Written determination 1143020: IRS denies exemption because member activities created substantial private benefit

Plain-English summary

The IRS issued a final adverse determination denying a membership organization exemption under § 501(c)(3). The organization conducted frequent social and professional networking events, mentored members, provided volunteer labor, and proposed scholarships limited to members or their families. The IRS concluded that these activities served substantial private and nonexempt interests, including benefits to members and to organizations that were not recognized as exempt under § 501(c)(3). Because the organization did not protest the proposed adverse determination within 30 days, the IRS made the denial final and required the organization to file a corporate income tax return.

Ruling snapshot

• Question: Did the membership organization operate exclusively for § 501(c)(3) exempt purposes and serve public rather than private interests?
• Outcome: denied
• Key authorities: IRC §§ 170, 501(a), 501(c)(3), 6110, and 7428(b)(2); Treas. Reg. §§ 1.501(c)(3)-1(a)(1), 1.501(c)(3)-1(c)(1), 1.501(c)(3)-1(d)(1)(ii), 1.501(c)(3)-1(d)(2), and 1.501(c)(3)-1(d)(3)

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION

Release Number: 201143020
Release Date: 10/28/2011
Date: August 1, 2011
Contact Person:
Identification Number:
Contact Number:
Employer Identification Number:
Form Required To Be Filed:
Form 1120 U.S. Corporation
Income Tax Return
Tax Years:

UIL Code: 501.00-00
501.03-22
501.03-30
501.33-00

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.

Because 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. File the returns in accordance with their
instructions, and do not send them to this office. Failure to file the returns timely may result in a
penalty.

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, follow the
instructions in Notice 437. If you agree with our deletions, you do not need to take any further
action.

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,

Lois G. Lerner
Director, Exempt Organizations

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

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION

Date: June 15, 2011
Contact Person:
Identification Number:
Contact Number:
FAX Number:
Employer Identification Number:

UIL:
501.00-00, 501.03-22, 501.03-30, 501.33-00

Legend
Articles =
Charter =
City =
Ethnic Group =
Ethnic Liquor =
Event Organizer =
State =
Website =

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.

Facts:

You are a State nonprofit membership corporation organized in 2009. Your Charter does not
state your exempt purposes. However, you have agreed to file an amendment adding “The
corporation is organized and operated exclusively for charitable, religious, educational, and
scientific purposes.” Your Articles state you were organized exclusively for charitable, religious,
educational, and scientific purposes and prohibits private inurement, lobbying, and campaign
intervention. Upon dissolution Art. 6 directs net assets to a named organization which is a
section 501(c)(3) exempt organization.

Membership is open to all persons who reside or work in greater City area and meet the
membership criteria. You have represented that there are not any written membership criteria
but that membership is open to all. You are governed by an uncompensated board elected
annually by the membership. The board elects all officers and none are compensated. All of
your activities are performed by your members.

Most of your activities or proposed activities can be generally described as business and social
networking, social events for members, community volunteering, fund raising, scholarships, and
grant-making. The most frequent event is weekly indoor volleyball. Similar frequent events
include monthly business mixers, social wine tastings, business networking events, social-
Ethnic Liquor, tennis tournament, tennis clinic, sand volleyball, dodge ball tournament, golf
tournament, picnics, and mock networking. The [illegible] supervises a

Nonmembers are charged higher fees to participate in events. You stated that “the social
activities provide a means to build personal relationships in order to build the organization.”

The first statement on your Website’s page is [illegible]

Your recruiting brochure emphasizes that members [illegible]

The networking events are to “gather and recruit potential members in order to
help the organization grow. Without resources (people) we could not fulfill projects or continue
to volunteer.”

You intend to recruit professionals to “mentor members about the professional world through
guidance and experience that more mature members have.” Only members are eligible to be
mentored.

You sponsor and provide volunteer labor primarily to Event Organizer. You said you did not
know whether Event Organizer was a tax-exempt organization described in section 501(c)(3) of
the Code. Event Organizer is not listed in Service Publication 78 (the IRS cumulative list of
section 501(c)(3) organizations). Event Organizer organized events such as ‘[Event Organizer]
at the State Fair’, [illegible]

[illegible], an [illegible], and an [illegible]
You participated in these events as a sponsor and by providing volunteer labor. You did help
organize [illegible] All events are open to the public.
Your members occasionally work on homes being constructed by [illegible], they have
also helped people clean-up after local floods, and participated in [illegible] and
fund raisers. You organized a [illegible] drive among your
members.

You report that thirty-five to fifty percent of your total effort across 2008, 2009, and 2010 is
dedicated to business networking and community volunteering. As a percentage of program
effort they represent more than [illegible] in some years.

Your scholarship activity is in two parts. First, you grant scholarships to individuals, and
second, you grants funds to Ethnic Group organizations who select qualifying recipients. You
organize and promote an Ethnic Group Benefit to raise funds to support your proposed
scholarship and grant-making efforts. The initial goal is to grant $5,000 each to 6 organizations,
and then to more organizations as fundraising permits.

Your scholarship program awards scholarships only to members or their families without regard
to income-testing and expressly favors Ethnic Group. The intent is to encourage your members
to apply for the scholarships. We asked you to represent that you would “ensure that your
grants are not used for scholarships that discriminate based upon race, color, religion, sex, or
national origin” and you represented that you will ensure that your scholarships will not
“discriminate based upon race, color, religion, sex, or national origin” but you also answered that
“We encourage the recipient to be of [Ethnic Group] descent.”

Eighty percent ([illegible]) of your funding for 2008, 2009, and 2010 comes from corporate donations
with some membership fees. The corporate donors appear to be solicited by members and the
you are not in any way an affiliate of any donor corporation. There is no investment income.
You will earn de minimis interest from checking/savings accounts and potentially some interest
from money markets or certificates of deposit where the you will deposit your scholarship funds
until disbursed.

Law

Section 501(c)(3) of the Code provides for recognition of exemption from federal income tax of
organizations which are organized and operated exclusively for, among other things, charitable
or educational purposes, no part of the net earnings of which inure to the benefit of any private
shareholder or individual.

Section 1.501(c)(3)-1(a)(1) of the Income Tax Regulations (the “regulations”) provides 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 purposes
specified in that 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
which accomplish one or more of the exempt purposes specified in section 501(c)(3) of the
Code. 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)(1)(ii) of the regulations provides that an organization is not operated
exclusively for any of the purposes specified in section 501(c)(3) of the Code unless it serves
public, rather than private interests. Thus, an organization applying for tax exemption under
section 501(c)(3) must establish that it is not organized or operated for the benefit of private
interests.

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 and is, therefore, not to be construed
as limited by the separate enumeration in section 501(c)(3) of other tax-exempt purposes which
may fall within the broad outlines of charity as developed by judicial decisions. Such term
includes: Relief of the poor and distressed or of the underprivileged; advancement of religion;
advancement of education or science; erection or maintenance of public buildings, monuments,
or works; lessening of the burdens of Government; and promotion of social welfare by
organizations designed to accomplish any of the above purposes, or (i) to lessen neighborhood
tensions; (ii) to eliminate prejudice and discrimination; (iii) to defend human and civil rights
secured by law; or (iv) to combat community deterioration and juvenile delinquency.

Section 1.501(c)(3)-1(d)(3) of the regulations defines the term ‘educational’, as used in section
501(c)(3) of the Code, as relating to: (a) The instruction or training of the individual for the
purpose of improving or developing his capabilities; or (b) The instruction of the public on
subjects useful to the individual and beneficial to the community. An organization may be
educational even though it advocates a particular position or viewpoint so long as it presents a
sufficiently full and fair exposition of the pertinent facts as to permit an individual or the public to
form an independent opinion or conclusion. On the other hand, an organization is not
educational if its principal function is the mere presentation of unsupported opinion.

The Supreme Court held in Better Business Bureau v. United States, 326 U.S. 279 (1945), that
a single nonexempt purpose, if substantial in nature, would preclude an organization from
qualifying under section 501(c)(3) of the Code.

In Retired Teachers Legal Defense Fund v. Commissioner, 78 T.C. 280, 286 (1982) the tax
court defined private benefit to include any "advantage; profit; fruit; privilege; gain or interest."

Rev. Rul. 60-143, 1960-1 C.B. 192, social and recreational activities carried on by an alumni
association of a university, which are merely incidental to its basic purpose and objective of
advancing the interests of the university, do not of themselves preclude such organization from
tax exemption under section 501(c)(3) of the Code as an association organized and operated
exclusively for educational and charitable purposes.

Rev. Rul. 70-186, 1970-1 C.B. 128, ruled exempt an organization formed to preserve a lake as
a public recreational facility and to improve the condition of the water in the lake to enhance its
recreational features. Although the organization clearly benefited the public at large, there
necessarily was also significant benefit to the private individuals who owned lake front property.

Rev. Rul. 73-128, 1973-1 C.B. 222, recognized as exempt under section 501(c)(3) of the Code
an organization formed to provide educational and vocational training and guidance or
nonskilled persons who are unable to find employment or cannot advance from poorly paid
employment due to inadequate education. The organization operates a number of community
programs including classes in remedial reading and language skills, general counseling
services, and job training programs.

Analysis

You will be organized for section 501(c)(3) of the Code exempt purposes upon amendment of
your Charter as you agreed. However, you will not be operated exclusively for section 501(c)(3)
exempt purposes because more than an insubstantial part of your activities (i) are social events
to build relationships among your members or are professional development events to advance
members’ careers, which are not exempt purposes, and (ii) provide a private benefit to your
members and to organizations that are not recognized as section 501(c)(3) organizations, which
is not merely incidental to providing a public benefit. Accordingly, you are operated to further a
substantial non-exempt purpose and therefore not operated exclusively for exempt purposes.

Section 501(c)(3) of the Code provides for recognition of exemption from federal income tax of
organizations which are organized and operated exclusively for, among other things, charitable,
religious, scientific, or educational purposes, no part of the net earnings of which inure to the
benefit of any private shareholder or individual. Section 1.501(c)(3)-1(a)(1) of the regulations
provides 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
purposes specified in that 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
which accomplish one or more of the exempt purposes specified in section 501(c)(3) of the
Code. An organization will not be so regarded if more than an insubstantial part of its activities
is not in furtherance of an exempt purpose. In Better Business Bureau v. U.S., 326 U.S. 279
(1945) the Supreme Court held that the presence of a single nonexempt purpose, if substantial
in nature, will destroy the exemption regardless of the number or importance of truly educational
purposes.

Section 1.501(c)(3)-1(d)(1)(ii) of the regulations provides that an organization also is not
operated exclusively for any exempt purpose unless it serves public, rather than private
interests. Thus, an organization applying for tax exemption under section 501(c)(3) of the Code
must establish that it is not organized or operated for the benefit of private interests. However,
Rev. Rul. 60-143 ruled that activities which have social and other related features do not
disqualify an alumni association from exemption under section 501(c)(3) because those
activities were ‘incidental’ to accomplishing the organization’s exempt purpose of serving its
university a section 501(c)(3) organization. An activity is “incidental” when it is necessary to the
accomplish an exempt purpose.

You are primarily a professional society for advancing members’ career and professional
development through numerous social events, business and social networking, mentoring, and
scholarships for members or members’ families. Your organizational structure includes a social
events director and career events director who report to your Vice-President of Programs.

Your most frequent events are social events for your members including weekly indoor
volleyball, social wine tastings, social-Ethnic Liquor, tennis tournament, tennis clinic, sand
volleyball, dodge ball tournament, golf tournament, and picnics. Generally, social activities for
members do not further section 501(c)(3) of the Code exempt purposes. Rev. Rul. 60-143
approves activities with social and other related features provided they are incidental to

accomplishing an organization’s exempt purposes. Unlike your annual Ethnic Group Benefit, a
fundraiser which has social features, your other social events are not raising money to fund
activities which further exempt purposes nor performing any charitable, educational, religious, or
scientific tasks. You said that “the social activities provide a means to build personal
relationships in order to build the organization.” Social activities are not necessary to build
relationships among your members. Performance of charitable activities also build
relationships, such as when your members worked together to clean up flooded houses and
worked together on houses being constructed for low-income people. More importantly,
building relationships among your members is not an exempt purpose. You also charge non-
members more than members to participate in your events, which is a private benefit to your
members. A private benefit is any "advantage; profit; fruit; privilege; gain or interest." See
Retired Teachers. Your social events are a substantial part of your activities and are not
incidental to furthering one or more exempt purposes. Additionally, they provide a private
benefit to your members. Accordingly, you have a substantial non-exempt purpose which
destroys the exemption regardless of the number or importance of truly exempt purposes. See
Better Business Bureau v. U.S.

Your business and social networking events also provide a private benefit to your members that
is not incidental to furthering any exempt purpose. Business and social networking has a
significant benefit of enhancing each member's business and social opportunities, which is an
advantage to your members. An advantage is a private benefit. See Retired Teachers.
Substantial private benefit is permitted only if it is incidental to accomplishing an exempt
purpose. Your purpose for such networking events is “to gather and recruit potential members
in order to help the organization grow. Without resources (people), we could not fulfill projects
or continue to volunteer.” Your advertising of these events emphasizes business and social
opportunities and minimizes your charitable mission. No charitable, educational, religious, or
scientific activities are performed at most of these events. Your board’s agenda and calendar of
events are replete with discrete networking activities which represent 20-30% of the your effort
for years 2008-2010. You report ‘recruiting’ (i.e. business and social networking) efforts were
25-30% of your total effort; more than volunteer efforts for 2008 and 2009, and equal to
volunteer efforts in 2010. Unlike in Rev. Rul. 70-186 where cleaning a public lake also
necessarily benefitted the surrounding land owners, your enhancement of members’ business
and social opportunities is not merely incidental to accomplishing your exempt purposes.
Accordingly, you have a substantial non-exempt purpose which destroys the exemption
regardless of the number or importance of truly exempt purposes. See Better Business Bureau
v. U.S.

You also propose to recruit professionals to “mentor members about the professional world
through guidance and experience that more mature members have.” Only members are eligible
to be mentored. Generally, mentoring is not a valid educational activity with the meaning of
section 1.501(c)(3)-1(d)(3) of the regulations because it lacks any formalities of instruction such
as curriculum, specific courses of instruction, or published instructional materials, which can be
administratively evaluated by the IRS to determine whether they are mere presentation of
unsupported opinion or constitute propaganda. Nor is it generally a charitable activity when the
recipients are skilled professionals. Mentoring your members about the professional world also
provides a private benefit to your members that is not incidental to providing any public benefit.
Accordingly, you have a substantial non-exempt purpose which destroys the exemption

regardless of the number or importance of truly exempt purposes. See Better Business Bureau
v. U.S.

Volunteering in the community represents 25%, 15%, and 20% of your effort for 2008, 2009,
and 2010 respectively. Event Organizer is the primary beneficiary of your volunteer efforts but
is not a section 501(c)(3) of the Code exempt organization. Rev. Rul. 56-304 held that a section
501(c)(3) organization may distribute funds to nonexempt organizations and to individuals for
projects which are in furtherance of its exempt purposes, provided that the charity retains
control and discretion as to the use of the funds and maintains records establishing that the
funds were used for section 501(c)(3) purposes. While some of Event Organizer's events
appear to be cultural events others are clearly not. Unlike the organization described in Rev.
Rul. 73-128 which provided employment services to nonskilled persons who could not find
employment or cannot advance from poorly paid jobs due to a lack of education, the
International Job Expo is directed at business professionals without regard to employment
status. The International Business Networking events improve the business and social
opportunities of your members, also without regard to employment status. Unlike the
organization in Rev. Rul. 56-304, your support to non-exempt organizations is not limited to
activities which clearly further section 501(c)(3) of the Code exempt purposes. Moreover, your
participation in these activities provides a private benefit to the Event Organizer. Accordingly,
you have a substantial non-exempt purpose which destroys the exemption regardless of the
number or importance of truly exempt purposes. See Better Business Bureau v. U.S.

Your scholarship criteria include scholastic ability and that recipients be members or family of
members. The scholarship committee reviews applications and submits recommendation to
Applicant officers who select recipients. Committee members and officers related to an
applicant must recuse themselves. Upon selection the application packet of each recipient is
destroyed. Scholarships are paid directly to the college or university. Unlike scholastic ability or
financial need, membership in you is not a criteria that furthers educational, charitable purposes,
religious, or scientific purposes within the meaning of section 501(c)(3). Such criteria make
these scholarships a private benefit to your members. A private benefit is any "advantage;
profit; fruit; privilege; gain or interest." Retired Teachers Legal Defense Fund v. Commissioner,
78 T.C. 280, 286 (1982). This private benefit is not incidental to serving any exempt purpose.

Additionally, destroying all scholarship records and case histories is not permitted. Certain
information must be retained. Rev. Rul. 56-304 requires organizations making grants to
individuals must maintain adequate records and case histories to show the name and address
of each recipient of aid; the amount distributed to each; the purpose for which the aid was given;
the manner in which the recipient was selected and the relationship, if any, between the
recipient and (1) members, officers, or trustees of the organization, (2) a grantor or substantial
contributor to the organization or a member of the family of either, and (3) a corporation
controlled by a grantor or substantial contributor, in order that any or all distributions made to
individuals can be substantiated upon request by the IRS. Because these scholarships provide
a substantial private benefit to your members that is not incidental to furthering any exempt
purpose, you have a substantial non-exempt purpose which destroys the exemption regardless
of the number or importance of truly exempt purposes. See Better Business Bureau v. U.S.

Because more than an insubstantial part of your activities further the career and social interests
of your members, which is a private benefit to your members that is not incidental to furthering
any exempt purpose, and provide a private benefit to non-exempt organizations which is not
incidental to furthering your exempt purposes, you are not operated exclusively for exempt
purposes. Accordingly, you are not an organization described in section 501(c)(3) of the Code.

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.

Your protest statement should be accompanied by the following declaration:

Under penalties of perjury, I declare that I have examined this protest statement, including
accompanying documents, and, to the best of my knowledge and belief, the statement
contains all the relevant facts, and such facts are true, correct, and complete.

You also have a right to request a conference to discuss your protest. This request should be
made when you file your protest statement. An attorney, certified public accountant, or an
individual enrolled to practice before the Internal Revenue Service may represent you. If you
want representation during the conference procedures, you must file a proper power of attorney,
Form 2848, Power of Attorney and Declaration of Representative, if you have not already done
so. For more information about representation, see 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 protest
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 this address:
Internal Revenue Service

1111 Constitution Ave, N.W.
Washington, DC 20224

You may also 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,

Lois G. Lerner
Director, Exempt Organizations