IRS determination 1203022: IRS revokes exemption for personal use of organizational assets

Plain-English summary

The IRS revoked the organization's section 501(c)(3) exemption effective January 1 of the redacted year. The examination found that organizational assets were used for the president's personal benefit, including expenses that were not shown to further the organization's charitable purposes. The IRS also found inadequate records and failures to substantiate transactions and reported financial information. Contributions were no longer deductible under section 170, and the organization was required to file Form 1120.

Ruling snapshot

• Question: Whether the organization operated exclusively for exempt purposes, avoided private inurement, and maintained adequate books and records.
• Outcome: revocation
• Key authorities: IRC §§ 501(a), 501(c)(3), 170, 6001, 6033, and 7428; Treas. Reg. §§ 1.501(c)(3)-1(a)(1), (b)(4), (c)(1), (c)(2), (d)(1)(ii), and 1.501(a)-1.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY

INTERNAL REVENUE SERVICE
TEGE EO Examinations Mail Stop 4920 DAL
1100 Commerce St.
Dallas, Texas 75242
TAX EXEMPT AND 501.03-00
GOVERNMENT ENTITIES
DIVISION

Date: September 26, 2011

Release Number: 201203022
Release Date: 1/20/2012

LEGEND
Employee Telephone Number:
ORG (Phone)
ADDRESS (Fax)

CERTIFIED MAIL — RETURN RECEIPT
Dear

This is a final adverse determination regarding your exempt status under section 501(c)(3) of the
Internal Revenue Code. Our favorable determination letter to you dated February 2, 20XX is
hereby revoked and you are no longer exempt under section 501(a) of the Code effective January
1, 20XX.

The revocation of your exempt status was made for the following reason(s):

Organizations described in IRC 501(c)(3) and exempt under section 501(a) must be both organized
and operated exclusively for exempt purposes. You must establish that you are operated
exclusively for exempt purposes and that no part of your net earnings inures to the benefit of
private shareholders or individuals. Your assets inured to the benefit of your President for his
personal use. IRC 501(c)(3) precludes Federal income tax exemption if net earnings inure to the
benefit of private shareholders or individuals. Because IRC 501(c)(3) prohibits inurement of
earnings, your exempt status is hereby revoked effective January 1, 20XX.

Contributions to your organization are no longer deductible under IRC §170 after January 1, 20XX.

You are required to file income tax returns on Form 1120. These returns should be filed with the
appropriate Service Center for the tax year ending December 31, 20XX, and for all tax years
thereafter in accordance with the instructions of the return.

Processing of income tax returns and assessments of any taxes due will not be delayed should a
petition for declaratory judgment be filed under section 7428 of the Internal Revenue Code.

If you decide to contest this determination under the declaratory judgment provisions of section
7428 of the Code, a petition to the United States Tax Court, the United States Claims Court, or the
district court of the United States for the District of Columbia must be filed before the 91st Day
after the date this determination was mailed to you. Please contact the clerk of the appropriate
court for rules regarding filing petitions for declaratory judgments by referring to the enclosed
Publication 892. You may write to the United States Tax Court at the following address:

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:

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

Sincerely,

Nanette M. Downing
Director, EO Examinations

Enclosures:
Publication 892

DEPARTMENT OF THE TREASURY
Internal Revenue Service
Tax Exempt / Government Entities
1100 Commerce Street
Dallas, TX 75242

GOVERNMENT ENTITIES
DIVISION

April 14, 2011

Taxpayer Identification Number:

ORG
ADDRESS Form:

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:

If you have any questions, please call the contact person at the telephone number
shown in the heading of this letter. If you write, please provide a telephone number and
the most convenient time to call if we need to contact you.

Thank you for your cooperation.

Sincerely,

Nanette M. Downing
Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Report of Examination

Letter 3618 (04-2002)
Catalog Number 34809F

Form 886-A Department of the Treasury - Internal Revenue Service
Explanation of Items Exhibit
Name of Taxpayer Year/ Period Ended
ORG December 31,
20XX
LEGEND
ORG - Organization name XX - Date State - state City - city
President - president Vice-President - vice president CO-1, CO-2 & CO-3

= 1st, 2nd & 3rd COMPANIES

ISSUE:

Is ORG, Inc operating exclusively for charitable purposes described in Internal Revenue Code
(IRC) § 501(c)(3)?

FACTS:

ORG was incorporated on November 29, 20XX in the state of State. Their Articles of
Incorporation were stamped by the Secretary of State of State on November 29, 20XX. The
Organization was recognized as being exempt from the Federal income under section 501(c)(3)
of the Internal Revenue Code on February 2, 20XX, with a foundation status of 509(a)(2). At the
end of their advanced ruling period, their foundation status remained the same.

The purpose of the Organization is to solicit donations of clothing, household items, food and
furniture for distribution to those individuals or families living below the poverty line, or in a
family or financial crisis. The Organization recruits churches within the Organization’s zip code
(zip code) to help with collecting and distributing. The Organization prepares a weekly mailing
list of all garage and estate sales in the CO-1 and CO-2, a free publication. The Organization
also solicits ads to the public for their donated vehicle program. The proceeds from the sale of
donated items and the motor vehicle auctions goes towards the purchase of food to restock their
food bank, gift cards from local grocery stores, and their operational expenses.

Individuals that ask for assistance are first required to fill out an application. The application
is then reviewed by one of the staff assistants, who then decide on how much assistance is to be
given. The assistance can either be for clothing, furniture, and/or food gift cards. This was
especially evident in 20XX after Hurricane Ike ravaged the greater City area. Many low-income
residents lost clothing, furniture, and food due to the storm, and ORG, helped out a large number
of those citizens. The applications for assistance, for calendar year 20XX, were reviewed by the
examining agent. Each application showed the name, address, and what type of assistance was
being requested. Attached to each approved application was the type of assistance granted, i.e.,
clothing, furniture, and/or food cards. ORG is a valuable source of assistance for the low income
residents in the area.

Bank statements and the check register were examined during our audit the last week of
September 20XX. The bank statements and check registers revealed a lot of questionable
expenses. When I returned to the office I completed a work paper entering each questionable
purchase. On October 6, 20XX I held a phone interview with President, and his representative,
since President was not at the audit in September, and asked him about some of the charges made

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -1-

Form 886-A Department of the Treasury - Internal Revenue Service
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG December 31,
20XX

to the Organization’s account. The few that I asked him about, most notably, the hospital bills,
rent for an apartment, purchases at CO-3, and maid service, were purchases made by President,
except for the maid services. The maid service was purchased by the late Vice President, the
Vice-President of the Organization at the time. The maid service was for Vice President’s
personal residence. After our conversation I decided to do a more in depth review of the bank
statements.

After the completion of my in depth review of the 20XX monthly bank statements I picked for
months to send to the Organization’s representative. I spoke with the representative on
December 20, 20XX, and told her that I was faxing her the four months of transactions, and I
would like to schedule another phone with her and President for January 5, 20XX. She agreed.

On January 5, 20XX I spoke with the representative only, as President was not in attendance.
We discussed the expenses, and we concluded that all of the grocery store, gas station, auto parts
stores, toll tag charges, and auto insurance purchases would be disregarded as personal for
President because the Organization does own several trucks with which to pick-up and/or deliver
furniture and clothing. The grocery store purchases were to re-supply the food bank and
purchase gift cards. The auto part store purchases were made because some of the donated
vehicles were not in running condition. As for the gas station, auto insurance, and toll tag
purchases, these were for the Organization’s vehicles. Before our conversation ended I told the
representative that I would remove all aforementioned charges, and send her all twelve months of
charges that needed further substantiation. The final work papers included in this report for these
charges are categorized as follows: Cash Withdrawals, Department and Supply Stores, Food and
Entertainment, Loans and Pay by Phone Charges, Medical and Pharmacies, Unknown
Transactions and Miscellaneous, and Utilities.

LAW:

IRC 501(a) provides, in part, that organizations described in section 501(c) are exempt from
federal income tax. Section 501(c)(3) provides in pertinent part, that an organization must be
organized and operated exclusively for religious, charitable, or educational purposes and no part
of its net earings may inure to the benefit of any private shareholder or individual.

IRC 501(c)(3) are corporations, and any community chest, fund, or foundation, organized
and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or
educational purposes, or to foster national or international amateur sports competition (but only if
no part of its activities involve the provision of athletic facilities or equipment), or for the
prevention of cruelty to children or animals, and no part of the net earnings of which inures to the
benefit of any private shareholder or individual.

IRC 6001 provides that every person liable for any tax imposed by this title, or for the
collection thereof, shall keep such records, render such statements, make such returns, and

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -2-

Form 886-A Department of the Treasury - Internal Revenue Service
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG December 31,
20XX

comply with such rules and regulations as the Secretary may from time to time prescribe.
Whenever in the judgment of the Secretary it is necessary, he may require any person, by notice
served upon such person or by regulations, to make such returns, render such statements, or keep
such records, as the Secretary deems sufficient to show whether or not such person is liable for
tax under this title.

IRC 6033(a)(1) provides, except as provided in IRC §6033(a)(2), every organization exempt
from tax under Section 501(a) shall file an annual return, stating specifically the items of gross
income, receipts and disbursements, and such other information for the purposes of carrying out
the internal revenue laws as the Secretary may by forms or regulations prescribe, and keep such
records, render under oath such statements, make such other returns, and comply with such rules
and regulations as the Secretary may from time to time prescribe.

Treasury Regulation §1.501(c)(3)-1(a)(1) of the Income Tax Regulations provides that in
order for an organization to be exempt under section 501(c)(3) of the Code it 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 or operational test, it is not exempt.

Treasury Regulation §1.501(a)-1(b)(3)(c) states that the words “private shareholder or
individual” in section 501 refer to persons having a personal and private interest in the activities
of the organization. The word “shareholder,” as used here, does not have the same meaning as it
does in a for-profit corporation. An exempt organization cannot have shareholders, or it would
not meet the organizational test. However, these are terms that Congress gave us.

Treasury Regulation §1.501(c)(3)-1(b)(4) provides that an organization is not organized
exclusively for one or more exempt purposes unless its assets are dedicated to an exempt
purpose. Further, it provides that an organization does not meet the organizational test if its
articles or the law of the State in which it was created provide that its assets would, upon
dissolution, be distributed to its members or shareholders.

Treasury Regulation §1.501(c)(3)-1(c)(1) 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 such 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.

Treasury Regulation §1.501(c)(3)-1(c)(2) states 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.

Treasury Regulation §1.501(c)(3)-1(d)(1)(ii) states that an organization is not organized or
operated exclusively for one or more of the purposes specified in subdivision (1) of this

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -3-

Form 886-A Department of the Treasury - Internal Revenue Service
Explanation of Items Exhibit
Name of Taxpayer Year/ Period Ended
ORG December 31,
20XX

subparagraph unless it serves a public rather than a private interest. Thus, to meet the
requirement of this subdivision, 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. This group of individuals is generally referred to as
“insiders.”’ This regulation places the burden of proof on the organization to demonstrate 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.

The Operational Test must meet the following three requirements:

1. Engage primarily (>50%) in activities which accomplish one or more of the exempt
   purposes specified in IRC section 501(c)(3) and (Treas. Reg. Section 1.501(c)(3)-1(c)(1)),
2. Not allow its net earnings to inure to the benefit of private shareholders or individuals
   (Treas. Reg. Section 1.501(c)(3)-1(c)(2)),
3. Not engage in substantial (>5%) lobbying activity (Treas. Reg. Section 1.501(c)(3)-
   1(c)(3)), and not engage in any political activity (Treas. Reg. Section 1.501(c)(3)-1(c)(3)).
   If an organization fails to comply with any of these requirements, it will fail the operational
   test and lose its IRC section 501(c)(3) exemption.

Rev. Rul. 59-95, 1959-1 C.B. 627, concerns an exempt organization that was requested to
produce a financial statement and statement of its operations for a certain year. However, its
records were so incomplete that the organization was unable to furnish such statements. The
Service held that the failure or inability to file the required information return or otherwise to
comply with the provisions of IRC § 6033 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 exempt status.

In accordance with the above cited provisions of the Code and regulations under IRC § 6001
and 6033, organizations recognized as exempt from federal income tax must meet certain
reporting requirements. These requirements relate to the filing of a complete and accurate annual
information (and other required federal tax forms) and the retention of records sufficient to
determine whether such entity is operated for the purposes for which it was granted tax-exempt
status and to determine its liability for any unrelated business income tax.

Revenue Ruling 78-232, 1978-1, C.B.69 explains that in the instant case the money
deposited by the taxpayer in the ABC church account was used or available for use for the
taxpayer’s benefit. The taxpayer had complete control and enjoyment of the money and it was
used to maintain the taxpayer’s accustomed standard of living. Under the circumstances no
portion of the amounts deposited by the taxpayer in the ABC church account can be identified as
for the exclusive benefit of the organization.

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -4-

Form 886-A Department of the Treasury - Internal Revenue Service
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG December 31,
20XX

Church by Mail, Inc. v. Commissioner of Internal Revenue 1985, 765 F.2d 1387, 56
A.F.T.R.2d 85-5483, 85-2 USTC P 9549. The dispositive issue in this case is whether the
Church meets the “operational” test imposed by I.R.C. § 501(c)(3). The Treasury Regulations
specify three criteria for this requirement. First, the organization must be primarily engaged in
activities which accomplish one or more of the exempt purposes specified in section 501(c)(3),
so that it is “operated exclusively” for exempt purposes. Treas.Reg. § 1.501(c)(3)-(1)(c)(1).
Second, the organization's net earnings must not be distributed in whole or in part to the benefit
of private shareholders or individuals.

The tax court upheld the Commissioner's determination, holding that (1) the Church was
operated for the non-exempt purpose of providing a market for Twentieth's services, and (2) a
substantial, if not principal, purpose of the Church's operations was to generate income for the
private benefit of Reverend Ewing and Reverend McElrath and their respective families.

In Church of Gospel Ministry, Inc. v. United States, 640 F. Supp. 96, 1986 U.S. Dist.,
due to the taxpayer's failure to keep adequate records, the court held that the taxpayer failed to
sustain its burden to show that it was qualified for federal tax exemption as a corporation
organized and operated exclusively for religious and charitable purposes, as required under IRC
§501 (c)(3), and that it was further qualified to receive deductible charitable contributions under
IRC §170(c)(2). The court found that as a prerequisite to an IRC §6033 filing exemption, it was
necessary for the taxpayer to show it qualified as an IRC §501 (c)(3) organization, which it could
not.

John Marshall Law School v. U.S. 1981 WL 11168, 48 A.F.T.R.2d 81-5340, 81-2 USTC P
9514 (Ct.Cl. Trial Div. Jun 24, 1981) (NO. 27-78, 28-78)
In its determination letter, the IRS stated that it had considered numerous items pertaining to the
fiscal years ended August 31, 1967 to August 31, 1973, including, but not limited to, payments
by John Marshall Law School (JMLS) for Fenster family: automobiles, education, and travel
expenses, insurance policies, basketball and hockey tickets, membership in a private eating
establishment, membership in a health spa, interest-free loans, home repairs, personal household
furnishings and appliances, and golfing equipment. John Marshall Law School hereinafter
(Plaintiff) argued that all the expenses incurred by the organization were ordinary and necessary
in furtherance of their exempt purpose. The term ‘net earnings' in the inurement-of-benefit
clause of § 501(c)(3) has been construed to permit an organization to incur ordinary and
necessary expenses in the course of its operations without losing its tax-exempt status. The
issue, therefore, is whether or not the expenditures Plaintiff paid to or on behalf of the Fenster
family were ordinary and necessary to Plaintiff operations. Also, the burden of proof was on
Plaintiff to establish that the grounds set forth in determination letter and the resulting revocation
of notice of exemption was erroneous.

Ultimately, the court decided that their jurisdiction was limited to a review of error for the
Service’s revocation of Plaintiff's favorable tax-exempt ruling. The burden of establishing

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -5-

Form 886-A Department of the Treasury - Internal Revenue Service
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG December 31,
20XX

whether the Plaintiff is an organization described in section 501(c)(3), furthermore, rests with the
Plaintiff. It is the courts decision that the Commissioner of Internal Revenue’s revocation of
Plaintiff's notices of exemption for the years 1966 through 1973 was correct.

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. Also, the existence of a substantial nonexempt purpose, regardless of the number or
importance of exempt purposes, will cause failure of the operational test. The Court found that
the trade association had an “underlying commercial motive” that distinguished its educational
program from that carried out by a university.

TAXPAYER’S POSITION:
The taxpayer has agreed to revocation, and will sign Form 6018.

GOVERNMENTS POSITION:

ORG, a corporation recognized by the Internal Revenue Service as being exempt from federal
income tax under Internal Revenue Code section 501(c)(3) and having a foundation status of
170(b)(1)(A)(vi), must pass two tests in order to continue its exempt status. The first test, the
Organizational Test, relates to the organization’s organizational documents. This test can only be
satisfied if the written documents prepared at the time of the organization’s formation meets the
requirements of the regulations. An organizational document must meet requirements in both
form and language. ORG satisfied the organizational requirement by having their Articles of
Incorporation formed under the State of State’ non-profit corporation law. Their Articles of
Incorporation were stamped received by the Secretary of State of State. ORG also satisfied the
language requirement by having an acceptable purpose clause, powers clause, and although not
needed in the State of State, a dissolution clause.

To establish that ORG operates primarily in activities which accomplish its exempt purposes, the
Organization must establish that no more than an insubstantial part of its activities does not
further an exempt purpose. Sec. 1.501 (c)(3)-1 (c)(1), Income Tax Regs. The presence of a single
substantial nonexempt purpose destroys the exemption regardless of the number or importance of
the exempt purposes. Better Business Bureau v. United States. While ORG is not an action
organization, it has failed to comply with the first two conditions of the operational test because
of the egregious usage of the Organization’s assets for private benefit.

A 501(c)(3)’s assets are required to be irrevocably dedicated to their exempt purpose(s). Treas.
Reg. § 1.501 (c)(3)-1 (b)(4). The inurement prohibition serves to prevent the individuals who
operate the organization from siphoning off any of a charity's income or assets for personal use.

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -6-

Form 886-A Department of the Treasury - Internal Revenue Service
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG December 31,
20XX

An organization is described in section 501(c)(3) only if no part of its net earnings inures to
the benefit of any private shareholder. The inurement prohibition is designed to insure that
organization’s assets are dedicated to exclusively furthering public purposes. An organization is
not operated exclusively for exempt purposes if its net earnings inure to the benefit of private
shareholders or individuals.

Inurement can take the form of questionable transactions that have no causal relationship to
the organization's exempt purposes but result in some benefit to an insider. The insider, President
is in a position to exercise control over the organization's net earnings as if they were his own by
using them at will rather than within the limitations of a fiduciary capacity. In effect, President is
using the public's “net earnings” for his own benefit. By using the Organization's assets
President has breached the private inurement prohibition. See John Marshall Law School v. U.S.

Although the requirements for finding inurement or private benefit are similar, inurement and
private benefit differ in two key respects. The first is that even a minimal amount of inurement
results in disqualification for exempt status, whereas private benefit must be more than
quantitatively or qualitatively incidental in order to jeopardize tax exempt status. The second is
that inurement only applies to “insiders” (individuals whose relationship with an organization
offers them an opportunity to make use of the organization’s income or assets for personal gain),
whereas private benefit may accrue to anyone. ORG has failed the operational requirement
(inurement), in using a substantial amount of the Organization’s assets for personal gain as
discussed in Treasury Regulation §1.501(c)(3)-1(d)(1)(ii). _Inurement can take the form of any
transaction. The transaction results in inurement because it provides a disproportionate benefit to
an insider. President is considered an insider. Private inurement may be as straightforward as a
cash payment to an insider when the organization has no obligation to pay. Put simply,
inurement is the use of an exempt organization’s assets to benefit an individual(s) connected to it
on a personal level. As a result, such use means the organization does not exclusively serve the
public. Note, that the payment of personal expenses of an insider that the organization did not
characterize as compensation at the time of payment may constitute inurement even when, if
added to compensation, the total amount of compensation would be reasonable.

As in the case of John Marshall Law School v. U.S., the assets of ORG inured to the private
benefit of President, an Officer of ORG The Internal Revenue Code and Regulations provide that
an organization exempt under IRC Section 501(c)(3) can not allow its assets to benefit private
interests; an organization that allows their assets to benefit private interests is not exempt.

The “not more than an insubstantial part of its activities” standard of section 1.501(c)(3)-
1(c)(1) of the regulations can be understood by reference to Better Business Bureau v. United
States, 316 U.S. 279 (1945) which held that an organization which engaged in some educational
activity but pursued nonprofit goals outside the scope of the statute was not exempt under section
501(c)(3) of the Code. The Court stated that an organization is not operated exclusively for
charitable purposes if it has a single noncharitable purpose that is substantial in nature. This is

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -7-

Form 886-A Department of the Treasury - Internal Revenue Service
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG December 31,
20XX

true regardless of the number or importance of the organization's charitable purposes. Thus, the
operational test standard prohibiting a substantial nonexempt purpose is broad enough to include
inurement, private benefit, and operations which further goals outside the scope of section
501(c)(3).

There was no calendar of events for when the auctions took place, how many vehicles were
sold, and the revenue received, no billing information, and no log books were kept as to where
and when the pick ups and deliveries took place. IRC 6001 requires that every person liable for
any tax imposed by the Code shall keep adequate records. ORG failed, or lost to keep such
records as required by this Code section. Also, IRC 6033(a)(1) requires every organization
exempt from tax under Section 501(a) shall file an annual return stating specifically the items of
gross income, receipts and disbursements.

CONCLUSION:

In the case of ORG, the primary activity is to use the assets of the Organization for personal
gain. ORG does not qualify for exemption from Federal Income Tax as an organization
described in section 501(c)(3) of the Code because of the egregious nature as to which the assets
of the Organization were used for personal gain.

Consequently, we are proposing that ORG exemption from federal income tax be revoked as
of January 1, 20XX. Please file U.S. Corporation income tax return Form 1120 for tax periods
ending December 31, 20XX, December 31, 20XX, and December 31, 20XX. Contributions to
your organization are not deductible under IRC Code section 170.

If you agree with our decision please sign and return Form 6018 in the enclosed
envelope.

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.

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -8-

Form 886-A Department of the Treasury - Internal Revenue Service
Explanation of Items Exhibit
Name of Taxpayer Year/ Period Ended
ORG December 31,
20XX
LEGEND
ORG - Organization name XX - Date State - state City - city
President - president Vice-President - vice president CO-1, CO-2 & CO-3

= 18, 2™¢ s 3°4¢ COMPANIES

ISSUE:

Is ORG, Inc operating exclusively for charitable purposes described in Internal Revenue Code
(IRC) § 501(c)(3)?

FACTS:

ORG was incorporated on November 29, 20XX in the state of State. Their Articles of
Incorporation were stamped by the Secretary of State of State on November 29, 20XX. The
Organization was recognized as being exempt from the Federal income under section 501(c)(3)
of the Internal Revenue Code on February 2, 20XX, with a foundation status of 509(a)(2). At the
end of their advanced ruling period, their foundation status remained the same.

The purpose of the Organization is to solicit donations of clothing, household items, food and
furniture for distribution to those individuals or families living below the poverty line, or in a
family or financial crisis. The Organization recruits churches within the Organization’s zip code
(zip code) to help with collecting and distributing. The Organization prepares a weekly mailing
list of all garage and estate sales in the CO-1 and CO-2, a free publication. The Organization
also solicits ads to the public for their donated vehicle program. The proceeds from the sale of
donated items and the motor vehicle auctions goes towards the purchase of food to restock their
food bank, gift cards from local grocery stores, and their operational expenses.

Individuals that ask for assistance are first required to fill out an application. The application
is then reviewed by one of the staff assistants, who then decide on how much assistance is to be
given. The assistance can either be for clothing, furniture, and/or food gift cards. This was
especially evident in 20XX after Hurricane Ike ravaged the greater City area. Many low-income
residents lost clothing, furniture, and food due to the storm, and ORG, helped out a large number
of those citizens. The applications for assistance, for calendar year 20XX, were reviewed by the
examining agent. Each application showed the name, address, and what type of assistance was
being requested. Attached to each approved application was the type of assistance granted, i.e.,
clothing, furniture, and/or food cards. ORG is a valuable source of assistance for the low income
residents in the area.

Bank statements and the check register were examined during our audit the last week of
September 20XX. The bank statements and check registers revealed a lot of questionable
expenses. When I returned to the office I completed a work paper entering each questionable
purchase. On October 6, 20XX I held a phone interview with President, and his representative,
since President was not at the audit in September, and asked him about some of the charges made

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -1-

orn 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG December 31,
20XX

to the Organization’s account. The few that I asked him about, most notably, the hospital bills,
rent for an apartment, purchases at CO-3, and maid service, were purchases made by President,
except for the maid services. The maid service was purchased by the late Vice President, the
Vice-President of the Organization at the time. The maid service was for Vice President’s
personal residence. After our conversation I decided to do a more in depth review of the bank
statements.

After the completion of my in depth review of the 20XX monthly bank statements I picked for
months to send to the Organization’s representative. I spoke with the representative on
December 20, 20XX, and told her that I was faxing her the four months of transactions, and I
would like to schedule another phone with her and President for January 5, 20XX. She agreed.

On January 5, 20XX I spoke with the representative only, as President was not in attendance.
We discussed the expenses, and we concluded that all of the grocery store, gas station, auto parts
stores, toll tag charges, and auto insurance purchases would be disregarded as personal for
President because the Organization does own several trucks with which to pick-up and/or deliver
furniture and clothing. The grocery store purchases were to re-supply the food bank and
purchase gift cards. The auto part store purchases were made because some of the donated
vehicles were not in running condition. As for the gas station, auto insurance, and toll tag
purchases, these were for the Organization’s vehicles. Before our conversation ended I told the
representative that I would remove all aforementioned charges, and send her all twelve months of
charges that needed further substantiation. The final work papers included in this report for these
charges are categorized as follows: Cash Withdrawals, Department and Supply Stores, Food and
Entertainment, Loans and Pay by Phone Charges, Medical and Pharmacies, Unknown
Transactions and Miscellaneous, and Utilities.

LAW:

IRC 501(a) provides, in part, that organizations described in section 501(c) are exempt from
federal income tax. Section 501(c)(3) provides in pertinent part, that an organization must be
organized and operated exclusively for religious, charitable, or educational purposes and no part
of its net earnings may inure to the benefit of any private shareholder or individual.

IRC 501(c)(3) are corporations, and any community chest, fund, or foundation, organized
and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or
educational purposes, or to foster national or international amateur sports competition (but only if
no part of its activities involve the provision of athletic facilities or equipment), or for the
prevention of cruelty to children or animals, and no part of the net earnings of which inures to the
benefit of any private shareholder or individual.

IRC 6001 provides that every person liable for any tax imposed by this title, or for the
collection thereof, shall keep such records, render such statements, make such returns, and

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -2-

Form 886-A Department of the Treasury - Internal Revenue Service
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG December 31,
20XX

comply with such rules and regulations as the Secretary may from time to time prescribe.
Whenever in the judgment of the Secretary it is necessary, he may require any person, by notice
served upon such person or by regulations, to make such returns, render such statements, or keep
such records, as the Secretary deems sufficient to show whether or not such person is liable for
tax under this title.

IRC 6033(a)(1) provides, except as provided in IRC §6033(a)(2), every organization exempt
from tax under Section 501(a) shall file an annual return, stating specifically the items of gross
income, receipts and disbursements, and such other information for the purposes of carrying out
the internal revenue laws as the Secretary may by forms or regulations prescribe, and keep such
records, render under oath such statements, make such other returns, and comply with such rules
and regulations as the Secretary may from time to time prescribe.

Treasury Regulation §1.501(c)(3)-1(a)(1) of the Income Tax Regulations provides that in
order for an organization to be exempt under section 501(c)(3) of the Code it 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 or operational test, it is not exempt.

Treasury Regulation §1.501(a)-1(b)(3)(c) states that the words “private shareholder or
individual” in section 501 refer to persons having a personal and private interest in the activities
of the organization. The word “shareholder,” as used here, does not have the same meaning as it
does in a for-profit corporation. An exempt organization cannot have shareholders, or it would
not meet the organizational test. However, these are terms that Congress gave us.

Treasury Regulation §1.501(c)(3)-1(b)(4) provides that an organization is not organized
exclusively for one or more exempt purposes unless its assets are dedicated to an exempt
purpose. Further, it provides that an organization does not meet the organizational test if its
articles or the law of the State in which it was created provide that its assets would, upon
dissolution, be distributed to its members or shareholders.

Treasury Regulation §1.501(c)(3)-1(c)(1) 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 such 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.

Treasury Regulation §1.501(c)(3)-1(c)(2) states 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.

Treasury Regulation §1.501(c)(3)-1(d)(1)(ii) states that an organization is not organized or
operated exclusively for one or more of the purposes specified in subdivision (i) of this

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -3-

Form 886-A Department of the Treasury - Internal Revenue Service
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG December 31,
20XX

subparagraph unless it serves a public rather than a private interest. Thus, to meet the
requirement of this subdivision, 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. This group of individuals is generally referred to as
“insiders.” This regulation places the burden of proof on the organization to demonstrate 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.

The Operational Test must meet the following three requirements:

1. Engage primarily (>50%) in activities which accomplish one or more of the exempt
   purposes specified in IRC section 501(c)(3) and (Treas. Reg. Section 1.501(c)(3)-1(c)(1)),
2. Not allow its net earnings to inure to the benefit of private shareholders or individuals
   (Treas. Reg. Section 1.501(c)(3)-1(c)(2)),
3. Not engage in substantial (>5%) lobbying activity (Treas. Reg. Section 1.501(c)(3)-
   1(c)(3)), and not engage in any political activity (Treas. Reg. Section 1.501(c)(3)-1(c)(3)).
   If an organization fails to comply with any of these requirements, it will fail the operational
   test and lose its IRC section 501(c)(3) exemption.

Rev. Rul. 59-95, 1959-1 C.B. 627, concerns an exempt organization that was requested to
produce a financial statement and statement of its operations for a certain year. However, its
records were so incomplete that the organization was unable to furnish such statements. The
Service held that the failure or inability to file the required information return or otherwise to
comply with the provisions of IRC § 6033 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 exempt status.

In accordance with the above cited provisions of the Code and regulations under IRC § 6001
and 6033, organizations recognized as exempt from federal income tax must meet certain
reporting requirements. These requirements relate to the filing of a complete and accurate annual
information (and other required federal tax forms) and the retention of records sufficient to
determine whether such entity is operated for the purposes for which it was granted tax-exempt
status and to determine its liability for any unrelated business income tax.

Revenue Ruling 78-232, 1978-1, C.B.69 explains that in the instant case the money
deposited by the taxpayer in the ABC church account was used or available for use for the
taxpayer’s benefit. The taxpayer had complete control and enjoyment of the money and it was
used to maintain the taxpayer’s accustomed standard of living. Under the circumstances no
portion of the amounts deposited by the taxpayer in the ABC church account can be identified as
for the exclusive benefit of the organization.

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -4-

Form 886-A Department of the Treasury - Internal Revenue Service
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG December 31,
20XX

Church by Mail, Inc. v. Commissioner of Internal Revenue 1985, 765 F.2d 1387, 56
A.F.T.R.2d 85-5483, 85-2 USTC P 9549. The dispositive issue in this case is whether the
Church meets the “operational” test imposed by I.R.C. § 501(c)(3). The Treasury Regulations
specify three criteria for this requirement. First, the organization must be primarily engaged in
activities which accomplish one or more of the exempt purposes specified in section 501(c)(3),
so that it is “operated exclusively” for exempt purposes. Treas.Reg. § 1.501(c)(3)-(1)(c)(1).
Second, the organization's net earnings must not be distributed in whole or in part to the benefit
of private shareholders or individuals.

The tax court upheld the Commissioner's determination, holding that (1) the Church was
operated for the non-exempt purpose of providing a market for Twentieth's services, and (2) a
substantial, if not principal, purpose of the Church's operations was to generate income for the
private benefit of Reverend Ewing and Reverend McElrath and their respective families.

In Church of Gospel Ministry, Inc. v. United States, 640 F. Supp. 96, 1986 U.S. Dist.,
due to the taxpayer's failure to keep adequate records, the court held that the taxpayer failed to
sustain its burden to show that it was qualified for federal tax exemption as a corporation
organized and operated exclusively for religious and charitable purposes, as required under IRC
§501 (c)(3), and that it was further qualified to receive deductible charitable contributions under
IRC §170(c)(2). The court found that as a prerequisite to an IRC §6033 filing exemption, it was
necessary for the taxpayer to show it qualified as an IRC §501 (c)(3) organization, which it could
not.

John Marshall Law School v. U.S. 1981 WL 11168, 48 A.F.T.R.2d 81-5340, 81-2 USTC P
9514 (Ct.Cl. Trial Div. Jun 24, 1981) (NO. 27-78, 28-78)
In its determination letter, the IRS stated that it had considered numerous items pertaining to the
fiscal years ended August 31, 1967 to August 31, 1973, including, but not limited to, payments
by John Marshall Law School (JMLS) for Fenster family: automobiles, education, and travel
expenses, insurance policies, basketball and hockey tickets, membership in a private eating
establishment, membership in a health spa, interest-free loans, home repairs, personal household
furnishings and appliances, and golfing equipment. John Marshall Law School hereinafter
(Plaintiff) argued that all the expenses incurred by the organization were ordinary and necessary
in furtherance of their exempt purpose. The term ‘net earnings' in the inurement-of-benefit
clause of § 501(c)(3) has been construed to permit an organization to incur ordinary and
necessary expenses in the course of its operations without losing its tax-exempt status. The
issue, therefore, is whether or not the expenditures Plaintiff paid to or on behalf of the Fenster
family were ordinary and necessary to Plaintiff operations. Also, the burden of proof was on
Plaintiff to establish that the grounds set forth in determination letter and the resulting revocation
of notice of exemption was erroneous.

Ultimately, the court decided that their jurisdiction was limited to a review of error for the
Service’s revocation of Plaintiffs favorable tax-exempt ruling. The burden of establishing

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -5-

Form 886-A Department of the Treasury - Internal Revenue Service
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG December 31,
20XX

whether the Plaintiff is an organization described in section 501(c)(3), furthermore, rests with the
Plaintiff. It is the courts decision that the Commissioner of Internal Revenue’s revocation of
Plaintiff's notices of exemption for the years 1966 through 1973 was correct.

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. Also, the existence of a substantial nonexempt purpose, regardless of the number or
importance of exempt purposes, will cause failure of the operational test. The Court found that
the trade association had an “underlying commercial motive” that distinguished its educational
program from that carried out by a university.

TAXPAYER’S POSITION:
The taxpayer has agreed to revocation, and will sign Form 6018.

GOVERNMENTS POSITION:

ORG, a corporation recognized by the Internal Revenue Service as being exempt from federal
income tax under Internal Revenue Code section 501(c)(3) and having a foundation status of
170(b)(1)(A)(vi), must pass two tests in order to continue its exempt status. The first test, the
Organizational Test, relates to the organization’s organizational documents. This test can only be
satisfied if the written documents prepared at the time of the organization’s formation meets the
requirements of the regulations. An organizational document must meet requirements in both
form and language. ORG satisfied the organizational requirement by having their Articles of
Incorporation formed under the State of State’ non-profit corporation law. Their Articles of
Incorporation were stamped received by the Secretary of State of State. ORG also satisfied the
language requirement by having an acceptable purpose clause, powers clause, and although not
needed in the State of State, a dissolution clause.

To establish that ORG operates primarily in activities which accomplish its exempt purposes, the
Organization must establish that no more than an insubstantial part of its activities does not
further an exempt purpose. Sec. 1.501 (c)(3)-1 (c)(1), Income Tax Regs. The presence of a single
substantial nonexempt purpose destroys the exemption regardless of the number or importance of
the exempt purposes. Better Business Bureau v. United States. While ORG is not an action
organization, it has failed to comply with the first two conditions of the operational test because
of the egregious usage of the Organization’s assets for private benefit.

A 501(c)(3)’s assets are required to be irrevocably dedicated to their exempt purpose(s). Treas.
Reg. § 1.501 (c)(3)-1 (b)(4). The inurement prohibition serves to prevent the individuals who
operate the organization from siphoning off any of a charity's income or assets for personal use.

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -6-

Form 886-A Department of the Treasury - Internal Revenue Service
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG December 31,
20XX

An organization is described in section 501(c)(3) only if no part of its net earnings inures to
the benefit of any private shareholder. The inurement prohibition is designed to insure that
organization’s assets are dedicated to exclusively furthering public purposes. An organization is
not operated exclusively for exempt purposes if its net earnings inure to the benefit of private
shareholders or individuals.

Inurement can take the form of questionable transactions that have no causal relationship to
the organization's exempt purposes but result in some benefit to an insider. The insider, President
is in a position to exercise control over the organization's net earnings as if they were his own by
using them at will rather than within the limitations of a fiduciary capacity. In effect, President is
using the public's “net earnings” for his own benefit. By using the Organization's assets
President has breached the private inurement prohibition. See John Marshall Law School v. U.S.

Although the requirements for finding inurement or private benefit are similar, inurement and
private benefit differ in two key respects. The first is that even a minimal amount of inurement
results in disqualification for exempt status, whereas private benefit must be more than
quantitatively or qualitatively incidental in order to jeopardize tax exempt status. The second is
that inurement only applies to “insiders” (individuals whose relationship with an organization
offers them an opportunity to make use of the organization’s income or assets for personal gain),
whereas private benefit may accrue to anyone. ORG has failed the operational requirement
(inurement), in using a substantial amount of the Organization’s assets for personal gain as
discussed in Treasury Regulation §1.501(c)(3)-1(d)(1)(ii). Inurement can take the form of any
transaction. The transaction results in inurement because it provides a disproportionate benefit to
an insider. President is considered an insider. Private inurement may be as straightforward as a
cash payment to an insider when the organization has no obligation to pay. Put simply,
inurement is the use of an exempt organization’s assets to benefit an individual(s) connected to it
on a personal level. As a result, such use means the organization does not exclusively serve the
public. Note, that the payment of personal expenses of an insider that the organization did not
characterize as compensation at the time of payment may constitute inurement even when, if
added to compensation, the total amount of compensation would be reasonable.

As in the case of John Marshall Law School v. U.S., the assets of ORG inured to the private
benefit of President, an Officer of ORG The Internal Revenue Code and Regulations provide that
an organization exempt under IRC Section 501(c)(3) can not allow its assets to benefit private
interests; an organization that allows their assets to benefit private interests is not exempt.

The “not more than an insubstantial part of its activities” standard of section 1.501(c)(3)-
1(c)(1) of the regulations can be understood by reference to Better Business Bureau v. United
States, 316 U.S. 279 (1945) which held that an organization which engaged in some educational
activity but pursued nonprofit goals outside the scope of the statute was not exempt under section
501(c)(3) of the Code. The Court stated that an organization is not operated exclusively for
charitable purposes if it has a single noncharitable purpose that is substantial in nature. This is

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -7-

Form 886-A Department of the Treasury - Internal Revenue Service
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG December 31,
20XX

true regardless of the number or importance of the organization's charitable purposes. Thus, the
operational test standard prohibiting a substantial nonexempt purpose is broad enough to include
inurement, private benefit, and operations which further goals outside the scope of section
501(c)(3).

There was no calendar of events for when the auctions took place, how many vehicles were
sold, and the revenue received, no billing information, and no log books were kept as to where
and when the pick ups and deliveries took place. IRC 6001 requires that every person liable for
any tax imposed by the Code shall keep adequate records. ORG failed, or lost to keep such
records as required by this Code section. Also, IRC 6033(a)(1) requires every organization
exempt from tax under Section 501(a) shall file an annual return stating specifically the items of
gross income, receipts and disbursements.

CONCLUSION:

In the case of ORG, the primary activity is to use the assets of the Organization for personal
gain. ORG does not qualify for exemption from Federal Income Tax as an organization
described in section 501(c)(3) of the Code because of the egregious nature as to which the assets
of the Organization were used for personal gain.

Consequently, we are proposing that ORG exemption from federal income tax be revoked as
of January 1, 20XX. Please file U.S. Corporation income tax return Form 1120 for tax periods
ending December 31, 20XX, December 31, 20XX, and December 31, 20XX. Contributions to
your organization are not deductible under IRC Code section 170.

If you agree with our decision please sign and return Form 6018 in the enclosed
envelope.

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.

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -8-