IRS determination 1146023: IRS revokes exemption from an organization that served a substantial nonexempt purpose

Plain-English summary

The IRS revoked an organization's exemption under IRC § 501(c)(3), effective on the date stated in the letter. The determination says the organization was not operated exclusively for charitable, educational, or other exempt purposes, and that more than an insubstantial part of its activities furthered a nonexempt purpose. The attached examination material describes counseling activities and concludes that the organization's activities differed substantially from examples of exempt counseling programs. The letter also states that contributions are not deductible under IRC § 170 and that the organization must file Form 1120.

Ruling snapshot

• Question: Did the organization continue to qualify for exemption under IRC § 501(c)(3)?
• Outcome: Revocation.
• Key authorities: IRC §§ 501, 170, 6001, 6033, 6104, 7428; Treas. Reg. §§ 1.501(c)(3)-1(a)(1), 1.501(c)(3)-1(c)(1), 1.501(c)(3)-1(d)(2), 1.501(c)(3)-1(d)(3)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury

Appeals Office
8701 S. Gessner Person to Contact:
MC 8000 H-AL,
Houston, TX 77074 Employee ID Number:

Tel:

Fax:
Number: 201146023 Refer Reply to:
Release Date: 11/18/2011

In Re:

Date: August 24, 2011
Form Required to be Filed:

Tax Period(s) Ended:

UIL: 501.03-30

Certified Mail
Dear

This is a final adverse determination as to your exempt status under section 501(c)(3) of
the Internal Revenue Code (IRC). It is determined that you do not qualify as exempt
from Federal income tax under IRC Section 501(c)(3) effective March 1, 2005.

Our adverse determination was made for the following reasons:

You are not operated exclusively for charitable, educational, or other exempt
purposes. You did not engage primarily in activities which accomplish one or
more of the exempt purposes specified in section 501(c)(3). More than an
insubstantial part of your activities were in furtherance of a non-exempt purpose..

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

You are required to file Federal income tax returns on the form indicated above. You
should file these returns within 30 days from the date of this letter, unless a request for
an extension of time is granted. 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 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.

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

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 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:

Taxpayer Advocate Service
Phone:
See the enclosed Notice 1214, Helpful Contacts for Your “Notice of Deficiency” for

additional Taxpayer Advocate telephone numbers and addresses.

Sincerely,

KAREN A. SKINDER
TEAM MANAGER

cc:
Enclosures:

Internal Revenue Service Department of the Treasury

TE/GE EO Examination
1100 Commerce St. Mail Code 4957:DAL

Dallas, TX 75242-1027

Taxpayer Identification Number:

Date:

Form:
ORG

Tax Year(s) Ended:
ADDRESS

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 (Rev. 11-2003)
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:

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,

Renee B. Wells
Acting Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Report of Examination

Letter 3618 (Rev. 11-2003)
Catalog Number: 34809F

Department of the Treasury - Internal Revenue Service Schedule No. or
Form 886A Explanation of Items Exhibit
Name of Taxpayer ORG Year/Period
EIN 990 Ended
20XX02
LEGEND
ORG - Organization Name XX - Date Address - address City - city |

State - state
Issue: |

Whether exempt organization qualifies for exemption under Section 501(c)(3) of the
Internal Revenue Code.

Facts:

ORG (ORG) was incorporated under the laws of the State of State on March 12,
19XX. In a determination letter dated February 27, 20XX, ORG was determined to
be exempt from federal income tax as an organization described in IRC Section
501(c)(3). ORG is located at Address, City, State.

In its Articles of Incorporation, ORG stated its mission was “to improve the lives of
individuals and families through better credit counseling, financial management
education, including credit restoration and correction procedures.

In its application for exempt status, Internal Revenue Service Form 1023, ORG
Stated that its activities would consist of providing credit counseling services to low
income and indigent individuals and the conducting of community seminars to assist
individuals in restoring good credit. According to the Form 1023, volunteer staff
would be utilized in these activities.

Activity Description
The CEO of ORG conducts a radio broadcast which invites listeners to call in to ask
questions about credit issues.

In addition, a website under the ORG name provides information about the
organization, access to archived radio broadcasts, and contact information.

According to the website, ORG provides “credit file restoration, correction with
settlement(s), education, and credit file clean-up.” To access these services, a fee is
required (currently $ for single persons and $ for married couples). This fee will
generate a “professional credit evaluation.” The Executive Director indicated that
occasionally these fees are waived in hardship cases at the discretion of the
Executive Director (CEO).

After the credit evaluation is prepared, a fee schedule and contract is provided the
client which details which credit services such as foreclosures, student loans, and
late payments to creditors will be provided.

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service
Page: -1-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer ORG Year/Period
EIN 990 Ended
20XX02

A review of the financials provided by the organization as well as the Form 990,
Return of Organization Exempt from Income Tax for the year under exam, indicated
that 100% of the support provided ORG was derived from these fees.

The Credit Counselors are not volunteers but are paid based ona percentage of
fees collected from the clients.

A review of the job description for the credit counselors indicates that contrary to a
response from the Executive Director as related by the POA in a memo dated
October 26, 20XX, education is but a small part of the counselors’ responsibilities.

Law:

Section 501(a) of the Internal Revenue Code provides that an organization
described in section 501(c)(3) is exempt from income tax. Section 501(c)(3) of the
Code exempts from federal income tax corporations organized and operated
exclusively for charitable, educational, and other purposes, provided that no part of the
net earnings inure to the benefit of any private shareholder or individual. The term
charitable includes relief of the poor and distressed. Section 1.501(c) (3)-1(d) (2),
Income Tax Regulations.

The term educational includes (a) instruction or training of the individual for the
purpose of improving or developing his capabilities and (b) instruction of the public on
subjects useful to the individual and beneficial to the community. Treas. Reg. §
1.501(c)(3)-1(d)(3). In other words, the two components of education are public
education and individual training.

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), an organization must be both
organized and operated exclusively for one or more of the purposes specified in such
section. If an organization fails to meet either the organizational test or the operational
test, it is not exempt.

Section 1.501(c)(3)-1(c)(1) of the regulations provides that an organization will be
regarded as “operated exclusively” for one or more exempt purposes only if it engages
primarily in activities that accomplish one or more of such exempt purposes specified in
section 501(c)(3). An organization will not be so regarded if more than an insubstantial
part of its activities is not in furtherance of an exempt purpose. The existence of a
substantial nonexempt purpose, regardless of the number or importance of exempt
purposes, will cause failure of the operational test. Better Business Bureau of
Washington, D.C. v. U.S., 326 U.S. 279 (1945).

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service
Page: -2-

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer ORG Year/Period
EIN 990 Ended
20XX02

Educational purposes include instruction or training of the individual for the
purpose of improving or developing his capabilities and instruction of the public on
useful and beneficial subjects. Treas. Reg. § 1.501(c)(3)-1(d)(3). In Better Business
Bureau of Washington D.C., Inc. v. United States, 326 U.S. 279 (1945), the Supreme
Court held that the presence of a single non-exempt purposes, if substantial in nature,
will destroy the exemption regardless of the number or importance of truly exempt
purposes. The Court found that the trade association had an “underlying commercial
motive” that distinguished its educational program from that carried out by a university.

In American Institute for Economic Research v. United States, 302 F. 2d 934 (Ct.
Cl. 1962), the Court considered the status of an organization that provided analyses of
securities and industries and of the economic climate in general. The organization sold
subscriptions to various periodicals and services providing advice for purchases of
individual securities. Although the court noted that education is a broad concept, and
assumed for the sake of argument that the organization had an educational purpose, it
held that the organization had a significant non-exempt commercial purpose that was
not incidental to the educational purpose and was not entitled to be regarded as
exempt.

The Service has issued two rulings holding credit counseling organizations to be
tax exempt. Rev. Rul. 65-299, 1965-2 C.B. 165, granted exemption to a 501(c)(4)
organization whose purpose was to assist families and individuals with financial
problems and to help reduce the incidence of personal bankruptcy. Its primary activity
appears to have been meeting with people in financial difficulties to “analyze the
specific problems involved and counsel on the payment of their debts.” The
organization also advised applicants on proration and payment of debts, negotiated with
creditors and set up debt repayment plans. It did not restrict its services to the needy.
It made no charge for the counseling services, indicating they were separate from the
debt repayment arrangements. It made “a nominal charge” for monthly prorating
services to cover postage and supplies. For financial support, it relied upon voluntary
contributions from local businesses, lending agencies, and labor unions.

Rev. Rul. 69-441, 1969-2 C.B. 115, granted 501(c)(3) status to an organization
with two functions: it educated the public on personal money management, using films,
speakers, and publications, and provided individual counseling to “low-income
individuals and families.” As part of its counseling, it established budget plans, i.e.,
debt management plans, for some of its clients. The debt management services were
provided without charge. The organization was supported by contributions primarily
from creditors. By virtue of aiding low income people, without charge, as well as
providing education to the public, the organization qualified for section 501(c)(3) status.

Form 886- AcRrev.468) Department of the Treasury - Internal Revenue Service
Page: -3-

E om 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer ORG Year/Period
EIN 990 Ended .
20XX02

In the case of Consumer Credit Counseling Service of Alabama, Inc. v. U.S., 44
A.F.T.R.2d 78-5052 (D.D.C. 1978), the District Court for the District of Columbia held
that a credit counseling organization qualified as charitable and educational under
section 501(c)(3). It fulfilled charitable purposes by educating the public on subjects
useful to the individual and beneficial to the community. Treas. Reg. § 1.501(c)(3)-
1(d)(3)(i)(b). For this, it charged no fee. The court found that the counseling programs
were also educational and charitable; the debt management and creditor intercession
activities were “an integral part” of the agencies’ counseling function and thus were
charitable and educational. Even if this were not the case, the court viewed the debt
management and creditor intercession activities as incidental to the agencies’ principal
functions, as only approximately 12 percent of the counselors’ time was applied to debt
management programs and the charge for the service was “nominal.” The court also
considered the facts that the agency was publicly supported and that it had a board
dominated by members of the general public as factors indicating a charitable
operation. See also, Credit Counseling Centers of Oklahoma, Inc. v. United States, 79-
2 U.S.T.C. 9468 (D.D.C. 1979), in which the facts and legal analysis were virtually
identical to those in Consumer Credit Counseling Centers of Alabama, Inc. v. United
States, discussed immediately above.

The organizations included in the above decision waived the monthly fees when
the payments would work a financial hardship. The professional counselors employed
by the organizations spent about 88 percent of their time in activities such as
information dissemination and counseling assistance rather than those connected with
the debt management programs. The primary sources of revenue for these
organizations were provided by government and private foundation grants,
contributions, and assistance from labor agencies and United Way.

Outside the context of credit counseling, individual counseling has, in a number
of instances, been held to be a tax-exempt charitable activity. Rev. Rul. 78-99, 1978-1
C.B. 152 (free individual and group counseling of widows); Rev. Rul. 76-205, 1976-1
C.B. 154 (free counseling and English instruction for immigrants); Rev. Rul. 73-569,
1973-2 C.B. 179 (free counseling to pregnant women); Rev. Rul. 70-590, 1970-2 C.B.
116 (clinic to help users of mind-altering drugs); Rev. Rul. 70-640, 1970-2 C.B. 117
(free marriage counseling); Rev. Rul. 68-71, 1968-1 C.B.249 (career planning
education through free vocational counseling and publications sold at a nominal
charge). Overwhelmingly, the counseling activities described in these rulings were
provided free, and the organizations were supported by contributions from the public.

Government's Position:

The purpose of ORG’s activities differ substantially from those of the organizations in

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service
Page: -4-

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer ORG Year/Period
EIN 990 Ended
20XX02

Rev. Rul. 65-299, Rev. Rul. 69-441, and Consumer Credit Counseling Service of

Alabama, Inc. In this case, ORG engages in minimal activities which further an
exempt purpose. Furthermore, no public financial support is provided.

Conclusion:

Based upon the information noted above, it is proposed the exempt status of the
organization be revoked effective March 1, 20XX. Form 1120, U.S. Corporation Income
Tax Return should be obtained for the year ended February 28, 20XX, and for future

tax years.

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service
Page: -5-