IRS determination 1211025: IRS denies exemption to a research organization linked to private therapy businesses

Plain-English summary

The IRS denied tax-exempt status under IRC § 501(c)(3) to a proposed research organization whose work was based on methods developed and used by an insider's private therapy businesses. The organization planned to test brainwave and related therapy methods, but the IRS found that the insider would control the organization, receive compensation, and benefit from the research and resulting exposure. The IRS also found that the organization had not shown that its results would be distributed for public benefit rather than kept under its control. Because the organization did not file a timely protest, the proposed adverse determination became final.

Ruling snapshot

• Question: Does the proposed research organization qualify for exemption under IRC § 501(c)(3)?
• Outcome: Denied.
• Key authorities: IRC §§ 501, 170, 6104, 6110, 7428; Treas. Reg. §§ 1.501(c)(3)-1(c)(2), 1.501(c)(3)-1(d)(1)(ii)

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION
Release Number: 201211025 Contact Person:
Release Date: 3/16/2012
Date: December 22, 2011 Identification Number:
UIL Code: 501.32-00
501.33-00 Contact Number:
Employer Identification Number:
Form Required To Be Filed:
Tax Years:
Dear

This is our final determination that you do not qualify for exemption from federal income
tax as an organization described in Internal Revenue Code section 501(c)(3). Recently,
we sent you a letter in response to your application that proposed an adverse
determination. The letter explained the facts, law and rationale, and gave you 30 days
to file a protest. Since we did not receive a protest within the requisite 30 days, the
proposed adverse determination is now final.

Since you do not qualify for exemption as an organization described in Code section
501(c)(3), donors may not deduct contributions to you under Code section 170. 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.

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, you should follow the instructions in Notice 437. If you agree with
our deletions, you do not need to take any further action.

Letter 4038 (CG) (11-2005)
Catalog Number 47632S

2

In accordance with Code section 6104(c), we will notify the appropriate State officials of
our determination by sending them a copy of this final letter and the proposed adverse
letter. You should contact your State officials if you have any questions about how this
determination may affect your State responsibilities and requirements.

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 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,

Lois Lerner
Director, Exempt Organizations

Enclosure
Notice 437
Redacted Proposed Adverse Determination Letter
Redacted Final Adverse Determination Letter

Letter 4038(CG) (11-2005)
Catalog Number 47632S

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION
Date: November 2, 2011 Contact Person:

Identification Number:

Contact Number:

FAX Number:

Employer Identification Number:
LEGEND: UIL:
B = individual 501.32-00
C = individual 501.33-00

M= foundation
N= foundation
P= business
Q = date

R = state

S = business

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)(3).
The basis for our conclusion is set forth below.

Issues

Will your net earnings inure to the benefit of any private shareholder or individual? Yes,
for the reasons described below.

Were you formed to benefit private rather than public interests? Yes, for the reasons
stated below.

Letter 4036(CG) (11-2005)
Catalog Number 47630W

Facts

You were formed as a nonprofit corporation in R on Q. Your Articles of Incorporation
state you were formed exclusively for public and charitable purposes within the meaning
of Section 501(c)(3), Internal Revenue Code, more specifically, for scientific research
and education.

Your Board of Directors consists of B, C, and three other individuals. B and C are
married. Both B and C will be compensated for their work with you, at first, on an hourly
wage, eventually becoming salaried. B will oversee your entire operation, will develop,
test and train individuals in his methods. B and C are the only board members identified
on your web site.

B teaches methods of brainwave therapy and EEG (electroencephalogram) therapy. He
has a private therapy practice in R, called the N. B currently conducts private trainings
and produces products for training in ERT and EEG hypnotherapy practices. He also
entertains on television and in stage show arenas, under the corporate name of P. B will
continue to conduct these activities through both of these for-profit organizations, N and
P. B will devote 85% of his time to you and the balance of his time to the two for-profit
entities of N and P.

The activities conducted by N and P and fall under the category of general hypnosis
therapy, where B sees a client normally for a variety of ailments, including alcoholism,
drug addiction relief, and at risk teenager programs dedicated to providing children the
ability to remain drug and alcohol free for life.

You state that you were formed to scientifically prove and document the natural healing
power of the mind, providing therapists and the scientific community a measure of
brainwave activity levels and how those levels correlate to the production of natural
chemicals in the body. “The only reason to be seeking non-profit status for this entity is
to gain funding to prove scientifically how these techniques work”.

Your function will be to scientifically test the methods of healing developed by B,
continuing the scientific research of B previously conducted under S. In fact, B’s past
activities and development of advanced studies in neurophysiological therapy and
testing are the basis for your present and future activities. B has been practicing for over
25 years and has personally funded testing and research in improving brainwave
therapy. B conducts private therapy sessions in the field at his private practice in R,
offers courses to educate others on the practice of hypnosis, and teaches brainwave
and emotional replacement therapy to interested students. B has authored books on
hypnotism and is constantly working on methods to achieve healing levels of brainwave
activity through various techniques and also developed a model for measuring
brainwave levels on the Hertz scale. B has trained hundreds of students and therapists

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in brainwave therapy and is currently teaching courses in the United States and abroad,
and per your web site, will be offering an S training course on B’s methods of emotion
therapy. B has been conducting these activities over the years through his companies
N, P and S.

Your activities will include testing of brainwave frequencies and amplitudes of the mind
and the healing power of naturally generated chemicals, conducting research in EEG
processes including altering brainwave states. Research will document the physical and
mental induction techniques needed to produce certain brainwave levels. You will
document the effects of these frequencies and amplitudes and the changes in natural
mind chemicals created during therapy processes. Testing will be done on paid subjects
suffering from disorders such as anxiety, chemical dependencies, obesity and PTSD, to
name a few. Most patients will hear of your studies through advertising such as TV and
radio. You hope to obtain documented evidence of the healing power of the minds using
various brainwave levels and the natural production of beneficial chemicals at those
levels. You contend the therapy to be conducted will study the effectiveness of longer
term session series and the ability to overcome extremely difficult issues in life that are
illusive to other therapy programs. This will allow for improvements to current cures as
well as potentially lead to new cures. You will offer training to therapists to learn these
methods. You have not secured a facility yet as a location where these studies will be
done.

You have outlined three studies you intend on initially conducting with the main areas of
concentration on those suffering from the above disorders as well as biological
problems. B, therapists trained in B’s methods, an overseeing physician and a
psychologist or psychiatrist, if needed, will conduct activities. The physician is a member
of your board and will contract for services when necessary.

Any findings, studies or documentation will remain in your sole possession, but you
have indicated results will be used to further cures and teach people how to use their
mind for natural healing. You did not indicate how these results or findings would be
distributed to the medical or scientific community or to the public at large.

The treatment you perform is not funded through your clients’ insurance plans, as is the
case with N and P. For this reason it is not feasible to run these tests through any for
profit operation due to the limited test subjects you could see. Additionally, since you will
not be producing any form of patent, pill or tangible commodity, a for profit would
therefore not be able to afford these types of studies. As a result, you were formed to
seek tax deductible donations to fund your programs and activities, citing the need for a
facility and funding for appropriate studies to test and prove these methods. Once
appropriate treatments are established, you will offer help to less advantaged
individuals in need of treatment.

Letter 4036(CG) (11-2005)
Catalog Number 47630W

Law

Section 501(c)(3) of the Internal Revenue Code of 1986 (the “Code”) provides for the
exemption from federal income tax of corporations organized and operated exclusively
for charitable and educational purposes, no part of the net earnings which inures to the
benefit of any private shareholder or individual.

Treasury Regulation 1.501(c)(3)-1(c)(2) provides that an organization is not operated
exclusively for one or more exempt purposes if its net earnings inure in whole or in part
to the benefit of private shareholders or individuals.

Treasury Regulation 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.

Revenue Ruling 69-526 shows that a nonprofit organization formed by a group of
physicians specializing in heart disease to research the cause and to publish treatments
of heart defects qualifies for exemption under section 501(c)(3) of the Code. Patients
are referred to the organization by physicians and welfare agencies when it appears
that their condition merits special study and evaluation. Each patient is first examined to
ascertain whether his condition falls within the scope of the organization's research
goals.

In Rev. Rul. 69-632, 1969-2 C.B. 120, a nonprofit organization composed of members
of a particular industry to develop new and improved uses for existing products of the
industry is not exempt under section 501(c)(3) of the Code. The association’s members
select research projects in order to increase their sales by creating new uses and
markets for their product. The primary purpose of the association’s research is to serve
the private interests of its creators, rather than the public interest.

In Church by Mail, Inc. v. Commissioner, T.C. Memo 1984-349, affd 765 F. 2d 1387 (9"
Cir. 1985), the Court affirmed a Tax Court decision. Church by Mail sent out sermons in
numerous mailings. This required a great deal of printing services. A for-profit company,
controlled by the same ministers, provided the printing and the mailing. The services
were provided under two contracts. The contracts were signed by the two ministers for
both the organization and the for-profit company. The organization’s business
comprised two-thirds of the overall business done by the for-profit company. The court
determined that there was ample evidence in the record to support the finding that the
organization was operated for the substantial non-exempt purpose of providing a market

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for the services of the for-profit company.

In International Postgraduate Medical Foundation v. Commissioner, T.C. Memo 1989-
36, the court found an organization that ran tours aimed at doctors and their families
was operated to benefit the private interests of an individual who controlled the
organization and a for-profit travel agency (H&C Tours). The organization used the H&C
Tours exclusively for all travel arrangements. There was no evidence that the
organization solicited competitive bids from any travel agency for travel arrangements
for its tours other than H&C Tours. The court found that a substantial purpose of the
organization's operations was to increase the income of H&C Tours. The president of
H&C Tours controlled the organization and exercised that control for the benefit of H&C
Tours. Moreover, the administrative record supported the finding that the organization
was formed to obtain customers for H&C Tours.

Application of Law

Based on our analysis you do not satisfy the operational requirements of the Code and
Regulations to be recognized as exempt under section 501(c)(3) of the Code. Your
income will inure to insiders and your operations will result in impermissible private
benefit. Moreover, you have not shown that you are formed exclusively for an exempt
purpose under section 501(c)(3) of the Code. Specifically, you were formed for the
purpose of expanding the private practice and supporting the medical methods of B.

Section 1.501(c)(3)-1(c)(2) of the Regulations provides 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. By forming this entity to conduct
research that otherwise would have been done by N and P, or by B himself, you are
supplementing the expenses of those entities. Funds being used by you for research
activities attributable to B, and B’s companies, N and P, are serving direct personal
interests. Further, you are creating an additional pool of services not covered by private
insurance funding but rather through gifts, grants, and contributions. Patients are being
subsidized for treatment, normally provided at a cost through N and P, and B is
compensated for his services as a result. As N and P are owned and operated by B,
and because B is an insider, this is inurement. Inurement in any form disqualifies an
organization from exemption.

Section 1.501(c)(3)-1(d)(1 (iii) of the Regulations state an organization must serve a
public rather than a private interest and not be organized for the benefit of designated
individuals. You have stated your function will be to scientifically test the methods of
healing developed by B. The only reason to be seeking non profit status is to gain
funding to prove scientifically how these techniques work. This demonstrates you have

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been formed to further private interests, here, the career work of B. Your research and
testing efforts are aimed at validating the work of B and having these techniques gain
acceptance into the mainstream medical community. You have indicated this will lead to
better cures but have provided no details as to how results will be disseminated to the
public, instead indicating that all results will remain your property. While there will be
some public benefit served by helping and treating afflicted patients the reason you
were formed was to test the methods of B, not to generate research results to benefit
the scientific or medical community at large. For these reasons you are serving primarily
private, rather than public, interests and do not qualify for exemption.

You differ from the organization in Revenue Ruling 69-526 in that there were multiple
doctors involved in the creation of the study rather then one individual, in your case, B.
Whereas you have made no indication as to how testing or research results would be
disseminated the organization in the ruling had results that were made public through
publication in professional journals, lectures, and film strips. Any personal benefit
derived by the physician-creators did not lessen the public benefits flowing from the
organization's operations whereas in your situation the personal benefits derived from
this work will outweigh any public benefit. Patients in that case were referred to the
organization as being recognized as in need, whereas you are advertising the study to
anyone who wants to participate and receive payment.

The organization in Rev. Rul. 69-632 was denied exemption as the primary purpose of
its research was to serve the interests of its creators, rather than the public. Members of
the organization selected research projects to increase sales by creating new uses and
markets for their product. You are similar in that your research is selected and based on
work currently performed by for profit practices run by your members, in this case, B
and indirectly, his wife C. The studies you intend on conducting are tailored on the
methods created and used by B at his practices with the goal of proving how these
techniques are effective. As you have stated, B’s past activities of advanced studies in
neurophysiological therapy and testing are the basis for your present and future
activities. Your function will be to scientifically test the methods of healing developed by
B. You have been formed to benefit your creator and not the public at large.

You are similar to the organization denied exemption in Church by Mail because you
are operated for the substantial non-exempt purpose of providing a market for the
services of N and P. Validation of these techniques through research will enable the
businesses of N and P to directly benefit. This is research that you have admitted
cannot be done by a for profit entity due to cost. Any results generated will directly
benefit N and P as they are offering the same treatments you are testing while at the
same time saving the cost of research and testing. B’s control over you provides him
with the ability to test methods that are used by N and P while being compensated for
performing the testing at the same time. These benefits constitute inurement, which
precludes exemption under section 501(c)(3) of the Code.

Letter 4036(CG) (11-2005)
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You are also similar to International Postgraduate Medical Foundation, because you are
operated to benefit the private interests of an individual (B) who controls you as well as
N and P. You have mentioned no other entities who offer these types of treatments, or
collaboration with any other facilities or therapists in this field. All testing is based on
past work done by B. By testing exclusively on B’s methods you further his personal
interests as well as the business interests of N and P. You are operated to benefit the
private interests of an individual and subsequently two for-profit travel entities and for
these reasons do not qualify.

Applicant’s Position

You have indicated you differ from the for profit entities of N and P by offering free
services, in fact, paying people to take part. You will provide many more therapy
sessions then N and P enabling you to demonstrate the effectiveness of your research.
You have set out to gain funding to prove how these techniques work which will mean
that more people will accept this type of therapy unleashing the talents and breaking
down the road blocks that hold so many back, teaching people how to take charge of
their own lives.

Service Response to Applicant’s Position

While treatment of an individual can provide a health benefit to qualify for exemption as
a scientific research organization it must be shown how research and results are
beneficial to the public at large rather then for private interests. The primary beneficiary
of your research and testing results will be B, due to his background and current
businesses, rather than the general public. Any public benefit is incidental to the private
benefit bestowed on B.

Conclusion

You were formed to further the private interests of B by performing research and testing
of his treatment methods. This serves a private, rather then a public, interest.
Additionally, due to the compensation of B and C and increased exposure of B’s
practices, N and P, inurement is present. You fail the operational test as you cannot
establish operations are exclusively educational or scientific and will not benefit insiders,
directly or indirectly, in a more than substantial manner. Accordingly, you do not qualify
for exemption under Section 501(c)(3).

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

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our determination. If your statement does not provide a basis to reconsider our
determination, we will forward your case to our Appeals Office. You can find more
information about the role of the Appeals Office in Publication 892, Exempt Organization
Appeal Procedures for Unagreed Issues.

Types of information that should be included in your appeal can be found on page 2 of
Publication 892, under the heading “Regional Office Appeal”. The statement of facts
(item 4) must be accompanied by the following declaration:

“Under penalties of perjury, | declare that | have examined the statement of facts
presented in this appeal and in any accompanying schedules and statements and, to
the best of my knowledge and belief, they are true, correct, and complete.”

The declaration must be signed by an officer or trustee of the organization who has
personal knowledge of the facts.

Your appeal will be considered incomplete without this statement.

If an organization’s representative submits the appeal, a substitute declaration must be
included stating that the representative prepared the appeal and accompanying
documents; and whether the representative knows personally that the statements of
facts contained in the appeal and accompanying documents are true and correct.

An attorney, certified public accountant, or an individual enrolled to practice before the
Internal Revenue Service may represent you during the appeal process. If you want
representation during the appeal process, you must file a proper power of attorney,
Form 2848, Power of Attorney and Declaration of Representative, if you have not
already done so. You can find more information about representation in 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 file a protest within 30 days, you will not be able to file a suit for declaratory
judgment in court because the Internal Revenue Service (IRS) will consider the failure
to appeal as a failure to exhaust available administrative remedies. Code section
7428(b)(2) provides, in part, that a declaratory judgment or decree shall not be issued in
any proceeding unless the Tax Court, the United States Court of Federal Claims, or the
District Court of the United States for the District of Columbia determines that the
organization involved has exhausted all of the administrative remedies available to it
within the IRS.

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

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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 the
applicable address:

Mail to: Deliver to:
Internal Revenue Service Internal Revenue Service
EO Determinations Quality Assurance EO Determinations Quality Assurance
Room 7-008 550 Main Street, Room 7-008
P.O. Box 2508 Cincinnati, OH 45202

Cincinnati, OH 45201
You may 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,

Lois G. Lerner
Director, Exempt Organizations

Enclosure, Publication 892

Letter 4036(CG) (11-2005)
Catalog Number 47630W