IRS denied section 501(c)(4) exemption for a port management organization

Plain-English summary

The IRS finalized its determination that a nonprofit created by for-profit port operators did not qualify for exemption under section 501(c)(4). The organization provided management services, collected fees, and distributed net proceeds to its members in proportion to their cargo activity. The IRS found that the organization primarily served the private business interests of its members rather than the public welfare of the port community. The organization also did not show that its activities lessened the burdens of government, because local government did not control its operations and the proposed legislation contemplated commercial contracting. The final letter required the organization to file federal income tax returns for the listed years.

Ruling snapshot

• Question: Did the organization operate exclusively for the promotion of social welfare under IRC section 501(c)(4)?
• Outcome: revocation
• Key authorities: IRC §§ 501 and 6110; Treas. Reg. §§ 1.501(c)(4)-1 and 1.501(c)(3)-1(d)(2); Rev. Rul. 85-1.

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION
Release Number: 201149043 Contact Person:
Release Date: 12/9/2011
Date: September 15, 2011 Identification Number:
Contact Number:
Employer Identification Number:
Form Required To Be Filed:
UIL: 501.04-00 Form 1120
Tax Years:
2007, 2008, 2009
Dear

This is our final determination that you do not qualify for exemption from Federal income tax
under Internal Revenue Code section 501(a) as an organization described in Code section
501(c)(4).

We made this determination for the following reason(s):

You are not operated exclusively for the promotion of social welfare as described in section
501(c)(4) of the Code. Your primary activity is providing managerial services in exchange for
fees under the terms of a management contract. Moreover, your activities serve private rather
than public interests.

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

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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,
Elizabeth Kastenberg for

Lois 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: March 26, 2010 Contact Person:
Identification Number:
Contact Number:
FAX Number:
Employer Identification Number:
B =
C =
D =
E =
F =
G =
M =
Date =
State =
Year 1 =
Year 2 =
Year 3 =
Commission =
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)(4). The basis for
our conclusion is set forth below.

Facts:

You are a nonstock corporation incorporated on Date in State. Your Articles of Incorporation
state that you were formed to:

...engage in activities which promote the efficient operation of M in the ports of E
and F, facilitate the efficient movement of international cargo through the E
metropolitan area, ease truck traffic congestion on the highways in and around the
ports, and improve the environment and safety of the surrounding communities,

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through the facilitation, implementation and support of a program to promote
operation of M in off-peak hours including through the collection and distribution of
funds to promote such non-peak hour operations of M facilities and through the
implementation of a D program, and any other activities relative to those purposes
that are appropriate and proper.

You state that the for-profit, privately held M operators (members), who compete for business at
ports E and F, created you to solve problems in the port community. Previously, the members
operated primarily during weekday business hours (peak hours) and only at low levels at night
and on weekends (off-peak hours). Their limited operating schedules created increasing traffic
congestion, air pollution and security risk problems in the port communities. Shipping
companies began diverting ships to other ports and building additional delivery days into their
supply chains. You state that the members were reluctant to relieve the problem by increasing
off-peak hour operations because the additional costs would place them at a competitive
disadvantage.

Under pressure from the public and from proposed legislation, and with the approval of the
Commission, which regulates certain M activities, the members created B, C, and you to
promote M during off-peak hours by assessing and collecting fees on cargo moved during peak
hours. You state that by assessing a fee during the peak hours, members have an incentive to
use M during off-peak hours when the fee is not assessed. All members are obligated to
operate during off-peak hours and to absorb associated costs.

The members hold common control of B, C, and you. Your application states that B is a limited
liability company (LLC). The M operators are the members of B and B has no direct employees.
C is an agreement between the M operators that obligates them to operate during off-peak
hours and absorb off-peak hour costs in accordance with a set schedule.

Your primary activity is providing managerial services to B in exchange for management fees.
The management agreement provides that your role is to collect fees imposed on goods that
move through M during peak hours and to distribute those fees to the members of B. Each
month, you distribute the proceeds, net of refunds, your management fees, operating costs and
an operating reserve, to B, who in turn distributes the net proceeds to the M operator members
in amounts that are proportionate to the percentage of total cargo that they moved through the
terminals. Your application states that your sole source of revenue is the management fees you
receive pursuant to the management agreement.

Your Articles of Incorporation provide that your members must be members of C. Your Board of
Directors is composed of six directors. Annually, each of the five largest members (based on
highest percentage of total cargo moved through M), will appoint representatives to your board.
The sixth director is elected by a majority vote of the members and may not be employed by
one of the five largest members or an affiliate of any such member. In addition, the sixth
director must be nominated by a member other than one of the five largest. Each director is
entitled to a single, equally weighted vote. Each member votes in proportion to the percentage of
total cargo moved by such member through M during the calendar year.

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You state that you have also installed and operate the D program which is a system designed to
automate the identification and authorization of the trucks that serve the terminals. You
acquired the system from a commercial company that distributes the identification tags and
interfaces its database with the terminals’ operating systems and replace any lost or damaged
units. The security checkpoints use the electronic system to identify the trucks moving through
the port. The D program helps your members stay in compliance with federal regulations that
require them to ensure the safety of the ports by inspecting the cargo trucks that pass through
the ports.

You assert that you lessen the burdens of government by engaging in a charitable activity. You
provided information that the State legislature proposed a bill in Year 1 and again in Year 2,
which included the following provisions:

1. Create an entity of local government that will establish an infrastructure fund and finance
   port or harbor infrastructure improvements.

2. Establish a governing authority including representatives from the ports, city councils,
   workers and other members of the port community.

3. State that the provisions of the bill would not become operative if a local agency or
   authority has established a fee on container cargo moving through the ports and at least
   20 percent of inbound cargo is transported during off-peak hours.

4. Deposit all revenues in a fund for expenditures to encourage other means of shipping
   cargo, to repair the transportation infrastructure, and encourage off-peak hour shipping.

5. Require all of the marine terminals at ports E and F to provide off-peak operations.

You state that the prospective legislation from Year 2 specifically referred to you in the
provisions. In Year 3, public information shows that the bill was vetoed by the governor of
State. To date, no other legislation with similar provisions is pending.

Law:

Section 501(c)(4) of the Internal Revenue Code (Code) provides an exemption from federal tax
for civic leagues or organizations not organized for profit but operated exclusively for the
promotion of social welfare.

Section 1.501(c)(4)-1(a)(1) of the Income Tax Regulations (regulations) states that, in general,
an organization may be exempt as an organization described in section 501(c)(4) if it is not
organized or operated for profit and it is operated exclusively for the promotion of social welfare.

Section 1.501(c)(4)-1(a)(2) of the regulations states that, in general, an organization is operated
exclusively for the promotion of social welfare if it is primarily engaged in promoting in some way
the common good and general welfare of the people of the community. An organization
embraced within this section is one that is operated primarily to bring about civic betterments
and social improvements. A “social welfare” organization will qualify for exemption as a
charitable organization if it falls within the definition of “charitable” set forth in paragraph (d)(2) of
section 1.501(c)(3)-1.

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Section 1.501(c)(3)-1(d)(2) of the regulations states that the term “charitable” is used in section
501(c)(3) in its generally accepted legal sense. Such term includes lessening the burdens of
Government.

Rev. Rul. 54-394, 1954-2 C.B. 131 holds that an organization whose sole activity was to provide
television reception for its members on a cooperative basis in an area not readily adaptable to
ordinary reception is not exempt under section 501(c)(4) of the Code. Members were required
to contract for and to pay service and installation fees. In its conclusion that the organization did
not qualify for exemption, this ruling stated:

When an organization's only activity is to provide television reception on a cooperative
basis to its members, who contract and pay for such services, such organization is held
to operate for the benefit of its members rather than for the promotion of the welfare of
mankind.

Rev. Rul. 62-167, 1962-2 C.B. 142 holds that an organization that is organized to construct and
maintain a translator, or reflector-type television station, capable of receiving signals of
television stations and reproducing such signals so that satisfactory television may be available
to the community in general is a social welfare activity. The organization made membership
available to all persons in the area. It derived its income from membership fees and donations.
It disbursed funds for the maintenance and operation of the television relay station.

Rev. Rul. 69-385, 1969-2 C.B. 123 holds that a community welfare corporation that purchases
and sells unimproved land and engages in other business activities, the profits from which are
distributed to members, is not exempt under section 501(c)(4) of the Code.

Rev. Rul. 75-199, 1975-1 C.B. 160 holds that an organization that provides sick benefits for its
members and paid death benefits to the beneficiaries of members does not qualify as an
exempt organization under section 501(c)(4) of the Code. Membership in the organization was
restricted to individuals of good moral character and health who belonged to a particular ethnic
group and resided in a stated geographic area. The organization's activities consisted of
holding monthly meetings and maintaining an established system for the payment of sick and
death benefits. It derived its income primarily from membership dues and used that income to
pay benefits to members and miscellaneous operating expenses. In concluding that this
organization did not qualify for exemption under section 501(c)(4), this revenue ruling found that
it was essentially a mutual, self-interest organization. It used its income to provide direct and
economic benefits to members and any benefit to the larger community was minor and
incidental. The ruling states:

Where the benefit from an organization is limited to that organization's members
(except for some minor and incidental benefit to the community as a whole), the
organization is not operated exclusively for the promotion of social welfare within
the meaning of section 501(c)(4) of the Code.

Rev. Rul. 79-316, 1979-2 C.B. 228, holds that an organization whose purpose is to
prevent liquid spills within a city port area and to develop a program for the containment
and cleanup of liquid spills that do occur is entitled to exemption as a social welfare

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organization under section 501(c)(4) of the Code provided that its services are equally
available to members and nonmembers and both members and nonmembers are
charged on the same basis for the cleanup services rendered.

Rev. Rul. 85-1, 1985-1 C.B. 178, sets out a two-part test for determining whether an
organization's activities lessen the burdens of government. First, it is necessary to determine
whether the governmental unit considers the organization’s activities to be its burden. The
second part of the test is whether these activities actually lessen the burdens of the
government. An activity is a burden of government if there is an objective manifestation by the
governmental unit that it considers the activities of the organization to be its burden. Whether
the organization is actually lessening the burdens of government is determined by considering
all relevant facts and circumstances.

Rev. Rul. 85-2, 1985-1 C.B. 178, held that an organization that provides legal assistance to
guardians ad litem who represent abused and neglected children before a juvenile court that
requires their appointment lessens the burdens of government, and, therefore, qualifies for
exemption under section 501(c)(3) of the Code. The determination of whether an organization’s
activities actually lessen the burdens of government is based on all the relevant facts and
circumstances.

Contracting Plumbers Cooperative Restoration Corp. v. United States, 488 F.2d 684 (2d Cir.
1973), cert. denied, 419 U.S. 827 (1974), held that a private, nonprofit cooperative, which was
organized by plumbers to insure efficient repair of “cuts” made in city streets in the course of
members’ plumbing activities, with each member enjoying such economic benefits precisely to
the extent that he used and paid for restoration services, was not exempt from federal income
taxation as a civic organization or a business league. Previously the “cuts” were repaired by the
city and the plumber was billed for the work. The court found that while all the plumbers
received some incidental benefit from the goodwill created by the properly filled excavations,
each individual member received more in economic terms precisely to the extent that he used
and paid for restoration services. “[W]here, as here, ... individual benefits are precisely proportional to the
member's financial involvement in the organization, the fundamentally non-exempt purpose of
providing a necessary service at reduced cost becomes too clear to be ignored.”

Analysis:

Based on the information you submitted, we conclude that you are not operated for the exempt
purpose described in section 501(c)(4) of the Code. An organization is recognized as exempt
under section 501(c)(4) only if it can establish that it is not organized for profit and operates
primarily for the promotion of social welfare. An organization does not operate exclusively for
the promotion of social welfare if it serves private rather than public interests. See sections
1.501(c)(4)-1(a)(1) and (2) of the regulations. More specifically, an organization that primarily
operates to provide its members with direct benefits in consideration for payments from the
members is a mutual benefit society that does not qualify under section 501(c)(4) as a social
welfare organization.

The information you provided indicates that your members organized you for a business
purpose and limited membership to M operators that signed the agreement. Your members

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receive services and net proceeds in proportion to the extent they use your services. Like the
organization in Contracting Plumbers Cooperative Restoration Corp. v. United States, 488 F.2d
684 (2d Cir. 1973), cert. denied, 419 U.S. 827 (1974), your members created you in response to
community and legislative pressure, which gave your members a substantial business interest.
Unlike the proposed state legislation, which would establish a governing authority composed of
representatives from the ports, the city councils, the city and county transportation authorities,
and other local government representatives, your thirteen for-profit members hold complete
control of B, C, and you. It is clear that your for-profit members organized you for a business
purpose, to get services at a low cost.

Officers and directors that receive benefits from the activities of a social welfare organization are
not regarded as receiving private benefit or inurement if all of the insiders benefit in the same
way and to the same extent as other members of the community. However, unlike the
organization described in Rev. Rul. 79-316, 1979-2 C.B. 228, your services are not equally
available to your members and are not available to nonmembers as well as members. Like the
organization described in Contracting Plumbers Cooperative Restoration Corp. v. United States,
488 F.2d 684 (2d Cir. 1973), cert. denied, 419 U.S. 827 (1974), your members enjoy the
economic benefits of your activities precisely to the extent that they use your services. The
members who move the highest percentage of total cargo through M each month sit on your
board and get the highest percentage of the vote and the largest distribution of net earnings.
Your members receive private benefits from your activities in direct proportion to the extent they
use your services. Accordingly, you provide private benefits to your members.

Organizations will not qualify under section 501(c)(4) if they operate primarily for the benefit of
their members, rather than for benefiting the community as a whole. Two rulings distinguish
mutual benefit societies from social welfare organizations; Rev. Rul. 54-394, 1954-2 C.B. 131
held that an organization that provided television distribution, service, maintenance and repair
services for fees was not entitled to exemption. Since the organization only provided services to
its members and placed restrictions on membership, it was a mutual benefit organization. See
also Rev. Rul. 75-199, 1975-1 C.B. 160. Compare to Rev. Rul. 62-167, 1962-2 C.B. 142, which
held that an organization created to make television available to all television owners in the
community was entitled to exemption. Since membership was available to all and the
organization obtained members and contributions on a voluntary basis, it was a social welfare
organization. See also Rev. Rul. 79-316, 1979-2 C.B. 228. When an organization limits the
benefits it provides to its members, it is not operated exclusively for the promotion of social
welfare within the meaning of section 501(c)(4) of the Code.

An applicant for exempt status under section 501(c)(4) must first show that it is operated
exclusively to promote the common good and general welfare of the people of the community.
While your activities may provide some incidental public benefit, we do not agree that you
operate primarily for social welfare purposes under section 501(c)(4). An organization is not
operated for the promotion of social welfare if its primary activity is carrying on a business with
the general public in a manner similar to organizations operated for-profit. Unlike the proposed
state legislation, you have not indicated that you will use excess funds to improve the common
good and general welfare of the port community by financing port or harbor infrastructure
improvements, undertaking projects to improve the flow and efficiency of container cargo to and
from the ports, or mitigating the air pollution caused by the movement of container cargo to and

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from the ports. You are essentially a mutual, self-interest type of organization. The
management services you perform for your members provide an economy or convenience
relating to the operation of M. See Rev. Rul. 69-385. You also operate the D program to help
your members stay in compliance with federal regulations. Therefore, you operate primarily for
the benefit of your for-profit members and you do not operate exclusively to promote the
common good and general welfare of the port community. These facts show that you operate
primarily for the benefit of your members instead of promoting the general welfare of the
community. Accordingly, you do not qualify under section 501(c)(4) as a social welfare
organization.

An organization that has first established that it meets the basic requirements of section
501(c)(4) and operates exclusively for the common good and general welfare of the community
may show that it also furthers a charitable purpose. Section 1.501(c)(3)-1(d)(2) of the
regulations. You have asserted that you promote social welfare as a charitable purpose by
conducting activities that lessen the burdens of government. The determination of whether an
organization actually lessens the burdens of government requires a two-part analysis of the
relevant facts and circumstances.

Rev. Rul. 85-1, 1985-1 C.B. 178, explains that the first part of the two-part test in the
determination of whether an activity lessens the burdens of government is whether the local
governmental unit considers the organization’s activities to be its burden. The fact that the
government or an official of the government expresses approval of an organization and its
activities is not sufficient to establish that an organization is lessening the burdens of
government. An objective manifestation by the government that it considers an activity to be
part of its burden may indicate that the activity is a burden of government. Factors that provide
evidence that a local government considers an activity to be its burden include, but are not
limited to, the following:

1. The interrelationship between the governmental unit and the organization,
2. The degree of control the local government has over the activities, and
3. The funding of an organization’s activities by the government.

Rev. Ruls. 85-1 and 85-2, 1985-1 C.B. 178, explains that the second test requires that the
organization conducting the activity demonstrate that its activities actually lessen the burdens of
government. When an organization seeks to show that its activities lessen a burden of
government on the basis that a state statute authorizes the activities it performs, the statute
must be read in its entirety to ascertain whether the legislative body intended the activities to be
performed on a normal commercial basis or by a nonprofit organization. If the statute, read as a
whole, indicates that the legislative body intended the private sector perform the activities,
those activities do not lessen the burdens of government.

Based on the facts and circumstances provided, you have not demonstrated conclusively that a
governmental unit considers your activities to be part of its burden or that your activities actually
lessen the burdens. You submitted copies of articles and letters from government officials that
expressed appreciation and overall approval of B’s off-peak hour program. However, your
records show that representatives from the port communities and local city councils are not
involved in your day-to-day management activities. Your for-profit members hold complete

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control of your board. In addition, your primary source of revenue is membership fees, not
support from the local government.

The proposed legislation would have established a community-based governing authority that
requires the ports to assess and collect user fees that will fund projects to improve the port
community through the issuance of revenue bonds. One provision stated that the ports might
contract with you to collect the user fee. The relationship between you and the local
government is more in the nature of a commercial contract for services. Since, read as a whole,
the proposed legislation shows that state lawmakers intended the ports to satisfy their burden
by contracting, on a commercial basis, for services, you do not lessen the government's burden.

Since you have not satisfied the first and second parts of the two-part test set out in Rev. Ruls.
85-1 and 85-2, your primary activities do not meet the definition of “charitable” set forth in the
regulations.

Finally, section 501(c)(4) provides tax exemption to organizations that engage in “social
welfare”. Section 501(c)(4) of the Code and section 1.501(c)(4)-1(a) of the regulations
specifically state that an organization that is not organized for profit but operated exclusively for
the promotion of social welfare and the net earnings of which are devoted exclusively to
charitable, educational, or recreational purposes shall be exempt from tax. All organizations
applying for exemption as a social welfare organization must meet the specific requirements of
section 501(c)(4) to be exempt under that section. Section 1.501(c)(4)-1(a)(2)(ii) of the
regulations states that a social welfare organization that is not exempt from taxation as an
organization described in section 501(c)(3) may qualify under section 501(c)(4) even though it is
an “action” organization, but it must otherwise qualify under this section. The reverse is not
true. An organization that fails to qualify for exempt status under section 501(c)(4) will not
qualify under section 501(c)(3). To sum, the statute, regulations and published guidance have
one common element, that an organization must meet the requirements of section 501(c)(4) to
be exempt under that subsection. You are not involved in social welfare activities within the
meaning of section 501(c)(4) and therefore not exempt under that section.

Conclusion:

Based on the information provided, you have not shown that you are organized and operate
exclusively for the promotion of social welfare. Your activities demonstrate that your primary
activity is to provide services for your members, rather than to provide a benefit to the
community as a whole. Your activities further the business interests of your members; they do
not lessen the burden of government or otherwise further charitable purposes. Since you do not
operate primarily to promote the common good and general welfare of the port community, you
are not operated exclusively for the promotion of social welfare as described in section 501(c)(4)
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.

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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. 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 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
TE/GE

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,

Robert Choi
Director, Exempt Organizations
Rulings & Agreements

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