Written determination 1143035: IRS revokes exemption after repeated private inurement

View official IRS release (PDF)

Plain-English summary

The IRS revoked a daycare organization's recognition as exempt under § 501(c)(3), effective January 1, 2003. The examination found repeated and substantial withdrawals and expenditures that were not adequately substantiated as serving the organization's exempt purposes, including transactions that appeared to benefit its founders personally. The IRS also found limited internal controls and no demonstrated correction or safeguards against recurrence. Because the organization did not operate exclusively for exempt purposes and its net earnings inured to private individuals, contributions were no longer deductible under § 170, and the organization was required to file Form 1120 for periods beginning on and after January 1, 2003.

Ruling snapshot

• Question: Should the organization's § 501(c)(3) exempt status be revoked because its funds inured to private individuals?
• Outcome: revocation
• Key authorities: IRC §§ 501(c)(3), 170, 4958, 6104(c), and 7428; Treas. Reg. §§ 1.501(c)(3)-1 and 31.6001-1

Full text (IRS public release)

Internal Revenue Service Department of the Treasury

Appeals Office
P.O. Box 2401&. Stop 5520¢ Person to Contact:
Fresno, CA 93779-401€
Employee ID Number:
Release Number: 201143035 Tel:
Release Date: 10/28/2011 Feb
Date: August 4, 2011 Refer Reply to:
A In Re:
EO Revocation
B Form Required to be Filed:
1120
EIN:
D
Tax Period(s) Ended:
Cc

UIL: Sol. 32-00

Certified Mail

Dear
ding your exempt status under section

This is a final adverse determination regar
e (IRC). It is determined that you do not qualify

501(c)(3) of the Internal Revenue Cod
as exempt from Federal income tax under IRC Section 501(c)(3) effective January 1,

2003.
Our adverse determination was made for the following reason(s):

Organizations exempt from Federal income tax under section 501(c)(3)
of the Internal Revenue Code are required to operate exclusively for
charitable, education, or other exempt purposes. Organizations are not
operated exclusively for exempt purposes if the net earnings of the
organization inure in whole or in part to the benefit of private
shareholders or individuals of the organization. See Treas. Reg. §

1.501(c)(3)-1(c)(2).

During 2003, 2004, and 2005 we have determined that your net earnings
inured to the benefit of your founders through a series of transactions
whereby substantial sums were withdrawn from your business bank
account by your founders without sufficient demonstration that such
amounts were expended to further your exempt purposes and through
further transactions directly benefitting only your founders such as
expenditures for their personal clothing and travel. The funds inuring to
your founders were substantial in comparison to your total operations
and were multiple or repeated over a pattern of years. You have not
implemented safeguards to prevent a recurrence of funds inuring to your

Letter 1371 (Rev. 9-2010)

founders and lack sufficient operational controls. As such, you have not
operated exclusively for exempt purposes and have operated for the
benefit of private interests of individuals in contravention of the
requirements of Treas. Reg. 1.501(c)(3)-1(d)(1)(ii).

Contributions to your organization are not deductible under section 170 of the Code.

You are required to file Forms 1120, U.S. Corporation Income Tax Return, for tax
periods beginning on and after January 1, 2003. File the returns in accordance with
their instructions and do not send them to this office. Processing of income tax returns
and assessment of any taxes due will not be delayed because you have filed a petition

for declaratory judgment under IRC code section 7428.

If you decide to contest this determination under the declaratory judgment provisions of
Code section 7428, a petition to the United States Tax Court, the United States Court of
Claims, or the district court of the United States for the District of Columbia must be filed
within 90 days from the date this determination was mailed to you. Contact the clerk of
the appropriate court for rules for filing petitions for declaratory judgment. To secure a
petition form from the United States Tax Court, write to the United States Tax Court,

400 Second Street, N.W. Washington, D.C. 20217.

We will notify the appropriate State officials of this action, as required by Code section
6104(c). You should contact your state officials if you have any questions about how
this determination may affect your state responsibilities and requirements.

You also 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 is not able to reverse legally correct
tax determinations, nor extend the time fixed by law that you have to file a petition in the
U.S. Tax 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. If
you want Taxpayer Advocate assistance, please contact the Taxpayer Advocate for the
IRS office that issued this letter. See the enclosed Notice 1214, Helpful Contacts for
Your “Notice of Deficiency’, for Taxpayer Advocate telephone numbers and addresses.

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

Sincerely,

Karen A. Skinder
Appeals Team Manager

Enclosure: Notice 1214 Helpful Contacts for your “Notice of Deficiency”

Letter 1371 (Rev. 9-2010)

DEPARTMENT OF THE TREASURY
Internal Revenue Service
TE/GE Division, EO Group 7983
9350 Flair Dr. 2nd Floor
Ta grr Ne El Monte,CA 91731-2885

GOVERNMENT ENTITIES
DIVISION

Taxpayer Identification Number:

Form:
990
Tax Year(s) Ended:

Person to Contact/ID Number:

Contact Numbers:
Telephone: °
Fax:

Certified Mail - Return Receipt Requested

Dear:

We have enclosed a copy of our report of examination explaining why we believe
revocation of your exempt status under section 501(c)(3) of the Internal Revenue Code

(Code) is necessary.

If you accept our findings, take no further action. We will issue a final revocation letter.

If you do not agree with our proposed revocation, you must submit to us a written
request for Appeals Office consideration within 30 days from the date of this letter to
protest our decision. Your protest should include a statement of the facts, the

applicable law, and arguments in support of your position.

An Appeals officer will review your case. The Appeals office is independent of the
Director, EO Examinations. The Appeals Office resolves most disputes informally and
promptly. The enclosed Publication 3498, The Examination Process, and Publication
892, Exempt Organizations Appeal Procedures for Unagreed Issues, explain 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.

You may also request that we refer this matter for technical advice as explained in
Publication 892. If we issue a determination letter to you based on technical advice, no
further administrative appeal is available to you within the IRS regarding the issue that

was the subject of the technical advice.

Letter 3618 (04-2002)
Catalog Number 34809F

If we do not hear from you within 30 days from the date of this letter, we will process
your case based on the recommendations shown in the report of examination. If you do
not protest this proposed determination within 30 days from the date of this letter, the
IRS will consider it to be a failure to exhaust your available administrative remedies.
Section 7428(b)(2) of the Code provides, in part: "A declaratory judgment or decree
under this section shall not be issued in any proceeding unless the Tax Court, the
Claims Court, or the District Court of the United States for the District of Columbia
determines that the organization involved has exhausted its administrative remedies
within the Internal Revenue Service." We will then issue a final revocation letter. We
will also notify the appropriate state officials of the revocation in accordance with section

6104(c) of the Code.

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:

300 N. Los Angeles St.
Room 5109, Mail Stop 6710

Los Angeles, CA. 90012

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,

Sunita B Lough
Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Report of Examination

Letter 3618 (04-2002)
Catalog Number 34809F

Schedule or

|
Form 886-A EXPLANATION OF ITEMS Exhibit No.
Name of Taxpayer Years Ended
ORG (EIN) 12/31/20XX-
12/31/20XX
LEGEND
ORG - Organization name XX - Date City - city State - state
President - president Director - director CO-1 through CO-33 = 1** through

337° COMPANIES

ISSUES
Should ORG Daycare’s tax-exempt status under Internal Revenue Code section 501(c)(3) be
revoked because of inurement?

FACTS

The subject organization is recognized as a section 501(c)(3) tax-exempt organization. The
organization was granted exempt status in December 19XX. In 20XX, the organization had
two daycare centers in City and City, State. To date, the organization has expanded to include
two more locations in City and City, State. According to its articles of incorporation, the
specific purpose of the organization is to operate a nonprofit corporation daycare that will
provide a quality daycare environment for infants and toddlers. The organization will provide
the proper love and care and high self-esteem to become accepted in today’s society.
Educational as well as recreational activities will be provided along with in-center activities.

The care of the children will allow parents to be gainfully employed.

A tour of the facilities revealed the typical attributes and activities of a daycare center. The
organization provides both educational and recreational activities in the center daily along with
occasional field trips to the beach, movies, zoo etc. The daycare is open Monday through
Friday from 6 am — 6 pm and accepts infants, toddlers and school age children. The
organization participates in government and subsidized tuition and food programs and
therefore a large majority of its revenue is derived from these programs. The organization

does not participate in any fundraising activities.

Per Director’s oral testimony, the organization was audited for the tax year 20XX and assessed
unpaid employment taxes and related interest and penalties. It currently is on an installment
agreement to repay outstanding amounts owed. Per Director, she was not aware that the
previous accountant was not filing the required employment tax returns.

Director is both the director of the daycare and the vice-president of the organization. Her
husband, President, is listed as the president. The only salaried board member is Director.
There are very limited internal controls established and President and Director are the only
board members with signing privileges on the checking account. They write all of the checks

and deposit the income themselves.
Page 1 of 10

Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A_ | EXPLANATION OF ITEMS Schedule or
Exhibit No.
Name of Taxpayer Years Ended
ORG (EIN) 12/31/20XX-
12/31/20XX

An examination of the organization’s bank account for the three years ending December 31,
20XX through December 31, 20XX revealed that there is a significant amount of large,
unusual, and questionable debits. A breakdown of these items are as follows:

Large. unusual, and questionable debits from the organization’s checking acct.
Year: 20XX Year 20XX Year 20XX

In-Branch Cash Withdrawals

Clothing

Travel

ATM Cash Withdrawals

Electronic Transfers to Savings Account

CO-1
CO-2

CO-3

CO-4
Restaurants
CO-5

CO-6 — President
CO-7

CO-8

City CO-9

Demo #21

CO-10
Miscellaneous
Bank Charges
Automobile Expenses
Leasing Services
CO-11. Payments
CO-12 (Director & President
Storage

Florists
CO-13-Director
Return Item
Return Item Fee
Nix Check Fee
On-Line
CO-14.-Director
CO-15 Director
Total

Page 2 of 10

Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A EXPLANATION OF ITEMS SC REGIE OF
Exhibit No.

Name of Taxpayer Years Ended
ORG (EIN) 12/31/20XX-
12/31/20XX

A detailed spreadsheet listing the large, unusual, and questionable debits was provided to the
EO director for the three years ending December 31, 20XX through December 31, 20XX. A
review of the bank statements revealed a similar pattern of large, unusual, and questionable
debits and/or withdrawals (i.e, in-branch w/drawls, ATM, withdrawals, clothing purchases,
travel etc.) throughout the years. To date, the EO director has only provided documentation as
it relates to the calendar year ending December 31, 20XX. The organization made frequent
large in-branch withdrawals each month. Additionally, the organization frequently withdrew
cash from ATMs each month. Initially, per the director's written response, in-branch and cash
withdrawals were made to pay for playground equipment since the organization was new and
did not have credit established. Copies of estimates were provided by the organization but no
substantiation was provided to establish how and when payments were made. Third party
letters were sent to the vendors provided by the EO. CO-16 provided copies of paid invoices
for equipment purchased by the EO but the invoices are related to the year 20XX. There were
no unpaid balances carried over to subsequent years. No invoices were provided for the year
20XX which is the year being audited. No other explanation or documentation was provided for
the large withdrawals. Refer to Exhibit A for a schedule of detailed debits related to in-branch

and ATM withdrawals.

The director stated that cash was used to purchase various items for the daycare. Refer to
Exhibit B for a detailed listing of items purchased with cash. On May 21, 20XX, the EO
provided invoices, estimates, and/or receipts to substantiate the detailed listing in ExhibitB. A
thorough review of the substantiation revealed that the majority of the purchases were food
related items from CO-17, CO-18 and CO-19. Third party verification IDRs were sent to the
three vendors and a response was received from CO-17 stating that it did not accept cash as a
form of payment. Further, the account was not current as there is an outstanding balance
owed. The invoices related to CO-18 and CO-19 list amounts due but the agent is unable to
determine if the amounts were ever paid. In addition, if payments were made, it could not be
determined the method of payment. Per Director, the EO purchased food from the three

vendors for the daycare and the CO-22 program.

Third party IDRs were sent to the vendors with the largest amounts since the majority of the
invoices do not indicate if the invoices were paid in full or the method of payment. Responses
were received from CO-20, CO-21, CO-22, CO-23, and CO-24. None of the responses
indicated that a service was provided or a sales transaction was actually completed. They all
appear to be estimates. Further, the response from CO-22 did not provide verification of
BOu’s involvement with the program and a substantial portion of the expenditures were related
to BOJ’s involvement with CO-22. They were food purchases, misc. supplies, equipment etc.
Therefore, the invoices provided above failed to establish how the expenditures furthered the

organization's exempt purpose.
Page 3 of 10

Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A EXPLANATION OF ITEMS wiapeditieror
Exhibit No.
Name of Taxpayer Years Ended
ORG (EIN) 12/31/20XX-
12/31/20XX

Some invoices provided actually list the method of payment as check and indicates the check

number.

Invoices were provided for educational supplies purchased from vendors such as CO-25. The
invoices from CO-25 list a completely different organization for billing purposes. Further, there
is no indication that the amount was paid by BOJ or the method of payment.

A bill of sale from CO-26 was provided but the bill of sale indicates that the vehicle was to be
used for personal purposes. Proof of insurance was not provided. Further, there is no
indication of the method of payment and the agent is unable to reconcile the date on the bill of
sale to the in-branch cash withdrawal date. Additionally, the invoice provided above failed to
establish how the expenditure furthered the organization's exempt purpose.

The review of questionable debits also revealed purchases made to clothing retailers such as
Chadwick’s, Lerner’s, Nordstrom’s, Ann Taylor, Motherhood Maternity, Dukes Men’s Store,
Gods Woman Co., Urban Underground Outlet, Hollywood Suit Outlet, LaRedoute, and Van
Heusen. Purchases were also made at Big 5 Sporting Goods and the Jewelry Exchange.
Some purchases were also made on-line. Per the director’s written explanation, the clothing
store purchases were clothes allowances for marketing purposes. Some were for parent
donations for referring children to its facility and others for attending parent training meetings.
No substantiation for the clothing purchases other than the written explanation was provided.
The director, who is married to the president and board member of the organization, was
pregnant in 20XX when purchases were made to Motherhood Maternity and has a teen age
son. The clothing appears to be personal in nature. Since the officers were the only
individuals that had full control and authorization of the organization’s checking account, it
appears that expenditures were used for the benefit of the officers. Refer to Exhibit A for a

detailed schedule of debits related to the above stated purchases.

Purchases were made for airline tickets and related hotel accommodations for travel to states
such as State and State. Per the director's written explanation, the director, head teacher, and
teacher’s aide traveled to these states to observe another daycare and get new marketing
ideas. The exempt purpose in addition to the necessity to travel out of state to observe
daycares has not been established. Moreover, a review of the organization’s checking
account reveals that the account was debited $ on July 21, 20XX for travel related
expenditures to City, State. Clothes were purchased the same day at Ann Taylor and Dukes
Men’s Store (both clothing department stores) for $ and $, respectively. On August 18, 20XX,
lodging accommodations at the hotel CO-27 in City, State for $ was debited from the
organization’s checking account. The account was also debited the same day for CO-28
photography (local photography retailer in City, State) in the amount of $, $ to CO-29 and $ to

Page 4 of 10

Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A EXPLANATION OF ITEMS Schedule or
Exhibit No.

Name of Taxpayer Years Ended
ORG (EIN) 12/31/20XX-
12/31/20XX

Tommy Hilfiger Outlet in City, State. No substantiation for the travel other than the written
explanation was provided. Refer to Exhibit A for a detailed schedule of debits related to the

above stated purchases.

Purchases were made from CO-2 which is a children’s retail store. Three separate purchases
were made in October 20XX for $$ and $. Per the director's written explanation, these
purchases were for baby shower gifts but no substantiation to support this statement has been
provided. The director was pregnant in 20XX and subsequently had her baby in early 20XX.

The organization has failed to provide contemporaneous documentation and explanations for
the remaining expenses. The charitable purpose of the expenses has not been established.
Refer to Exhibit A for a detailed schedule of debits related to the above stated purchases.

Subsequently on May 21, 20XX, Director provided a handwritten receipt indicating that the
purchase from CO-2 represented a one time purchase for infant cribs. The receipt does not
represent a valid receipt from CO-2 and therefore it can not be determined that the associated

funds were used to further the organization’s exempt purpose.

The director, Director, is the only salaried board member but the bank statements revealed an
electronic funds transfer to President on June 23, 20XX for $. An explanation or
documentation of the exempt purpose of this transfer has not been provided.

The examination of the organization determined that no one other than President and Director
had access to the organization’s checking account. A review of the minutes did not reveal that
the other board members were aware of the large in-branch and ATM withdrawals. There was
no discussion of playground equipment purchases. Further, the only asset listed on the
balance sheet of the as-filed 990 is cash and no depreciation has been claimed. This is not
consistent with the purchase of depreciable assets such as playground equipment.

There were numerous monthly debits from the checking account for purchases made to
various gas stations for gas and for oil changes. Although the organization did have a
company van used to transport the children to and from activities and school, the amounts
appear to be excessive. Further, per Director's oral testimony, the organization did not provide
any board members with a vehicle. The director resides in City, State. and commutes daily to
the daycare centers in City, State. The frequency of the gasoline purchases and oil changes is
more consistent with the director’s long commute. Refer to Exhibit A for a detailed schedule of

debits related to automobile expenses.

There were also numerous purchases made to CO-30, CO-31, CO-32, CO-33 and various
grocery stores that were not included in the agent's workpaper of large, unusual and
Page 5 of 10

Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A_ | EXPLANATION OF ITEMS Schedule or
| Exhibit No.

Name of Taxpayer Years Ended
ORG (EIN) 12/31/20XX-
12/31/20XX

questionable debits. The director's written explanations for these purchases were that they
were for various supplies that the individual daycare centers needed and that personal and
business purchases were not co-mingled. The review of the cancelled checks reveals checks
written to various vendors for supplies in addition to these debit card purchases. Although the
credibility of the director’s testimony is in question and no substantiation has been provided to
support the claim that business and personal purchases were not co-mingled, it appears that

the purchase of supplies from those retailers is reasonable.

The review of the organization’s bank statements also reveal frequent debits for overdraft, non-
sufficient funds and bank card fees. The amounts are excessive in nature and the exempt
purpose of the expenses has not been verified. Refer to Exhibit A for a detailed schedule of

debits related to bank fees.

A review of the organization's cancelled checks reveals that the organization appears to be
incurring and paying for normal expenditures such as utilities, supplies, food, tax and licenses
etc... Although there appears to be legitimate business expenses paid from the organization's

checking account, the charitable purposes of the questionable items have not been well
established. Further, no documentation has been provided to support the director's

explanation for the amounts.

The EO has not provided any explanations or substantiation for the large, unusual, and/or
questionable items for calendar years ending December 31, 20XX through December 31,

20XX.

Financial Information
ORG Daycare’s Form 990 for the year ending December 31, 20XX through December 31,

20XX reported revenue and expenses as follows:

Revenue
20XX 20XX 20XX
Program service revenue
Total Revenue $
Expenses
$

Compensation of officers
Other salaries

Other employee benefits
Accounting fees

Legal fees

Telephone
Page 6 of 10
Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A | EXPLANATION OF ITEMS Seheguie wt
Exhibit No.
Name of Taxpayer Years Ended
ORG (EIN) 12/31/20XX-
12/31/20XX
Postage and shipping
Occupancy
Printing and publications
Travel
Interest . -
Depreciation, depletion, etc. -
Other expenses
Total Expenses $
LAW

Section 501(c)(3) of the Code exempts from federal income tax organizations organized and
operated exclusively for charitable, educational, and other exempt purposes, provided that no
part of the organization's net earnings inures 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, the organization must be one that is
both organized and operated exclusively for one or more of the purposes specified in that

section.

Section 1.501(c)(3)-1(c)(1) of the regulations provides that an organization will not be regarded
as operated exclusively for exempt purposes if more than an insubstantial part of its activities

is not in furtherance of exempt purposes.

Regulation section 1.501(c)(3)-1(c)(2) provides that an organization is not operated exclusively
for one or more exempt purposes if its net earnings inure in whole or in part to the benefit of
private shareholders or individuals. The words "private shareholder or individual" refer to
persons having a personal and private interest in the activities of the organization. The term
“private shareholder or individual” is defined in regulation section 1.503(a)-1(c).

Section 1.501(c)(3)-1(d)(ii) of the regulations provides that an organization is not organized or
operated exclusively for one or more exempt purposes unless it serves a public rather than a
private interest. Thus, 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, directly or indirectly, by such

private interests.

Regulation section 1.501(c)(3)-1(f), interaction with Section 4958, provides for the application
of five factors when revocation is pursued on inurement grounds. In determining whether to
Page 7 of 10

Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A EXPLANATION OF ITEMS Schedule or
Exhibit No.

Name of Taxpayer Years Ended
ORG (EIN) 12/31/20XX-
12/31/20XX

continue to recognize the tax-exempt status of an applicable tax-exempt organization (as
defined in section 4958(e) and §53.4958-2) described in section 501(c)(3) that engages in one
or more excess benefit transactions (as defined in section 4958(c) and §53.4958-4) that violate

the prohibition on inurement under section 501(c)(3), the Commissioner will consider all
relevant facts and circumstances, including, but not limited to, the following —

(A) The size and scope of the organization's regular and ongoing activities that
further exempt purposes before and after the excess benefit transaction or

transactions occurred;

(B) The size and scope of the excess benefit transaction or transactions
(collectively, if more than one) in relation to the size and scope of the organization's

regular and ongoing activities that further exempt purposes,

(C) Whether the organization has been involved in multiple excess benefit
transactions with one or more persons;

(D) Whether the organization has implemented safeguards that are reasonably
calculated to prevent excess benefit transactions; and

(E) Whether the excess benefit transaction has been corrected (within the meaning
of section 4958(f)(6) and §53.4958-7), or the organization has made good faith efforts
to seek correction from the disqualified person(s) who benefited from the excess

benefit transaction.

The presence of a single substantial nonexempt purpose can destroy the exemption

regardless of the number or importance of exempt purposes. Better Bus. Bureau v. United
States, 326 U.S. 279. 283, 90 L. Ed. 67, 66 S. Ct. 112 (1945); Am. Campaign Acad. v.
Commissioner, 92 T.C. 1053, 1065 (1989); see also Old Dominion Box Co., Inc. v. United
States, 477 F.2d. 340 (4th Cir. 1973), cert. denied, 413 US 910 (1973) (“operating for the benefit
of private parties who are not members of a charitable class constitutes a substantial
nonexempt purpose”). When an organization operates for the benefit of private interests, such
as designated individuals, the creator or his family, or persons directly or indirectly controlled
by such private interests, the organization by definition does not operate exclusively for exempt

purposes. Am. Campaign Acad. v. Commissioner, supra at 1065-1066.

In Spokane Motorcycle Club v. U.S., 222 F. Supp. 151 (E.D. Wash. 1981), net profits were
found to inure to private individuals where refreshments, goods and services amounting to
$825 (representing some 8% of gross revenues) were furnished to members.

Paae 8 of 10
Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A EXPLANATION OF ITEMS Schedule or
Exhibit No.

Name of Taxpayer Years Ended
ah leat 12/31/20XX-
12/31/20XX

In Revenue Ruling 67-5, 1967-1 C.B. 123, it was held that a foundation controlled by the
creator's family was operated to enable the creator and his family to engage in financial
activities which were beneficial to them, but detrimental to the foundation. It was further held
that the foundation was operated for a substantial non-exempt purpose and served the private
interests of the creator and his family. Therefore, the foundation was not entitled to exemption

from Federal income tax under section 501(c)(3).

Regulation section 31.6001-1(a) states in part that organizations, “..shall keep such permanent
books of account or records, including inventories, as are sufficient to establish the amount of
gross income, deductions, credits, or other matters required to be shown by such persons in

any return of such tax or information.”

Regulation section 1.6033-2(i)(2) states, “Every organization which is exempt from tax,
whether or not it is required to file an annual information return, shall submit such additional

information as may be required by the Internal Revenue Service for the purpose of inquiring
into its exempt status and administering the provisions of subchapter F (section 501 and
following), chapter 1 of subtitle A of the Code, section 6033, and chapter 42 of subtitle D of the

Code.”

Revenue Ruling 59-95 provides that a failure to file required information return or comply with
the provision of section 6033 of the Code and the regulations which implement it, may result in
the termination of the exempt status of an organization previously held exempt, on the grounds
that the organization has not established that it is observing the conditions required for the

continuation of an exempt status

In Church of Gospel Ministry v. United States, 640 F. Supp. 96 (D.D.C. 1986), the court ruled
that a failure to keep and present accurate and adequate records prevented the Church from
meeting its burden of showing that its operations were primarily for charitable purposes and did
not inure to the private benefit of its officers. The court also stated that, “_..the lack of
adequate records or receipts... makes it impossible for CGM to establish that it is not being
operated for the private benefit of its members and provides independent grounds for rejecting

its claim to tax-exempt status.”

TP’S POSITION |
TP’s position is unknown at this time.

GOVERNMENT’S POSITION

Regulation section 1.501(c)(3)-1(f), interaction with Section 4958, provides for the application
of five factors when revocation is pursued on inurement grounds. Factors for consideration

Page 9 of 10
Form 886-A

Department of the Treasury - Internal Revenue Service

Form 886-A’ | EXPLANATION OF ITEMS pPoneenles!
Exhibit No.

Name of Taxpayer Years Ended
ORG (EIN) 12/31/20XX-
12/31/20XX

include the size and scope of the organization’s ongoing activities that further exempt
purposes before and after the excess benefit transaction(s) occurred; the size and scope of the
excess benefit transaction(s) in relation to the size and scope of the organization's activities
that further exempt purposes; whether the organization was involved in multiple excess benefit
transactions; whether the organization has implemented any safeguards to prevent any excess
benefit transactions and whether the excess benefit transaction has been corrected. Based on
the facts of the examination, the organization does not qualify for exemption since the excess
benefit transaction has risen to a level where the organization’s exempt function, on the whole,
is called into question. There appears to be a pattern of large, unusual, and questionable
withdrawals and debits from the organization's bank accounts that have not been adequately
substantiated. Further, there are virtually no internal controls as the director of the daycare,
Director and her spouse are the only ones with signing privileges on the checking account.
They write all of the checks and deposit the income themselves. No other safeguards have
been implemented and correction has not been made. Although the purpose in operating the
daycare centers may arguably benefit the public and community as a whole, it appears that the
director of the organization is using the organization’s funds for personal purposes. The
charitable purpose of the large, unusual and questionable withdrawals and debits have not

been established.

CONCLUSION

Based on the foregoing reasons, the organization does not qualify for tax exemption under
section 501(c)(3) due to inurement of the organization’s funds to Director. Therefore, ORG’s

tax exempt status should be revoked effective January 1, 20XX.

Page 10 of 10
Form 886-A

Department of the Treasury - Internal Revenue Service