IRS denies section 501(c)(3) exemption to a family trust

Plain-English summary

The IRS denied section 501(c)(3) exemption to a family trust established to pay health, education, welfare, and religion expenses for named relatives of the grantor. The trust agreement did not limit the trust's purposes to those described in section 501(c)(3), and the trust did not provide enough detail about its activities or finances. The IRS concluded that the trust served private family interests rather than a public interest, failed both the organizational and operational tests, and would provide private inurement. The proposed adverse determination became final after the applicant did not file a protest within 30 days.

Ruling snapshot

• Question: Did the family trust meet the organizational and operational tests for exemption under IRC § 501(c)(3)?
• Outcome: Denied
• Key authorities: IRC §§ 170, 501(a), 501(c)(3), 2055, 6104(c), 6110, and 7428(b)(2); Treas. Reg. §§ 1.501(a)-1(c), 1.501(c)(3)-1(a), (b), (c), and (d)

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION
Release Number: 201219029 Contact Person:
Release Date: 5/11/2012
Date: February 13, 2012 Identification Number:
UIL Code: 501.03-00
501.03-03 Contact Number:
501.33-00
Employer Identification Number:
Form Required To Be Filed:
Tax Years:
All 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.

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.

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

2

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 Lemer
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: December 20, 2011 Contact Person:
Identification Number:
Contact Number:
FAX Number:
Employer Identification Number:
LEGEND: UIL:
B = Individual (Grantor) 501.03-00
C = Individual (Grantor's grandchild) 501.03-03
D = Individual (Grantor's grandchild) 501.33-00

E = Individual (Grantor's grandchild)
F = Individual (Grantor's sister)

M = State
N = Date
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

1. Do you meet the organizational test under section 501(c)(3) of the Code? No, for
   the reasons stated below.

2. Do you meet the operational test under section 501(c)(3) of the Code? No, for
   the reasons stated below.

Facts
You were formed by a revocable trust agreement executed by B on N in the State of M.

The trust agreement states in pertinent part, “The Grantor creates this Family Charitable
Trust Agreement for the health, education, welfare and religion for the Grantor's three

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

grandchildren, namely, C, D, and E.”

It further states, “The Grantor creates a Family Charitable Trust within the purview of a
private foundation under the [sic] of Section 501(c)(3) of the Internal Revenue Code for
the benefit of all those individuals related to the Grantor by blood or marriage for the
beneficial interest related to health, education, welfare and religion.”

The trust agreement also states “This Trust is created for the benefit of the Grantor’s
sister, F, who is currently in need of health and welfare benefits. The Trustees are
authorized to expend income before the invasion of principal in administering benefits to
the Grantor’s sister F and any other beneficiary under this Family Charitable Trust
Agreement.”

You did not submit an activity description with your application for exemption. During
case processing, we asked you to submit a narrative description explaining your specific
activities in detail. You failed to submit a detailed description but instead stated “The
charitable trust, for the most part, contains language that is clear, definite and
unambiguous. The charitable trust in its entirety speaks for itself. The trust is patterned
after what a good government would render to its citizens.”

You also did not provide projected revenues and expenses with your initial application
for exemption. We asked you to submit financial information that corresponds to your
proposed activities. You failed to submit financial information but instead stated “The
trust has been in existence for less than a year and has only the $10 consideration.
Additional and future proceeds will be added to the trust corpus when claims are paid
and satisfied as stated on Schedule A of the trust instrument. This trust will terminate
when the last charitable transaction occurs.” Schedule A of the trust agreement
indicates the trust plans to receive additional funding from “...the pursuit of the Grantor's
claims for back pay, interest and penalties, federal and state refunds with accrued
interest, and any insurance claims for proceeds to fund this Family Charitable Trust
Agreement within the purview of the U.S. Constitution, the Internal Revenue Code, and
the Rule of Law.”

Law

Section 501(c)(3) of the Code describes corporations organized and operated
exclusively for charitable purposes, no part of the net earnings of which inures to the
benefit of any private shareholder or individual.

Section 1.501(a)-1(c) of the Regulations provides that the terms “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(a)(1) of the Regulations states that, in order to be exempt as an
organization described in section 501(c)(3) of the Code, 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.

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

3

Section 1.501(c)(3)-1(b)(1)(iv) of the Regulations provides that in no case shall an
organization be considered to be organized exclusively for one, or more exempt
purposes, if, by the terms of its articles, the purposes for which such organization is
created are broader than the purposes specified in section 501(c)(3).

Section 1.501(c)(3)-1(c)(1) of the Regulations 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 of 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.

Section 1.501(c)(3)-1(c)(2) of the Regulations 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 as defined in Section
1.501(a)-1(c).

Section 1.501(c)(3)-1(d)(1)(ii) of the Regulations provides that an exempt organization
must serve a public rather than a private interest. The organization must establish that it
is not organized or operated to benefit 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 67-367, 1967-2 C.B. 188, holds that a nonprofit organization whose
sole activity is the operation of a scholarship plan for making payments to pre-selected,
specifically named individuals does not qualify for exemption from Federal income tax
under section 501(c)(3) of the Code.

Revenue Procedure 2011-9, section 4.03 states that exempt status may be recognized
in advance of the organization's operations if the proposed activities are described in
sufficient detail to permit a conclusion that the organization will clearly meet the
particular requirements for exemption pursuant to the section of the Internal Revenue
Code under which exemption is claimed.

(1) A mere restatement of exempt purposes or a statement that proposed activities
will be in furtherance of such purposes will not satisfy this requirement.

(2) The organization must fully describe all of the activities in which it expects to
engage, including the standards, criteria, procedures or other means adopted or
planned for carrying out the activities, the anticipated sources of receipts, and the
nature of contemplated expenditures.

(3) Where the organization cannot demonstrate to the satisfaction of the Service that
it qualifies for exemption pursuant to the section of the Internal Revenue Code
under which exemption is claimed, the Service will generally issue a proposed
adverse determination letter or ruling.

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

4

In Better Business Bureau of Washington, D.C., Inc. v. United States, 326 U. S. 279
(1945), the Supreme Court of the United States interpreted the requirement in section
501(c)(3) that an organization be “operated exclusively” by indicating that an
organization must be devoted to exempt purposes exclusively. This plainly means that
the presence of a single non-exempt purpose, if substantial in nature, will destroy the
exemption regardless of the number and importance of truly exempt purposes.

In Old Dominion Box Co. v. United States, 477 F2d 344 (4th Cir. 1973) cert. denied 413
U.S. 910 (1973), the court held that operating for the benefit of private parties
constitutes a substantial non-exempt purpose.

In Wendy L. Parker Rehabilitation Foundation, Inc. v. Commissioner, T.C. Memo. 1986-
348, the tax court upheld the Service’s position that a foundation formed to aid coma
victims, including a family member of the founders, was not entitled to recognition of
exemption. Approximately 30% of the organization's net income was expected to be
distributed to aid the family coma victim. The court found that the family coma victim
was a substantial beneficiary of the foundation’s activities.

Application of Law

You are not described in section 501(c)(3) of the Code because you are not organized
or operated exclusively for charitable purposes. Instead, you were formed for the
benefit of private individuals, namely relatives of B.

Organizational Test

Your trust agreement does not contain the appropriate provisions to meet the
organizational test of section 501(c)(3) of the Code. The agreement does not limit your
purposes exclusively to those specified in section 501(c)(3). Your purposes are to
benefit individuals related to B by blood or marriage. Therefore, you do not satisfy
section 1.501(c)(3)-1(b)(1)(iv) of the Regulations. Likewise, your trust agreement does
not contain an adequate provision to distribute your assets exclusively for 501(c)(3)
purposes upon your dissolution. Therefore, you do not meet the organizational test and
fail meet the requirements of Section 1.501(c)(3)-1(a)(1) of the Regulations

Operational Test

You are not described in sections 501(c)(3) of the Code and 1.501(c)(3)-1(a)(1) of the
Regulations because you fail the operational test. Specifically the facts show you are
operated not exclusively for 501(c)(3) purposes but for the substantial private benefit of
family members of B.

You are not as described in section 1.501(c)(3)-1(c)(1) of the Regulations because you
are not engaged primarily in activities which accomplish one or more purposes specified
in section 501(c)(3) of the Code. You were created to engage primarily in activities for
the benefit of family members of B.

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

5

You are not as described in section 1.501(c)(3)-1(c)(2) of the Regulations because your
earnings inure in whole or in part to the benefit of private individuals. Specifically your
earnings inure to the benefit of family members of B.

You are not as described in section 1.501(c)(3)-1(d)(1)(ii) of the Regulations because
you serve a private interest rather than a public interest. The facts show that your sole
purpose is to pay the health, education, welfare and religion expenses of the four
individuals specifically named in your trust agreement who are all family members of
your grantor, B. Therefore, you are organized for the private benefit of “designated
individuals, the creator or his family, shareholders of the organization, or persons
controlled, directly or indirectly, by such private interests."

You are similar to the organization described in Rev. Rul. 67-367 because you were
formed to benefit pre-selected, specifically named individuals. By paying funds to or on
behalf of pre-selected, specifically named individuals designated by the trust
agreement, you are serving private interests rather than public interests contemplated
under section 501(c)(3) of the Code.

You have not provided adequate details to prove that you are operating in an
exclusively exempt manner as required by Rev. Proc. 2011-9, section 4.03. Although,
you have not described your specific activities in detail, the trust agreement makes it
clear that your activities are directed solely toward providing benefits to the family
members of B.

Like the organization in Better Business Bureau of Washington, D.C., Inc. v. United
States, supra, you have a substantial non-exempt purpose. Your purpose is to benefit
individuals related to B by blood or marriage. Any expenses paid on behalf of these
individuals would create private inurement, which destroys your claim for exemption.

Similar to the organization described in Old Dominion Box Co., Inc. v. United States, a
substantial portion of your activities serve private interests. Your trust agreement states
that you were created for the benefit of all those individuals related to B by blood or
marriage for the beneficial interest related to health, education, welfare and religion. As
such, a substantial portion of your activities benefits private interests, which is a
substantial non-exempt purpose.

Like the organization in Wendy L. Parker Rehabilitation Foundation, Inc. v.
Commissioner, you were formed to benefit specifically named family members of your
creator. Each family member benefiting from your activities would be considered a
substantial beneficiary. In fact, your purposes and activities are even more contrary to
exemption under section 501(c)(3) than the entity described in the court case. The facts
show that 100% of your net income will benefit designated family members.

Applicant’s Position

You state that you are applying for tax exempt status since the trust is created for
charitable purposes. You state numerous courts have decided that the criteria of
health, education, welfare, and religion is an ascertainable standard for establishing

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

6

charitable transactions. You state the trust, for the most part, contains language that is
clear, definite, and unambiguous; and, the trust in its entirety speaks for itself.

In reference to our additional information request letter, dated May 17, 2011, you state
that all the provisions of the law, with the exception of section 501(c)(3) of the Code, are
inapplicable and not apropos to the application and trust instrument and are without
merit or substance.

Relating to section 1.501(a)-1(c) of the Regulations, you state there are no “private
shareholders” or “individuals” and nobody possesses a private interest; and, any
individual can be the recipient of a charitable bequest.

Pertaining to section 1.501(c)(3)-1(d)(1)(ii) of the Regulations, you state that the trust
agreement stipulates that the trust will be operated exclusively by established charitable
criteria of health, education, welfare, and religion most of the standards that are
expressed in section 2055 of the Code and existing court decisions.

You state that Rev. Rul. 67-367 is not applicable to you because you do not award
scholarships to any pre-selected individuals. You state that the trust instrument does
permit proceeds for educational purposes which is an established charitable criteria
under section 2055 of the Code.

You state that you are distinguishable from the organization in Wendy L. Parker
Rehabilitation Foundation, Inc. v. Commissioner because the trust instrument has no
restrictions as to any percentage of net earnings used for charitable purposes.

Service Response to Applicant’s Position

Based on the purposes described in your trust agreement, you were not created for
charitable purposes as described in section 501(c)(3) of the Code. Your trust
agreement clearly states that you are created for the benefit of all those individuals
related to B by blood or marriage for the beneficial interest related to health, education,
welfare and religion. The promotion of health, education, welfare, and religion can
qualify for exemption under section 501(c)(3) of the Code. However, as evidenced by
the law cited above, these purposes must be directed to benefit the public at large and
not specifically named private individuals related to your creator.

Although you claim you do not award scholarships, your trust agreement makes it clear
that you plan to pay the educational expenses of C, D, and E. Whether you define this
as a scholarship or not, you are similar to the organization described in Revenue Ruling
67-367 because you plan to pay the educational expenses of specifically named, pre-
selected individuals.

Although your application does not name a specific percentage of your net income that
will be paid to or for the benefit of designated individuals, it is evident from your trust
agreement that your entire purpose (100%) is to benefit C, D, E, and F, who are all
relatives of your creator and grantor, B. Therefore, we disagree with your conclusion
that you are not similar to Wendy L. Parker Rehabilitation Foundation, Inc. v.
Commissioner.

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

Conclusion

You do not meet the organizational test because your organizing document does not
limit your purposes exclusively to purposes described in section 501(c)(3). In fact, your
purpose is to benefit specifically named private individuals which is in direct
contradiction to section 501(c)(3) of the Code. Also, your organizing document does not
dedicate your assets exclusively to 501(c)(3) purposes upon dissolution.

You also do not meet the operational test. The facts show that you are not operated for
a public purpose, but instead for the direct benefit of private individuals; namely the
family members of B. Accordingly, we conclude that you do not qualify for exemption
under Section 501(c)(3) of the Code.

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

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

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
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 P.O. Box 2508 550 Main Street, Room 7-008
Cincinnati, OH 45201 Cincinnati, OH 45202

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