IRS denies exemption to a stock-trading charity

Plain-English summary

The IRS denied an organization's application for recognition under IRC § 501(c)(3). The organization planned to buy and sell stocks and options with donated funds, retain some proceeds, and give a portion of net proceeds to other charities. The IRS concluded that stock trading was the organization's primary commercial activity, that related parties controlled much of the organization, and that the arrangement could benefit traders, brokerage houses, and related donors. Because the organization did not operate primarily for an exempt purpose and served private rather than public interests, it did not qualify for exemption.

Ruling snapshot

• Question: Did the stock-trading organization qualify for exemption under IRC § 501(c)(3)?
• Outcome: Denied
• Key authorities: IRC §§ 170, 501(c)(3), 502(a), 6110, and 7428(b)(2); Treas. Reg. §§ 1.501(a)-1(c), 1.501(c)(3)-1(c)(1), 1.501(c)(3)-1(c)(2), 1.501(c)(3)-1(d)(1)(ii), and 1.502-1(a); Rev. Ruls. 67-5, 76-206, and 98-15.

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION

Release Number: 201215010 Contact Person:

Release Date: 4/13/2012

Date: January 17, 2012 Identification Number:

UIL: 501.03-00
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.

Because 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. File the returns in accordance with their
instructions, and do not send them to this office. Failure to file the returns timely may result in a
penalty.

We will make this letter and our proposed adverse determination letter available for public
inspection under Code section 6110, after deleting certain identifying information. Please read
the enclosed Notice 437, Notice of Intention to Disclose, and review the two attached letters that
show our proposed deletions. If you disagree with our proposed deletions, follow the
instructions in Notice 437. If you agree with our deletions, you do not need to take any further
action.

If you have any questions about this letter, please contact the person whose name and
telephone number are shown in the heading of this letter. If you have any questions about your
Federal income tax status and responsibilities, please contact IRS Customer Service at

2

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 G. Lerner
Director, Exempt Organizations

Initiator Reviewer
SE:T:EO:RA:T:1 SE:T:EO:RA:T:1

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION

Date: November 17, 2011 Contact Person:
Identification Number:
Contact Number:
FAX Number:

UIL: 501.03-00
Employer Identification Number:

LEGEND

You:

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.

FACTS

Your Articles of Incorporation state that your purpose is to buy and sell stocks and
options to provide funding to other charities. The donations you receive for funding will
be “aggressively traded in the stock and option equity markets.” You state that you will
give a percentage of the net proceeds from the trading to other charitable organizations.
The remaining proceeds will be retained for future trading and operating expenses.

You stated that your operation is very simple; to take donated funding and trade it
in the stock market. You stated that once you develop a consistent history of profitable
trading you will accept donations from the public. You indicated that with more money,
the profits you receive from trading will be larger and thus donations to the other
charities will also be larger. Initially you stated that there will be a four percent (4%)
payout to charities once per year; however, you later amended the statement to say that
the payouts would be whatever IRS determined would be appropriate. You stated that
you will not require periodic or final reports on the use of donated funds to other
charities.

You indicated that you will solicit funds for operations strictly through word of mouth
advertising and this will be your only form of solicitation. Currently, the largest source
of funding to your organization has come from related individuals. You have
acknowledged that six out of eight of your board members are closely related to each
other and to your officers by virtue of family ties.

You stated that all or part of your assets will be entrusted to your
employees/volunteers for the purpose of actively trading donated funds in stocks and
the options equity market. You stated that the employees/volunteers will be known as
traders. The traders will be elected by a unanimous vote of the Board of Directors. The
board members will meet once every six months or as needed in order to review the
actions of each trader. The Board members, by a two thirds (2/3) vote, will select which
charities will receive donations.

Your founder will retain the title of president and solely decide the compensation for
any trader or employee. The board members, by a simple majority, will determine your
compensation. The board will meet annually to determine the charities that will receive
donations and to elect new traders. Your president will have the sole authority to hire
employees other than traders and will also have the sole authority to fire traders. Any
bylaw ratifications, articles of incorporation ratifications, or disputes of any kind will be
settled by a unanimous vote by the Board.

LAW

Section 501(c)(3) of the Internal Revenue Code (the Code) provides exemption
from federal income tax for organizations that are "organized and operated exclusively"
for religious, educational, or charitable purposes. The exemption is further conditioned
on the organization being one "no part of the net income of which inures to the benefit of
any private shareholder or individual."

Section 502(a) of the Code provides that an organization operated for the
primary purpose of carrying on a trade or business for profit shall not be exempt from
taxation under section 501 on the ground that all of its profits are payable to one or
more organizations exempt from taxation under section 501.

Section 1.501(a)-1(c) of the Income Tax Regulations (the Regs) states that "[t]he
words 'private shareholder or individual’ in section 501 refer to persons having a
personal and private interest in the activities of the organization."

Section 1.501(c)(3)-1(c)(1) of the Regs states 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 of such exempt purposes specified

in section 501(c)(3). An organization will not be so regarded if more than an
insubstantial part of its activities is not in furtherance of an exempt purpose.

Section 1.501(c)(3)-1(c)(2) of the Regs 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.

Section 1.501(c)(3)-1(d)(1)(ii) of the Regs states 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.

Section 1.502-1(a) of the Regs states that in the case of an organization
operated for the primary purpose of carrying on a trade or business for profit, exemption
is not allowed under section 501 on the ground that all the profits of such organization
are payable to one or more organizations exempt from taxation under section 501. In
determining the primary purpose of an organization, all the circumstances must be
considered, including the size and extent of the trade or business and the size and
extent of those activities of such organization which are specified in the applicable
paragraph of section 501.

Rev. Rul. 67-5, 1967-1 C.B. 123, holds that a foundation controlled by the
creator's family was operated to enable the creator and his family to engage in financial
activities that were beneficial to them, but detrimental to the foundation. This resulted in
the foundation's ownership of common stock of a corporation controlled by the
foundation's creator and his family that paid no dividends. This prevented the
foundation from carrying on a charitable program commensurate in scope with its
financial resources. This ruling concluded that the foundation was operated for a
substantial non-exempt purpose and served the private interest of the creator and
therefore, was not entitled to exemption under section 501(c)(3) of the Code.

Rev. Rul. 76-206, 1976-1 C.B. 154, considered an organization formed to
promote broadcasting of classical music in a particular community. The organization
carried on a variety of activities designed to stimulate public interest in the classical
music programs of a for-profit radio station, and thereby enable the station to continue
broadcasting such music. The activities included soliciting sponsors, soliciting
subscriptions to the station's program guide, and distributing pamphlets and bumper
stickers encouraging people to listen to the station. The organization's board of directors
represented the community at large and did not include any representatives of the for-

profit radio station. The revenue ruling concludes that the organization's activities
enable the radio station to increase its total revenues and therefore benefit the for-profit
radio station in more than an incidental way. Therefore, the organization is serving a
private rather than a public interest and does not qualify for exemption.

Rev. Rul. 98-15, 1998-1 C.B. 718, states that if a private party is allowed to
control or use the non-profit organization's activities or assets for the benefit of the
private party, and the benefit is not incidental to the accomplishment of exempt
purposes, the organization will fail to be organized and operated exclusively for exempt
purposes.

Better Business Bureau of Washington D.C., Inc. v. United States, 326 U.S. 279
(1945) the Supreme Court held that in order to fall within the claimed exemption, an
organization must be devoted to educational purposes exclusively. This plainly means
that the presence of a single non-educational purpose, if substantial in nature, will
destroy the exemption regardless of the number or importance of truly educational
purposes.

Founding Church of Scientology v. United States, 188 Ct. Cl. 490, 498, 412 F.2d
1197, 1201 (1969), cert. denied, 397 U.S. 1009 (1970), the Court reasoned that the
congressional intent behind the conditional language of section 501(c)(3) of the Code,
coupled with the burden of proof placed upon the taxpayer in these circumstances,
requires plaintiff to clearly demonstrate its right to exemption.

St. David's Health Care System v. U.S. , 349 F.3d 232, (C.A.5 2003), the Court
held that in order to ascertain whether an organization furthers non-charitable interests,
the Service can examine the structure and management of the organization; including
which individuals or entities control the organization.

University Hill Foundation, etc., v. C.I.R., 446 F.2d 701, (C.A. 9 1971) the Court
held that an organization operated for the primary purpose of carrying on a trade or
business for profit shall not be exempt under any paragraph of this section on the
ground that all of its profits are payable to one or more organizations exempt under this
section from taxation.

Lowry Hosp. Ass'n v. Commissioner, 66 T.C. 850, 859-60, 1976 WL 3664 (1976)
The Court concluded that a hospital could not be deemed to operate exclusively for
charitable purposes, partly because of the "control and dominance" exercised by a
single physician over the hospital's affairs. If private individuals or for-profit entities
have either formal or effective control, one may presume the organization furthers the
profit-seeking motivations of those private individuals or entities.

In B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978), the court stated that
petitioner's activity constitutes the conduct of a consulting business of the sort which is
ordinarily carried on by commercial ventures organized for profit. The court also stated
competition with commercial firms is strong evidence of the predominance of
nonexempt commercial purpose. The court went further and stated that the conduct of
a business with an apparently commercial character is the petitioner's sole activity, a
fact that weighs heavily against exemption.

In Christian Manner Int'l, Inc., v. CIR, 71 T.C. 661, 1979 WL 3825 (1979), the
court held that when an activity is engaged in to further both an exempt and nonexempt
purpose, the Court must decide whether the nonexempt purpose was sufficient to deny
the exemption or was so incidental to the exempt purpose as not to disqualify petitioner
for exemption.

Greater United Navajo Enterprises v. CIR , 74 T.C. 69, 78-79 (1980) the Court
interpreting Reg. 1.501(c) (3)-1(c)(1), held that some activity not serving an exempt
purpose is permitted, but the organization's wholly nonexempt activities must be
relatively insubstantial in comparison with the organization's activities serving an exempt
purpose.

Bubbling Well Church of Universal Love, Inc. v. Commissioner, 74 T.C. 531
(1980) aff'd, 670 F.2d 104 (9th Cir. 1980), the Tax Court considered the qualification for
exemption of an organization purporting to be a church. The Applicant was controlled by
three family members. The court stated that, “While this domination of petitioner by the
three family members, alone may not necessarily disqualify it for exemption, it provides
an obvious opportunity for abuse of the claimed tax-exempt status. It calls for open and
candid disclosure of all facts bearing upon petitioner's organization, operations, and
finances so that the Court, should it uphold the claimed exemption, can be assured that
it is not sanctioning an abuse of the revenue laws.

Church of Ethereal Joy v C.I.R., 83 T.C. No. 3, 83 T.C. 20, although control by ...
a small group may not necessarily disqualify [an organization] for exemption, it provides
an obvious opportunity for abuse of the claimed tax-exempt status.

American Campaign Academy v. Commissioner, 92 T.C. 1053 (1989), The Court
explained that genuine public benefit often provides an incidental benefit to private
individuals. But if private interests are served other than incidentally, exemption is
precluded. Qualitatively incidental means that the private benefit is a mere byproduct of
the public benefit. For private benefit to be quantitatively incidental, it must be
insubstantial in amount. The private benefit must be compared to the public benefit of
the specific activity in question, not the public benefit provided by all the organization's
activities. The more exactly you can quantify the private benefit, the more likely it is to

be non-incidental.

Redlands Surgical Services v. Commissioner, 113 T.C. 47 (1999) The Tax Court
maintained that, where private individuals or for-profit entities have either formal or
effective control of a non-profit organization, it may be presume that the organization
furthered the profit-seeking motivations of those private individuals or entities.

RATIONALE

An organization is not organized or operated exclusively for exempt purposes
unless it serves a public rather than a private interest. Section 501(c)(3) of the Code
and Section 1.501(c)(3)-1(d)(1)(ii) of the Regs To meet the requirement, an organization
must establish that it is not organized or operated for the benefit of private interests
such as the creator or his family, or persons controlled, directly or indirectly, by such
private interests. While you organized as a non-profit, family members overwhelmingly
dominate your board. Your initial funding comes from these related parties. Your
founder is president and makes exclusive decisions regarding employment and
compensation of traders. A simple majority of the board, on which related parties
comprise a substantial majority, determines the president's salary. Funding comes from
the same related officers and directors. You anticipate soliciting donations from a
broader group in the future, but only by word of mouth, so that all of your donors will
have some connection to your officers and directors.

Your traders will receive substantial experience in trading securities with their
compensation approved by your president. The brokerage houses will receive
commissions for exercising trades. Your sole purported exempt activity of donating a
small percentage of your net profits to charity once per year is insignificant and
insubstantial as it relates to your year long trading activities. Your non-exempt activities
are significant and substantially commercial in nature and promote private benefits to
the traders and the brokerage houses doing business with you. In Better Business
Bureau of Washington D.C.., Inc. v. United States, the Supreme Court held that the
presence of a single non-exempt purpose, if substantial in nature, would destroy the
exemption regardless of the number or importance of truly exempt purposes. See also
Section 1.501(c)(3)-1(d)(1)(ii) of the Regs.

In addition, since the initial funding comes from related parties, granting
exemption would greatly benefit the related parties who would be entitled to charitable
deductions under §170 of the Code. These benefits, which should be incidental in
nature in comparison to the charitable endeavors, would greatly exceed any charitable
benefits bestowed upon the public. See Rev. Rul. 67-5, 1967-1 C.B. 123, (foundation
controlled by the creator's family was operated to enable the creator and his family to
engage in financial activities that were beneficial to them). See also Redlands Surgical

Services v. Commissioner (if private individuals or for-profit entities have either formal or
effective control of a non-profit organization, it is presumed that the organization furthers
the profit-seeking motivations of those private individuals or entities).

The Tax Court stated that a genuine public benefit often provides an incidental
benefit to private individuals; however, the Court denies exemption if an organization
benefits private interests other than incidentally. The principles set forth in Rev. Rul. 76-
206, underscores that benefits to a private interest in more than an incidental way
precludes exemption. See also American Campaign Academy v. Commissioner.

The control of an organization by related parties invites scrutiny regarding
potential private benefits and abuse of its tax-exempt status. Bubbling Well Church of
Universal Love, Inc. v. Commissioner, (“While this domination of petitioner by the three
family members, alone may not necessarily disqualify it for exemption, it provides an
obvious opportunity for abuse of the claimed tax-exempt status....”). See also Lowry
Hosp. Ass'n v. Commissioner, (If private individuals or for-profit entities have either
formal or effective control, we presume that the organization furthers the profit-seeking
motivations of those private individuals or entities), and Church of Ethereal Joy v C.I.R.,
(although control by ... a small group may not necessarily disqualify [an organization] for
exemption, it provides an obvious opportunity for abuse of the claimed tax-exempt
status).

An organization operated for the primary purpose of carrying on a trade or
business for profit, may not be recognized as exempt under § 501(c)(3) on the ground
that all the profits of such organization are payable to one or more organizations exempt
from taxation under § 501(c)(3) of the Code. Section 502 of the Code and §1.502-1(a)
of the Regs. The Court in B. S. W. Group, Inc., relying on St. Louis Union Trust Co. v.
United States, 374 F.2d 427, 431-432 (8th Cir.), reasoned that the fact that petitioner's
activity may constitute a trade or business does not, of itself, disqualify it from
Classification under § 501(c)(3), provided the activity furthers or accomplishes an
exempt purpose. The critical inquiry is whether petitioner's primary purpose for
engaging in its sole activity is an exempt purpose, or whether its primary purpose is the
nonexempt one of operating a commercial business producing net profits for petitioner.

You stated that your primary activity to generate funding and profits would be
stock trading, a commercial activity that does not further an exempt purpose. Your
premise for tax-exemption is that you will donate a portion of your revenue to a
designated charity. Congress has specifically stated that even donating all of the profits
of a trade or business is not sufficient grounds to recognize it as exempt, and you plan
to donate much less than all of your profits.

You stated that you will donate a portion, initially four percent (4%), of your net
proceeds from security trading to charity. You stated that you will not initially seek

contributions from the public until you have established a performance record in trading;
but you will use the funds acquired from related parties for trading in securities. You
stated that your contribution to charities would be dependent upon your trading
performance. You did not indicate whether you would solicit funds directly for charities;
but you would solicit funds for stock trading with portion of any profits going to charities.
In Greater United Navajo Enterprises v. CIR, the Tax Court held that an organization's
wholly nonexempt activities must be relatively insubstantial in comparison with the
organization's activities serving an exempt purpose. Your primary activity, measured by
the amount time your officers, directors, and employees devote to trading, is
overwhelmingly and substantially commercial in nature.

In conclusion, you have not met your burden in demonstrating that your purpose
and activities satisfy the standard for recognition as exempt under § 501(c)(3) of the
Code. Your primary purpose of trading in stocks and options is commercial, not
charitable, and it does not further an exempt purpose You fail to qualify for exemption
because the facts show that you primarily serve a private rather than a public interest.

You have the right to file a protest if you believe this determination is incorrect.
To protest, you must submit a statement of your views and fully explain your reasoning.
You must submit the statement, signed by one of your officers, within 30 days from the
date of this letter. We will consider your statement and decide if the information affects
our determination.

Your protest statement should be accompanied by the following declaration:

Under penalties of perjury, I declare that I have examined this protest statement,
including accompanying documents, and, to the best of my knowledge and belief,
the statement contains all the relevant facts, and such facts are true, correct, and
complete.

You also have a right to request a conference to discuss your protest. This
request should be made when you file your protest statement. An attorney, certified
public accountant, or an individual enrolled to practice before the Internal Revenue
Service may represent you. If you want representation during the conference
procedures, you must file a proper power of attorney, Form 2848, Power of Attorney
and Declaration of Representative, if you have not already done so. For more
information about representation, see Publication 947, Practice before the IRS and
Power of Attorney. All forms and publications mentioned in this letter can be found at
www.irs.gov, Forms and Publications.

If you do not 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 protest 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
determination letter. That letter will provide information about filing tax returns and other
matters.

Please send your protest statement, Form 2848 and any supporting documents
to this address:

Internal Revenue Service
TE/GE (SE:T:EO:RA:T:1)
1111 Constitution Ave, N.W.
Washington, DC 20224

You may also fax your statement using the fax number shown in the heading of
this letter. If you fax your statement, please call the person identified in the heading of
this letter to confirm that he or she received your fax.

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

Sincerely,

Lois G. Lerner
Director, Exempt Organizations

Enclosure