IRS revokes an organization's section 501(c)(3) exemption for nonexempt activity and private inurement

Plain-English summary

The IRS revoked an organization's federal tax exemption under section 501(c)(3), effective on the redacted date stated in the letter. The IRS concluded that the organization was not operated primarily for exempt purposes, furthered a substantial nonexempt commercial purpose, and served private rather than public interests. The examination report also states that a property owned by the organization was sold and the proceeds were diverted to a related entity and an individual, which the IRS treated as private inurement. The package explains the loss of deductibility for contributions, the requirement to file Form 1120, and the taxpayer's available declaratory-judgment remedies.

Ruling snapshot

• Question: Whether the organization continued to qualify for exemption under IRC section 501(c)(3).
• Outcome: revocation
• Key authorities: IRC §§ 501(c)(3), 509(a)(2), and 7428; Treas. Reg. §§ 1.501(a)-1(c), 1.501(c)(3)-1(a)(1), 1.501(c)(3)-1(c)(2), and 1.501(c)(3)-1(d)(1)(ii).

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
1100 Commerce Street 501.03-00
Dallas, TX 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Date: 9/12/2011

Release Number: 201203032
Release Date: 1/20/2012

LEGEND Person to Contact:
ORG - Organization name Badge Number:
XX - Date Address - address Contact Telephone Number:
ORG Contact Address:
ADDRESS Employer Identification Number:

CERTIFIED MAIL
Dear

This is a final notice of adverse determination that your exempt status under section

501(c)(3) of the Internal Revenue Code is revoked. Recognition of your exemption under
Internal Revenue Code section 501(c)(3) is revoked effective January 1, 20XX for the following
reason(s):

You are not operated exclusively for an exempt purpose as required by Internal Revenue Code
section 501(c)(3). You are not and have not been engaged primarily in activities which
accomplish one or more exempt purposes. You are not a charitable organization within the
meaning of Treasury Regulation 1.501(c)(3)-1(d); rather, your activities further a substantial
nonexempt commercial purpose and serve private rather than public interests.

Because you did not protest the proposed modification of your non-private foundation status and
have indicated your agreement by signing the Form 6018 on June 15, 20XX, it is further determined
that you have not exhausted your available remedies for purposes of declaratory judgment under
section 7428 of the Code.

Contributions to your organization are no longer deductible effective January 1, 20XX.

Since your exempt status has been revoked, you are required to file Form 1120, U.S.
Corporation Income Tax Return, for all years beginning on or after January 1, 20XX.

Income tax returns for subsequent years are to be filed with the appropriate Service Center
identified in the instructions for those returns.

It is further determined that your failure to file a written appeal constitutes a failure to exhaust
your available administrative remedies. However, if you decide to contest this determination in

court, you must initiate a suit for declaratory judgment in the United States Tax Court, the
United States Claims Court, or the district court of the United States for the District of Columbia
before the (ninety-first) 91st day after the date that this determination was mailed to you.
Contact the clerk of the appropriate court for rules for initiating suits for declaratory judgment.
To secure a petition form, write to the following address: United States Tax Court, 400 Second
Street, NW, Washington, DC 20217.

Please understand that filing a petition for a declaratory judgment under IRC section 7428 will
not delay the processing of subsequent income tax returns and assessment of any taxes due.

You also have the right to contact the Office of the Taxpayer Advocate. However, you should
first contact the person whose name and telephone number are shown above since this person
can access your tax information and can help you get answers. You can call 1-877-777-4778,
and ask for the Taxpayer Advocate assistance or you can contact the Advocate from the site
where this issue was determined by writing to:

Taxpayer Advocate assistance cannot be used as substitute for established IRS procedures,
formal appeals processes, etc. The Taxpayer Advocate is not able to reverse legal or technically
correct tax determination, nor extend the time fixed by law that you have to file a petition in
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.

This letter should be kept within your permanent records.

If you have any questions, please contact the person whose name and telephone number are
shown above.

Sincerely,

Nanette M. Downing
Director, EO Examinations
Enclosures:
Publication 892

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
300 N. Los Angeles St., MS 7300
Los Angeles, CA 90012

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Employer Identification Number

Form Number
Tax Year
Date: January 10, 2011
Person to Contact/ID Number
Contact Number

Tel:
Fax:
ORG
ADDRESS
Dear

On May 29, 20XX, the IRS issued a report of examination proposing revocation of ORG
(hereinafter ORG) tax exempt status under Internal Revenue Code (IRC) section
501(c)(3) on the ground that ORG was not operated for one or more exempt purposes
under such section. The facts as stated in the report of examination dated May 29,
20XX were obtained primarily through your verbal testimony. On behalf of ORG, you
consented to the proposed revocation and signed Form 6018 Consent to Proposed
Action — Section 7428 to memorialize the present intent.

Subsequent to the issuance of the report dated May 29, 20XX, we discovered additional
information relevant to the tax exempt status of ORG. The additional information was
obtained from third parties and was provided to you for your records.

Enclosed please find our revised report of examination. The revised report seeks to
supplement the facts as set forth in the report dated May 29, 20XX. Please note that
the Government maintains its position that ORG’s tax exempt status should be revoked
effective January 1, 20XX.

If you agree with the Government's position, no action is required on your part. If you
disagree with the Government's position, please state your position in writing. You may
cite established legal precedent to support your position. Please respond by January
21, 20XX.

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.

Sincerely,

Perry Tu
Revenue Agent

Enclosure:

Revised Report of Examination dated January 10, 20XX

Form 886A Department of the Treasury- Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Years Ended
December 31,
ORG (EIN) 20XX
Thru
December 31,
20XX
LEGEND
ORG - Organization name XX - Date Address - address City - city
State - state President - president DIR-1 - *** DIR
CO-1, CO-2 & CO-3 - 1st, 2nd & 3rd COMPANIES
ISSUES

1. Whether ORG’s tax exempt status under Internal Revenue Code (IRC) §501(c)(3)
   be revoked for failure to operate for exempt purposes described under such section.

2. Whether the sale of the Property owned by ORG’s by President, who then retained
   the proceeds from the sale constitutes inurement.

FACTS

Facts As Stated in Original Report of Examination
ORG (hereinafter ORG) was incorporated during 19XX in City, State. In September
19XX, ORG applied for Federal tax exempt status and was subsequently recognized as
an organization exempt from Federal income tax under IRC § 501(c)(3) and 509(a)(2).

In its application for Federal tax exempt status, Form 1023 Application of Recognition of
Exemption Under Section 501(c)(3) of the Internal Revenue Code, ORG proposed to
engage in activities that would provide for affordable housing to low income individuals.

In November 20XX, ORG’s Form 990 for the tax year ended December 31, 20XX, was
selected for examination. During the course of the examination, it was discovered that
ORG has not conducted any activities since its inception in 19XX. ORG received no
income and had no assets or liabilities. The only officer of the organization was
President. They incorporated to provide affordable housing to low income individuals.
According to President, the organization did not begin any operations nor do they plan
on starting any operations to provide affordable housing to low income individuals or
any other activities as provided under the requirements of IRS §501(c)(3). President
stated that he purchased the exempt organization from the prior owner and initially
intended to conduct said activities, but never got around to it.

Based on President’s verbal testimony, on May 29, 20XX, the IRS issued a report of
examination proposing revocation of ORG’s tax exempt status effective January 1,
20XX. President, on behalf of ORG, consented to the proposed revocation and signed
Form 6018 Consent to Proposed Action — Section 7428 to memorialize the present
intent.

Supplemental Facts Discovered Subsequent to Issuance of Original Report

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

Form 886-A Department of the ‘Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit

Name of Taxpayer Years Ended
December 31,

ORG (EIN) 20XX
Thru
December 31,
20XX

Subsequent to the issuance of the original report dated May 29, 20XX, the IRS
discovered the additional facts described below.

Formation of ORG

ORG (hereinafter referred to as ORG) was originally known as ORG and was
incorporated on June 13, 19XX, by DIR-1 for the purpose of bringing about civic
betterments and social improvements by providing for the preservation, management,
maintenance and care of the architecture and appearance of a residential cooperative
apartment project known as ORG located in the City of City.

On August 2, 19XX, ORG amended its Articles of Incorporation changing its name to
ORG. The amended purpose is to provide for the preservation, ownership,
management, maintenance, and care of low-income housing.

In 19XX, ORG applied for Federal tax exempt status and was subsequently recognized
as an organization exempt from Federal income tax under IRC § 501(c)(3). For the
years in question, President served as President and was the sole officer of ORG.

Related Entity

In June 19XX, President formed another business entity with the identical name, ORG.
President incorporated the new ORG in the state of State (hereinafter ORG State).
ORG State did not apply for Federal tax exempt status and was never recognized as a
tax exempt entity. According to the State Secretary of State, ORG State’s corporate
status was revoked. President and his spouse were listed as sole officers of ORG
State. Internet research found no information on the existence of ORG State.

Activities Conducted by ORG

In August 19XX, ORG acquired a 160-unit low-housing apartment complex known as
CO-1 (Property) located at Address, City, State. The purchase price is not known.
Neither ORG nor President provided the requested information. The purchase was
either financed or backed by the Department of Housing and Urban Development.

ORG engaged CO-2 (Management) to lease, manage and rent the Property. President
signed the management agreement on behalf of ORG. Management collected rent,
paid related operating expenses, maintained the property and provided monthly reports
to President. The monthly reports entailed monthly rent collected, related expenses
and any requests that President needed to approve. Since 19XX, ORG has not filed a
Form 990 to report its financial and non-financial activities.

Based on information obtained from Management, ORG reported the following financial
information relating to its rental activities.

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 Years Ended
December 31,
ORG (EIN) 20XX
Thru
December 31,
20XX
12/31/20XX 12/31/20XX as of 7/31/20XX

Revenue net of vacancy
Total expense
Net income

Sale of the Property

In July 20XX, President sold the Property to CO-1, a limited partnership located in
Portland, Oregon. According to the Special Warranty Deed obtained from the Office of
the County Clerk, County of County, President signed the deed in the capacity of
president. ORG State was listed as the seller on the deed.

According to information obtained from CO-3, the sale price was $$. The outstanding
mortgage on the Property at the time of the sale was $$. After selling expenses and
loan payoff, the net proceeds from the sale totaled $$. The net proceeds from the sale
of the Property were then diverted to ORG State and President.

LAW

IRC § 501(c)(3) exempts from federal income tax 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, no part of the net earnings of which inures to the benefit of any private
shareholder or individual, no substantial part of the activities of which is carrying on
propaganda, or otherwise attempting, to influence legislation (except as otherwise
provided in subsection (h)), and which does not participate in, or intervene in (including
the publishing or distributing of statements), any political campaign on behalf of (or in
opposition to) any candidate for public office.

Reg. §1.501(c)(3)-1(a)(1) provides that, in order to be exempt as an organization
described in IRC § 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.

Reg. §1.501(c)(3)-1(c)(2) clarifies that an organization is not operated exclusively for
exempt purposes if its net earnings inure to the benefit of private individuals.

Reg. §1.501(a)-1(c) defines “private shareholder or individual” as persons having a
personal and private interest in the activities of the organization.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -3-

Form 886-A Department of the Treasury= Internal Revenue Service Schedule No. or
Explanation of Items Exhibit

Name of Taxpayer Years Ended
December 31,

ORG (EIN) 20XX
Thru
December 31,
20XX

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

In Church By Mail, Inc. v. Commissioner, 765 F.2d 1387 (9th Cir. 1985), the Court
determined that Church By Mail, Inc. was not eligible for tax exempt status under IRC
§501(c)(3) because its net earning inured to benefit private persons.

TAXPAYER’S POSITIONS

In its original position, ORG agreed with the Government's position. ORG consented to
the proposed revocation and signed Form 6018 Consent to Proposed Action — Section
7428 to memorialize the present intent.

GOVERNMENT’S POSITION

Issue 1

The Government maintains that ORG’s Federal tax exempt status under IRC § 501(c)(3)
should be revoked effective January 1, 20XX for failure to operate for an exempt
purpose under such section.

Issue 2

The proceeds from the sale of the Property owned by ORG were retained by President.
The sale was not recorded on the organization’s 990. The proceeds from the sale that
were retained by President constitutes inurement within the meaning of Reg.
§1.501(c)(3)-1(c)(2). As such, revocation is warranted.

CONCLUSION
Since ORG was not operated for an exempt purpose under IRC § 501(c)(3), its Federal
tax exempt status under such section should be revoked effective January 1, 20XX.

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