise or control its operations, so the IRS also concluded that it was not operating under the lodge system. The organization agreed to the revocation and had filed taxable returns for specified prior years. The revocation was effective January 1 of the redacted year.

Ruling snapshot

• Question: Does the organization qualify as a fraternal beneficiary society operating under the lodge system under IRC § 501(c)(8)?
• Outcome: Revocation.
• Key authorities: IRC §§ 501(c)(8) and 501(c)(10); Treas. Reg. §§ 1.501(c)(8)-1 and 1.501(c)(10)-1; National Union v. Marlow, 374 F. 775, 778 (1896); Philadelphia and Reading Relief Association, 4 B.T.A. 713 (1926); Polish Army Veterans Post 147, 24 T.C. 891 (1955), affirmed as to nonexempt status, 236 F.2d 509 (1956); Wheeler v. Ben Hur Life Ass'n, 264 S.W.2d 289 (1953); Western Funeral Benefit Association v. Hellmich, 2 F.2d 367, 369 (1924)

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
Attn: Mandatory Review, MC 4920 DAL
1100 Commerce Street
Dallas, Texas 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION
501-08-00

LEGEND
ORG = Organization name XX = Date Address = address

Number: 201104045
Release Date: 1/28/2011

Date: November 5, 2010
ORG Employer Identification Number:
ADDRESS Person to Contact/ID Number:
Contact Numbers:

Dear:

In a determination letter dated November 20XX you were held to be exempt from
Federal income tax under IRC § 501(c)(8).

We have determined that you have not operated in accordance with the provisions of
IRC §501(c)(8). We have explained the basis for our determination in the enclosed
report of examination.

On April 14, 20XX, you signed Form 6018-A, Consent to Proposed Action, agreeing to
the revocation of your exempt status under section 501(c)(8) of the Code. Therefore,
your exemption from Federal income tax is revoked effective January 1, 20XX.

You have filed taxable returns on Forms 1120, U.S. Corporation Income Tax Return, for
the years ended December 31, 20XX, 20XX, 20XX and 20XX with us. For future
periods, you are required to file Form 1120 with the appropriate service center indicated
in the instructions for the return.

This is a final adverse determination letter with regard to your status under IRC §
501(c)(8).

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

Sincerely,

Nanette M. Downing,
Director, EO Examinations

Enclosures:
Report of Examination
Copy of Form 6018-A

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
TE/GE EO Examinations

400 N. 8th Street, Box 74
Richmond Va 23219

March 19, 2010
TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Taxpayer Identification Number:
Form:
Tax Year(s) Ended:
ORG Person to Contact/ID Number:
ADDRESS Contact Numbers:
Telephone:
Fax:

CERTIFIED MAIL - RETURN RECEIPT REQUESTED

Dear:

We have enclosed a copy of our report of examination explaining why we believe an
adjustment of your organization’s exempt status is necessary.

If you accept our findings, please sign and return the enclosed Form 6018-A, Consent
to Proposed Action. We will then send you a final letter modifying or revoking your
exempt status.

If we do not hear from you within 30 days from the date of this letter, we will process
your case on the basis of the recommendations shown in the report of examination and
this letter will become final. In the event of revocation, you will be required to file
Federal income tax returns for the tax period(s) shown above. If you have not yet filed
these returns, please file them with the examiner as soon as possible, unless a report
of income tax liability was issued to you with other instructions. File returns for later tax
years with the appropriate service center indicated in the instructions for those returns.

If you do not agree with our position, you may appeal your case. The enclosed
Publication 3498, The Examination Process, explains how to appeal an Internal Revenue
Service (IRS) decision. Publication 3498 also includes information on your
rights as a taxpayer and the IRS collection process. Please note that Fast Tract
Mediation Services referred to in Publication 3498, do not apply to Exempt
Organizations.

If you request a conference, we will forward your written statement of protest to the
Appeals Office and they will contact you. For your convenience, an envelope is
enclosed.

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

Name of Taxpayer
Tax Identification Number
Year/Period Ended
ORG EIN
12/31/20XX

LEGEND
ORG = Organization name
XX = Date
President = president
RA-1, RA-2 & RA-3 = 1st, 2nd & 3rd RA
CO-1 THRU CO-5 = 1st THRU 5th COMPANIES
BM-1 THRU BM-6 = 1st THRU 6th BM

Facts:

The ORG Inc. (hereinafter referred to as ORG) was incorporated under the laws of the state of
State on June 13, 20XX.

ORG was recognized as exempt under IRC 501(c)(8) by the Internal Revenue Service in a letter
dated December 7, 20XX.

ORG’s Form 990 for period ending December 31, 20XX was selected for examination.

President, is President of ORG, and also owns CO-1 and CO-2. CO-1 owns five for-profit
establishments called CO-3 which are operationally very similar to ORG (except these
establishments are only licensed to operate 5 video lottery terminals, while tax exemption allows
ORG to operate 10 video lottery terminals and offer free beverages and snacks). CO-1 loaned a
total of $$ to ORG to fund initial operations.

ORG leases it’s facility from CO-2 for $$ per month. CO-2 also has a management agreement
with ORG for maintenance and bookkeeping of four video lottery terminals for $$ per month.

ORG’s Bylaws provide as follows:

Article I. Name

The name of this organization shall be the ORG and each ORG-1 shall be organized as a
subordinate ORG-1 of the ORG under the constitution, by virtue of the Charter granted by the
CO-3.

Article II. Object

The object of the ORG shall be:

To promote the social and moral welfare of its members.
To encourage human and spiritual values of life.

To cooperate in all charitable and civic appeals....

Article III. Clubs

Section 4. A chartered club shall hold regularly scheduled meetings not less than one (1) each
month, on such day and at such place as shall be determined by the Trustees, for transaction of
business.

Section 6. A quorum of at least ten members must be present at a meeting in order to transact
business.

Article IV. Election of Officers:

Section 1. A chartered club shall hold its annual meeting and election of officers and trustees not
earlier than the first week in November and not later than the second week in December. The
officers shall serve for one (1) year or until their successors are duly elected by a plurality vote.
The trustees shall serve for the term prescribed in the club bylaws or until their successors are
duly elected by plurality vote.

Section 2. The elected officers shall be president, vice president, invocator, secretary, treasurer,
warden, sentinel, picket and three trustees.

Article VI. Membership

Section 1. Applicants for membership shall be any person not less than 21 years of age and of
good moral character. Application for membership shall be received in writing, signed by the
applicant and by a member of the ORG-1 in good standing who recommends the applicant and
shall give the applicant’s name, age, residence, occupation and such other information as the
chartered club may prescribe.

Section 2. All applications must be investigated by the Secretary and investigating committee
before being balloted on in accordance with the balloting procedures of each chartered club. The
initiation fee for membership shall accompany each application.

Section 3. Active members shall maintain regular attendance at meetings and shall actively
participate in activities of the ORG-1.

Section 4. Transfer of members from one ORG to another is allowed by transfer card and after
having paid a transfer fee to the Chartered club as required and to the Home ORG-1.
Transferring member must procure an official membership dues paid receipt stating that member
is in good standing from the ORG-1 which transfer is being made.

Section 5. Per Capita Tax: All members shall pay dues annually as set by the Subordinate ORG-1
which includes the per capita tax paid to the CO-3.

Section 6. Initiation: A new member processing fee, i.e. initiation fee, will be charged to each
new member to defray administrative costs for both the Subordinate ORG-1 and Home ORG-1.

Section 7. All ORG fees will be set annually by the Supreme Officers of the Home ORG-1 at
their July meeting and become effective on the first of January of each year.

The review of the minutes of ORG’s meetings showed the following:

Minutes dated December 20XX state “an operational council consisting of BM-1, BM-2, BM-3,
BM-4, BM-5, BM-6 and President met for the first time to elect officers.“ President was
nominated and elected unanimously to serve as President. Also elected were BM-4, VP, and
BM-3 Recording Secretary. President stated “that the next order of business would be to
establish and operate a social club.”

Summary of minutes of all other meetings held between 20XX and 20XX:

Meeting Date | # of Persons Attending | Notable business transacted
02/10/XX | 6 | CO-1, Inc offered to loan start-up money
03/XX/XX | not stated in minutes | Loan from CO-1 accepted
04/01/XX | 4 | hired RA-1 on 10/7/XX
10/XX/XX | not stated but 4 named | club opened, motion to hire mgmt co.
No date | not stated | RA-2’s motions to start quarterly meet
01/XX/XX | not stated but 3 named | need to find new location
07/23/XX | not stated but 2 named | almost paid CO-1 off for monies loaned
01/11/XX | not stated but 2 named | buying Pleasant County Lodge to fix-up
02/XX/XX | not stated but 2 named | purchased lodge
03/15/XX | 3 | rehab, CO-1 final payment, club robbed
11/01/XX | 3 | new club in old CO-3 building, sublease from CO-2 management
03/01/XX | 5 | air conditioner not cooling
06/XX/XX | 3 | roof leak, CO-2 management to fix
09/XX/XX | 5 | discuss planning Christmas party
12/12/XX | no show, 10 inch snow | none
03/XX/XX | 2 | donations of $ and $ passed
06/XX/XX | 6 | try again to charter member trip to football
09/10/XX | 4 | buy new tractor
12/02/XX | 2 | donation to PHS girls basketball CO-2m
03/25/XX | 3 | $ donation to children’s shelter
06/XX/XX | 4 | 3 scholarships to CO-4
09/XX/XX | 2 | club must go non-smoking
12/XX/XX | ? | RA-3 reports can have separate smoking area with air vents

A small group consisting of President, BM-3 and a few other officers, employees and/or
contractors were the only persons ever to attend meetings. No general members were present at
any of the meetings held.

ORG does not follow its own Bylaws in regards to any of the provisions shown above:
ORG failed to conduct regular monthly meeting, never had a quorum of 10 members at any
meeting and never elected the officers and trustees as required and prescribed in its Bylaws.
ORG failed to require general members to attend meetings or pay dues or initiation fees as
required by the Bylaws.

Membership is open to anyone and President admitted that no one has ever been refused
membership. While members are not allowed guest, anyone may become a member simply by
filling out a membership application consisting only of date, name, address, and phone number.
ORG failed to ask for occupation as required by Bylaws. (Some membership applications
reviewed only contained a date and name.)

ORG does not enforce the Bylaw requirements that new members must be recommended by a
current member and investigated by the Secretary or investigation committee.
Initially there was a one dollar initiation fee charged but the fee was eliminated because patrons

complained that other clubs did not charge anything.

No regular general membership meetings have been held and there were no club activities (other
than video lottery gaming) for members to participate in. While minutes of board meeting
indicated discussions of activities such as organizing a trip to a football game, President
admitted, this activity never actually occurred. Also, members of other ORG-1 are allowed entry
without any fee and members do not pay any annual dues or initiation fee.

ORG entered an affiliation agreement and paid a charter fee to a parent organization referred to
as the “Home ORG-1”. ORG could not produce a copy of the affiliation agreement with the
Home ORG-1, claiming it was done before the current officers took over.

ORG pays the Home ORG-1 a quarterly head tax based on the number of members. However,
the parent Home ORG-1 does not supervise ORG, or exercise any control over the activities or
operations of ORG.

LAW:

Section 501(c)(8) of the Internal Revenue Code (the Code) provides for the exemption of 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.

Section 501(c)(10) of the Code provides for the exemption from federal income tax of 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.

Section 1.501(c)(10)-1 of the Income Tax Regulations (the regulations) provides that an organization will
qualify for exemption under section 501(c)(10) of the Code 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.

The leading judicial pronouncement as to what constitutes a “fraternal beneficiary society” is contained in
the following extract from National Union v. Marlow, 374 F. 775, 778 (1896):

“....a fraternal-beneficial society ... would be 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....

Many of these associations make a practice of assisting their sick
and disabled members and of extending substantial aid to the families
of deceased members. Their work is at the same time of a beneficial
and fraternal character, because they aim to improve the condition of
a class of persons who are engaged in a common pursuit and to unite them

by a stronger bond of sympathy and interest....”

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.

Central to the concept of fraternal beneficiary societies, whether described in section 501(c)(8) or
501(c)(10) of the Code is the requirement of a fraternal element, a common bond among members. The
requirement of a fraternal element is set forth in Philadelphia and Reading Relief Association, 4 B.T.A.
713 (1926).

In that case, an organization composed of railroad employees organized to administer a relief fund for the
payment of benefits to its members in case of sickness, accident or death, fell short of this requirement
because it lacked the required fraternalistic element. The court noted that the association’s membership
consisted of individuals whose vocations were as numerous and diverse as the classifications of jobs of a
railroad company; that the only motive for the existence of the association was a mercenary one (to
provide insurance benefits); that the organization did not have “rituals, ceremonial, and regalia”
commonly associated with fraternal associations; and that it was not operated on the lodge system.

In another case, the U.S. Tax Court held that an organization cannot be classified as fraternal when the
only common bond between the majority of its members is their membership in that organization. Polish
Army Veterans Post 147, 24 T.C. 891 (1955), affirmed as to nonexempt status, 236 F.2d 509 (1956).
Only 10 percent of the members had common ties in that they were Polish war veterans or children of
such veterans who had served in the armed forces of the Western Alliance. All other dues-paying
members were admitted indiscriminately as long as they were elected to membership by a majority vote
of members present at any meeting.

The question as to the meaning of “fraternal” was also explored in Wheeler v. Ben Hur Life Ass'n, 264
S.W.2d 289 (1953). The court concluded that the organization was not fraternal.

... The association's constitution and by-laws duly provide for a lodge system, ritualistic
form of work, and representative form of government. It has no capital stock and is
ostensibly organized solely for the mutual benefit of its members. But actually, while
giving superficial attention to these requirements, the Association has been engaged in
the life insurance business. The local agent of the Association draws a salary and
receives as a commission 50% of the first premium on all insurance policies. He receives
a smaller percentage of subsequent premiums ... The Association's constitution and by-
laws provisions relative to ritualistic work are observed only perfunctorily ... We are
convinced from the evidence in this record that the primary function of the Ben Hur Life
Association is to sell insurance, and that the Association actually is an insurance
company operating under the guise of a fraternal benefit society.

To qualify for recognition of exemption as a fraternal beneficiary organization under section 501(c)(8) or
section 501(c)(10) of the Code, an organization must also be operated under the lodge system. Section

1.501(c)(8)-1 of the regulations states that operating under the lodge system means “carrying on its
activities under a form of organization that comprises local branches, chartered by a parent organization
and largely self-governing, called lodges, chapters, or the like.” At a minimum, this requires separate
subordinate lodges that operate under the general control and supervision of a parent lodge, and are
subject to the laws and edicts of the parent lodge.

In Western Funeral Benefit Association v. Hellmich, 2 F.2d 367, 369 (1924), the District Court for the
Eastern District of Missouri defined “lodge system” as follows:

By the “lodge system” is generally understood an organization which holds regular meetings at a
designated place, adopts a representative form of government, and performs its work according to a
ritual. That does not seem to be a harsh definition of what is usually understood as the lodge system
and is not so strict in its requirements as the definitions often stated in the statute books.

Rev. Rul. 73-165, 1973-1 C.B. 224 concerns an organization that was operated under the lodge system,
was engaged in conducting fraternal activities, but whose predominant activity was the provision of
benefits to its members. The ruling concludes that the organization was described in section 501(c)(8)
because there is no requirement that either the fraternal or the insurance features predominate so long as
both are present. The ruling is clear, however, that in order for an organization to be described in section
501(c)(8) it must contain substantial fraternal features and conduct substantial fraternal activities. The
courts have described fraternal activities as a grouping together of like-minded individuals to accomplish
a common purpose. The group must be bound by more than membership in the organization and
motivated by purposes other than solely the provision of insurance benefits.

Rev. Rul. 77-258, 1977-2 C.B. 195, provides that a domestic fraternal society operating under the lodge
system, which does not provide life, sick, accident, or other benefits, whose members are interested in the
use of and philosophy behind a method of attempting to divine the future, and whose net income is used
to provide instruction on the use of the method, maintain a reference library, and supply information on
the method to the public, qualifies for exemption under section 501(c)(10) of the Code.

RATIONALE:

Fraternal Purposes:

Although there is no definition of fraternal purpose in the Internal Revenue Code, we presume that
Congress used the term in the ordinary sense, and according to its legal significance in 1909 when section
501(c)(8) was added. The courts in the cases cited above, were clear in requiring at a minimum that the
members of a fraternal organization have a common tie that is more substantial than the desire to
purchase insurance or engage in social activities. “....a fraternal-beneficiary society...would be 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.” National Union v. Marlow, supra. “An organization cannot be classed as fraternal
where the only common bond between the majority of the members is their membership in that
organization.” Polish Army Veterans Post 147. Evidence of fraternal activities, such as “rituals,
ceremonial, and regalia,” helps to establish that an organization has a fraternal purpose. Philadelphia and
Reading Relief Association, supra. Rev. Rul. 73-165 echoes Congress and the courts in holding that to
establish exemption, a fraternal organization must have substantial fraternal features and conduct
substantial fraternal activities. Lastly, we look to substance over form. The fact that an
organization’s constitution and bylaws may provide for a “lodge system, a ritualistic form of work,
and representative form of government” is not enough if actual operations establish a primary
function that is not fraternal. Wheeler v. Ben Hur Life Association, supra.

ORG does not have substantial fraternal features. ORG’s membership is open to anyone over 21.
Members are not charged any initiation or membership fee. ORG’s bylaws do state that membership
applications should contain occupation. However, ORG did enforce that provision and submitted no
evidence to establish that its members have a specific “calling, avocation or profession” or a “common
tie.” Unlike the organization described in Rev. Rul. 77-258, whose members had a single pursuit; ORG’s
activities do not illustrate how its members have joined together or worked in unison to accomplish any
worthy objective. The only common bond among ORG’s members appears to be their membership and
desire to engage in video lottery.

Further, ORG admitted that it does not follow its own bylaws regarding new or transferred members and
initiation and membership fees. The effects of these policies lead us to conclude that ORG is open to the
general public in the same manner as a commercial establishment.

Nor has ORG submitted evidence that its listed members have actually participated in substantial fraternal
activities. ORG’s operation of the Club and conduct of gaming is not inherently a fraternal or a charitable
activity. ORG’s charter and bylaws do not provide for rituals, ceremonials or regalia commonly
associated with fraternal associations. ORG has had no member meetings other than those described
above. Nor has ORG engaged in any member activities in furtherance of its’ stated objectives.
Accordingly, ORG is not operated for fraternal purposes.

Lodge System:

An organization is “operating under the lodge system” if it operates under the general control and
supervision of a parent lodge, and is subject to the laws and edicts of the parent lodge. It is generally
understood that such an organization holds regular meetings at a designated place, adopts a representative
form of government, and performs its work according to a ritual. The courts look to substance over form.
Wheeler v. Ben Hur Life Association, supra. A similar result was reached in Western Funeral Benefit
Association v. Hellmich, supra.

ORG could not produce a signed copy of any affiliation agreement with its parent Home ORG-1. ORG
admitted that the Home ORG-1 does not exercise any control over its activities or operations. This is
contrary to the requirement that a parent control and supervise separate, independent, subordinate lodges
that are operating under the lodge system. We cannot conclude, on the basis of this record, that ORG is
properly chartered and under the general control and supervision of a parent lodge.

Further, ORG has had only one meeting since 20XX at which it elected officers. Since then, there have
been no meeting attended by the general membership and no elections have been held. Since ORG is
totally controlled by its founder and does not follow its bylaws as to member input, we cannot conclude
that ORG has a representative form of government.

In addition, since ORG has held neither general membership meetings nor commenced fraternal activities,
we cannot conclude that ORG performs its work according to a ritual. Accordingly, ORG is not operated
under the lodge system.

Conclusion:

The results of the examination show that ORG, Inc failed to establish that it is operated as a domestic
fraternal society, order, or association. ORG, Inc is not operated under the lodge system as required, and
thus does not meet the organizational or operational requirements for exemption under IRC 501(c)(8) or

any other code section. Therefore, we are proposing revocation the organization’s exempt status under
IRC 501(c)(8) effective January 1, 20XX.