IRS denies exemption to a job-training organization with commercial operations

Plain-English summary

The IRS denied section 501(c)(3) exemption to an organization that offered fee-based interview, career, coaching, and online training programs. The organization’s founders also controlled a for-profit company that offered related services, and the nonprofit reused one of that company’s programs. The IRS found commercial operations, compensation arrangements benefiting insiders, and insufficient evidence that the organization served a public rather than private interest. The organization therefore failed the operational test and did not qualify for exemption.

Ruling snapshot

• Question: Did the organization qualify for exemption under section 501(c)(3), despite its commercial operations and insider compensation?
• Outcome: Denied
• Key authorities: IRC §§ 170, 501(a), 501(c)(3), 6104, 6110, and 7428; Treas. Reg. §§ 1.501(c)(3)-1(a), 1.501(c)(3)-1(c), and 1.501(c)(3)-1(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: 201237019 Contact Person:
Release Date: 9/14/2012
Date: June 19, 2012 Identification Number:
UIL code: 501.30-02
501.03-30 Contact Number:
501.35-00
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: May 1, 2012 Contact Person:

Identification Number:
Contact Number:
FAX Number:

Employer Identification Number:

Legend: UIL Codes:
B = state 501.30-02
C = date 501.03-30
D = individual 501.35-00
F = individual

G = individual

H = business

J = program

K = program

L = program

M = program

N = program

P = program

w = number

x = dollar amount
y = dollar amount

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
Do you qualify for exemption under section 501(c)(3) of the Code? No, for the reasons
set forth below.

Does the inurement of earnings to your insiders, D and F, preclude exemption under
section 501(c)(3) of the Code? Yes, for the reasons set forth below.

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

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Do you operate in a substantially commercial manner, which would preclude
exemption? Yes, for the reasons set forth below.

Facts

D, your president, and F, your vice president, are employed by the for-profit company,
H, which was organized by F. F acts as the president and sole director of H. D and F
both work 30 and 40 hours a week, respectively, for H.

H offers corporate training to employed people, including management skills training,
sales training and customer service training, to help the workplace be more efficient and
productive.

H, doing business as N, started with a program, P, as a test marketed to both job
seekers hoping to improve interview skills, and employed executives looking to improve
their presentation skills. The fee charged for P was x dollars. Due to high levels of
unemployment, the program gained popularity, and H refocused the content exclusively
to those seeking jobs. To make the program more affordable you started providing
scholarships and gifts. You realized in forming a non-profit entity you could raise funds
to supplement program fees. D and F decided to use P as initial material, which was
then rebranded into J, as described below.

With the removal of P, H currently offers eight different training programs, for fees,
aimed at corporations/group corporate training to help improve business processes for
those already employed and/or wanting to improve segments of their company. The
difference between you and H is that your training focuses on teaching unemployed
people skills on being a successful interviewer and getting employed, while H's trainings
focus on training current employed workplace teams. H is working in a private manner
while you work in a public venue. You have stated the non-profit was formed to secure
grants and other contributions to sponsor individuals who could not afford the fees
associated with your services.

You were formed in B as a nonprofit corporation on C (date). Your Articles of
Incorporation indicate your purpose is:

to develop and facilitate educational programs and workshops for America’s
workforce and empower our participants with interviewing skills and careering
tools to 1) get a job and become re-employed; 2) build a career that aligns their
background, purpose and capabilities; and 3) give participants vision, a plan and
a process to go forward.

You also submitted Bylaws reflecting similar purposes, as well as a Conflict of Interest
policy, which was not signed.

Letter 4036(CG) (11-2005)
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Your governing body consists of D (president), F (vice-president) and G
(secretary/treasurer). D and F share the same household as domestic and business
partners. G is F’s daughter. Both D and F are compensated as independent contractors
for their roles as “training managers”. They both work in this capacity approximately 30
hours per week.

You will offer the following programs:

J: A 12-hour in-person program for job seekers held at regional level includes on-
camera training and personal coaching. Seminars usually have approximately 15
participants to keep the individual coaching and learning retention at a high level. This
highly successful interview skills training program (initially run by H) has been held in a
public venue every month since 2009.

K: A 12-hour in-person program for transitioning to a new career held at regional level
including on-camera training and personal coaching. This program was introduced
during 2011.

L: One-on-one coaching includes four 90-minute sessions either in person or via Skype
including behavioral inventory. This program has been offered as a stand-alone product
and also as a supplemental product after participants have gone through the J training.

M: An online learning application, which uses a combination of self-paced training
modules, personal branding modules and interactive training on the internet with
individuals and groups. This training is targeted to wider audiences across the United
States.

You offer your trainings on a fee basis. The schedule of fees is as follows:

1) x dollars (same as previously charged by H) if job-seeker has been out of work for
less than six months

2) x dollars—25% (25% discount) if job-seeker has been out of work for more than six
months

3) x dollars—50% (50% discount) if job seeker has been out of work for 14 months or
longer (and does not receive unemployment compensation)

4) x dollars—75% “Work Study” Fee (75% discount) if job seeker wants training, cannot
afford anything else and agrees to do volunteer work for you which you have stated
equals 24 hours of volunteer work

5) FREE if jobseeker is long term unemployed and been out of work for over three years

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

Participants in your programs receive a copy of a book written by D and F, labeled as a

trail guide workbook. Participants are also given the opportunity to schedule one-on-one
coaching sessions with D or F at a rate ranging between $75-$100 hourly. The program
itself is held in a church, which has given use of the space to you rent free.

Over the course of one year, you had w people attend your trainings. Of them, around
18% received free services. The remainder paid varying rates, including the full asking
price of x dollars.

Optimally, you would like to see grants cover all fees and costs of the training for all
unemployed job seekers and those job-seekers who are employed but need financial
assistance. If such grants are secured, they would pay the full price of x dollars for each
recipient covered. You could not provide independent comparative data related to the
fees you charge as you have stated there are no organizations offering the particular
services you offer.

Thus far, all of your income has been from fees for services. We requested a
breakdown of your expenses on more than one occasion, however, you never
elaborated on the expenses you have or expected to incur. You have projected
compensation for both D and F of approximately $ 15,000 annually.

F, who provides facilitation of the program, is paid approximately $ 75/hour through H. D
receives 20% of a contract price as a sales commission and for assisting in facilitating
the program of H, which is approximately $30/hour. You have included a service
contract for both D and F that provides compensation averaging around $55/hour for F
and $20-$25 for D. While G is not listed as a contracted employee she is listed in your
training book as an expert facilitator.

The pricing contract broke down the costs for services to you both D and F will provide,
which ranged between $500-$1000 each, including facilitation, camera work and
editing, program management and coordination and marketing. D and F have stated the
contract was negotiated arms length because the fees they charge are fair market. The
amounts charged were based on the hourly compensation rates for both D and F. The
contract did not cap or place any limit on the compensation that D and F could receive.

Law

Section 1.501(c)(3)-1(a) of the regulations states that 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.

Income Tax Regulation (“Regulation”) section 1.501(c)(3)-1(c)(2) provides that an

Letter 4036(CG) (11-2005)
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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.
Regulation section 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 Revenue Ruling 69-266, 1969-1 CB 151, an organization formed and controlled by a
doctor of medicine, "hired" to conduct research programs consisting of examining and
treating patients who are charged the prevailing fees for services rendered, is not
exempt under section 501(c)(3) of the Code. Under the facts described the operation of
the medical practice by the organization does not differ significantly from the private
practice of medicine for profit. The organization's primary function is to serve the private
interest of its creator rather than a public interest.

In Revenue Ruling 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 Revenue Ruling 72-369, 1972-2 CB 245 an organization formed to provide
managerial and consulting services at cost to unrelated exempt organizations did not
qualify for exemption under section 501(c)(3). Providing managerial and consulting
services on a regular basis for a fee is a trade or business ordinarily carried on for profit.
The fact that the services in this case are provided at cost and solely for exempt
organizations is not sufficient to characterize this activity as charitable within the
meaning of section 501(c)(3) of the Code. Furnishing the services at cost lacks the
donative element necessary to establish this activity as charitable.

In Better Business Bureau of Washington D.C., Inc. v. United States, 326 U.S. 279
(1945), the Supreme Court held that the presence of a single non-exempt purpose, if
substantial in nature, will destroy the exemption regardless of the number or importance
of truly exempt purposes. The Court found that the trade association had an “underlying
commercial motive” that distinguished its educational program from that carried out by a
university.

In B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978), the court found that a

Letter 4036(CG) (11-2005)
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corporation organized to provide counseling services was not exempt under section
501(c)(3) because its activities constituted the conduct of a trade or business that is
ordinarily carried on as a commercial venture organized for profit. The corporation's
primary purpose was not charitable, educational or scientific, but rather commercial in
nature. Further, the court found that the organization’s financing did not resemble that of
a typical 501(c)(3) organization as it had not solicited, nor had it received voluntary
contributions from the public. Its only source of income was from the fees for services
that it collected. Those fees were set high enough to recover all projected costs and
produce a profit. Moreover, it did not appear that the corporation ever planned to charge
a fee less than “cost.”

In Airlie Foundation v. Commissioner, 283 F. Supp. 2d 58 (D.D.C., 2003), the court
relied on the “commerciality” doctrine in applying the operational test under section
501(c)(3). Because of the commercial manner in which the organization conducted its
activities, the court found that it was operated for a non-exempt commercial purpose,
rather than for a tax-exempt purpose. The case noted that among the major factors that
courts have considered in assessing commerciality are competition with for-profit
entities, pricing policies, the extent and degree of below cost services provided and the
reasonableness of financial reserves. Additional factors include whether the
organization uses commercial promotional methods (such as advertising) and the extent
to which the organization receives charitable donations.

Application of Law

You are not operated exclusively for charitable, educational, or religious purposes
consistent with Section 501(c )(3) of the Code nor Section 1.501(c)(3)-1(a) of the
Income Tax Regulations and therefore fail to meet the operational test. Specifically, the
facts above indicate that you are not operated for exempt purposes but that you are
operated in a commercial manner to market and sell your training programs. You are
not distinguishable from any commercial operation in that you charge similar fees for all
of your products, market these products to the general public, and are carrying on
similar operations of a still active for profit entity.

As described in section 1.501(c)(3)-1(c)(2) of the Regulations, you are not operated
exclusively for exempt purposes because your net earnings inure to the benefit of private
shareholders or individuals. This is evidenced by the fact that your activities consist of
marketing and selling the training programs J, K, L and M, which were created by D and F,
and originally sold through their for-profit entity, H. In addition, D and F control you and
receive contracted compensation in direct correlation to the amount of programs sold.

You have not established that you are organized and operated for the benefit of public
rather than private interests as required in Regulation 1.501(c)(3)-1(d)(1)(ii). You are

carrying on the activities previously conducted by a for-profit entity still in existence and
under the control of your founders, D and F, while charging the same fees for services.

Letter 4036(CG) (11-2005)
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Many of the products you will use are trademarked and/or created by D and F, and you
have not established that D or F will not benefit from the use and marketing of these
products. All three of your governing body members are related. Compensation was not
decided in an arms length manner. Further, there has been no definitive maximum level
set for the wages that could potentially be received by D and F through one-on-one
coaching services.

You are similar to the organization in Revenue Ruling 69-266 in that your operations do
not differ significantly from the private, for-profit entity D and F still own and operate, H.
You offer the same training program started by H, P. You hired your controlling
governing body members, D and F, to provide services for fees. Although you have
indicated that the fees charged are in most cases reduced, your pricing policy has not
changed since the services were first offered under H . The rates charged are similar,
and in some cases, identical to what H charged. You are compensating D and F similar
rates to what they are paid for training and counseling under H. You have not
demonstrated how your rates materially differ from prevailing fair market rates for such
services. You also intend to ensure that the full price is paid regardless of any fee
reduction by securing grants to supplement anyone who cannot pay full price.

Similar to the organization denied exemption in Revenue Ruling 69-632, you were
created to provide a new market for the services previously offered by a related for-
profit. You were formed to expand the client base of D and F by creating an additional
pool of services for which fees are charged supplemented by grant funding you expect
to receive. The eventual use of grant funding will allow you to service more individuals
at full price, which means more compensation to D and F. Even though you are
providing educational job training services the private interests being served outweigh
the public benefit.

You are similar to the organization described in Revenue Ruling 72-369 as you are
providing a business service on a regular basis for a fee. Although you provide some
discounted services your operations are not distinguishable from a regular commercial
business. You use paid staff with salaries comparable to similar for profit operations,
you charge fees in line with similar for profit operations, and you market your products
similar to for profit operations.

As noted in B.S.W. Group and Airlie Foundation, supra, your trainings are counseling
services that constitute a business ordinarily carried on as a commercial venture. You
have not, thus far, received any contributions from private or public sources. Your only
source of income is fees for services. Your fees are set high enough to cover the
projected costs and produce a profit. Comparatively, you charge fees that resemble the
for-profit rates of H. As noted previously, the costs associated for the services of D and
F are similar to costs charged in their for-profit employment at H. Although you have
provided some services at a reduced price, you intend to secure grants only so that you

Letter 4036(CG) (11-2005)
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are paid the full price for those who cannot afford your fees. These factors show the
commerciality of your services. Further, by using the same key directors and employees
as H, rebranding a product of H, charging the same fees as H, and operating in the
same location where programs were initially conducted by H, you are indistinguishable
from H. Providing some free or reduced cost services does not change the manner in
which you operate which is commercial in nature.

Since your operations are commercial in nature, they are distinguishable from an
exclusively charitable and educational program, which would be exempt in nature. This
underlying commercial motive is similar to what caused denial of exemption in Better
Business Bureau of Washington D.C., supra.

Applicant’s Position
You contend that you have demonstrated you are operating in an exempt manner and
should be granted exemption under section 501(c)(3) of the Code.

Service Response to Applicant’s Position

Due to your commercial operations and the private benefit to your insiders, D and F,
you are not operated exclusively for an exempt purpose under section 501(c)(3) of the
Code.

Conclusion

Based on the facts presented above, we hold that you are not exclusively charitable
within the meaning of section 501(c)(3) of the Code. You do not meet the operational
test as you are commercial in nature and your operations serve private, rather than
public interests. Accordingly, we conclude you fail the operational tests and do not
qualify for exemption under IRC 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
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.

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,

Letter 4036 (CG) (11-2005)
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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
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 Lerner

Director, Exempt Organizations

Rulings & Agreements
Enclosure: Publication 892

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