IRS denies section 501(c)(3) exemption to an organization with vague and commercial operations

Plain-English summary

The IRS finalized its denial of tax-exempt status to an organization that proposed health, fitness, education, and foreclosure-counseling activities. The organization did not provide enough consistent detail about its operations, fees, locations, finances, or governance for the IRS to determine that it would operate exclusively for exempt purposes. The IRS also found that the organization’s planned health and wellness services resembled the founder's for-profit business and raised private-benefit and commerciality concerns. The denial means donors may not deduct contributions under section 170, and the organization was instructed to file the required federal returns unless it requested an extension.

Ruling snapshot

• Question: Does the organization qualify for exemption under section 501(c)(3)?
• Outcome: Denied
• Key authorities: IRC §§ 170, 501, 6104, 6110, and 7428; Treas. Reg. §§ 1.501(a)-1, 1.501(c)(3)-1; B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978); La Verdad v. Commissioner, 82 T.C. 215 (1984); Airlie Foundation v. Commissioner, 283 F. Supp. 2d 58 (D.D.C. 2003); New Dynamics Foundation v. United States, 70 Fed. Cl. 782 (2006)

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Number: 201302041 Contact Person:
Release Date: 1/11/2013
Identification Number:

Date: October 18, 2012
Contact Number:

Employer Identification Number:
Form Required To Be Filed:

Tax Years:
UIL: 501.32-00; 501.33-00; 501.36-01

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 476328

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,

Holly O. Paz
Director, Exempt Organizations
Rulings and Agreements

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

Letter 4038(CG) (11-2005)
Catalog Number 476328

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

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Contact Person:

Identification Number:
Date: August 23, 2012

Contact Number:

FAX Number:

Employer Identification Number:

Legend: UIL:

B = state 501.32-00
D = date 501.33-00
G = individual 501.36-01
H = individual

J = individual

M = business

N = organization

O = organization

p = dollar amount

q = dollar amount

r = dollar amount

Dear

We have considered your application for recognition of exemption from federal income tax
under section 501(a) of the Internal Revenue Code (“Code”). Based on the information
provided, we have concluded that you do not qualify for exemption under section 501(c)(3)
of the Code. The basis for our conclusion is set forth below.

Issues
Will you operate in a commercial, non-exempt manner? Yes, for the reasons given below.

Are private interests being served resulting in inurement and prohibiting you from
qualification under Section 501(c)(3) of the Code? Yes, for the reasons stated below.

Facts
You are a B nonprofit, non-stock corporation incorporated on D. Your Articles of
Incorporation state that you are organized and operated exclusively for charitable purposes

within the meaning of Internal Revenue Code section 501(c)(3). Your Articles of
Incorporation (“Articles”) state that your specific purpose is to:

“... [p]artner with local schools, the religious community, and other organizations, to
establish workshops to address the causes of the health, fitness, educational and
financial problems plaguing this targeted group. The workshops will include but are
not limited to, health, fitness, education, and financial awareness.”

Your initial board of directors consisted of G (CEO), and H, (secretary and treasurer), who
are husband and wife. G is a certified tutor, works in the field of fitness and weight
management and is certified as a trainer by the American Counsel on Exercise. She is
founder and owner of M, a for profit entity that provides health and wellness training
services. She provides professional nutrition consultation and fitness training to
corporations, churches, local communities, and personal clients. H is certified in radio
marketing, and in foreclosure counseling and loan modification through O. On request, you
added J as an additional board member, listed as your community outreach officer. Her
duties were given as building, cultivating and sustaining new and existing business
relationships as a community outreach officer. J is not related by family to G or H; G had
collaborated to provide services for J’s non-profit entity (N).

You submitted copies of your agenda/minutes from board meetings already held. Despite
the addition of J as a new board member, no notation of this was included in your minutes,
no vote was held on the inclusion of J, and J has been absent from the three documented
meetings held since her addition. When asked of J’s involvement with your operations to
date, you indicated “board member, founder of N”.

Given that two of the three members of your board are related, we asked you to explain the
enforcement and validity of your conflict of interest policy. You stated “monitoring by the
board”.

Your Bylaws state that your board would consist of no fewer than two directors, and while
the term for a director was two years, they could serve indefinitely.

You stated you would conduct workshops to provide the following:

1. Form collaborative partnerships with other community based organizations and
   other entities geared toward enhancing the lives and health of youth, adults and
   seniors and those underserved in their communities.

2. Advocating for the necessary changes in policy and funding to improve the
   quality of life and services to those youth, adults and seniors in need of the
   necessary resources to help them to become productive citizens in their
   communities.

3. Implement, grow, and sustain various programs that will address the needs of
   underserved youth, adults and seniors in the community.

4. Help youth, adults and seniors transform their lives through increased education
   and awareness.

Workshops are conducted in various community places. Each workshop focuses on one
topic and are open to the public. There are no fees for any of the workshops.

You also planned to conduct foreclosure counseling for homeowners in distress. You
provided the details of your foreclosure counseling as follows:

A seasoned foreclosure counselor will explore a wider variety of intervention
operations available to homeowners in distress. You will focus on loss
mitigation tools determined to be the least understood or utilized in today's
foreclosure environment. Counselors will identify the most critical financial
factors in foreclosure cases and then suggest the loss mitigation tool that best
addresses a homeowner's mortgage problems. Additional resources on the
most recent foreclosure initiatives created to assist homeowners are also
provided.

You further provided copies of various forms and worksheets that you use to negotiate with
lenders. However, you dropped the activities of mortgage loss mitigation, loan modification,
mortgage foreclosure intervention, financial counseling and the like in your response letter
—stating H was no longer available to conduct these activities. In addition to that, you stated
that you will move forward solely with the activities of health and fitness, which now
accounts for 100% of your efforts and budget in the areas of health and fitness. This activity
is carried out by G at public venues.

You described your health and fitness activities as “health and fitness. Contacting those
that want to attend the class and teaching them, once they arrive. ” You will conduct these
activities “when and where attendees were available”, however, you had previously stated
your operations were run out of the home of G and H. Dates and times of classes were to
be determined, but would usually be on the weekend. Depending on the class, fees may or
may not be charged, despite your statement that no fees would be charged for workshops.
You did not state what the actual fees to be charged would be. You did state you hoped to
solicit some donations or grants. When asked who would conduct this service, you
indicated, “G, no salary/wages’”. You detailed the work hours and compensation of your
board as “varies, no compensation’.

When asked for details on operations that were more complete you submitted the exact
same responses.

You submitted three different sets of financial data as well as separate details on income

and expenses. Your initial financial data was dated prior to your submission of Form 1023.
Despite this, your actual income and expenses given changed three times. Further, despite
the separate details provided regarding expenses paid to and incurred by G and H, your
last set of financial data shows zero income and expenses for the two years you have been
in existence. You did list separate income and expenses which showed G had been paid a
total of p dollars for varying services. Further, H had incurred q dollars and G r dollars for
professional certifications. When asked for further details about compensation at a later
date, you stated you did not pay for the certifications of G or H, nor was there any
compensation.

Law

Section 1.501(c)(3)-1(a)(1) of the regulations provides that, in order to be exempt as an
organization described in section 501(c)(3), an organization must be both organized and
operated exclusively for one or more of the purposes specified in such section. If an
organization fails to meet either the organizational test or the operational test, it is not
exempt.

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 that 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 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. Section 1.501(a)-1(c) of the regulations
defines the words “private shareholder or individual” in section 501 to refer to persons
having a personal and private interest in the activities of the organization.

Section 1.501(c)(3)-1(d)(1)(ii) of the regulations provides that an organization is not
organized or operated exclusively for one or more exempt purposes unless it serves a
public rather than a private interest. Thus, to meet the requirements of this subsection, 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.

Rev. Proc. 2012-9; 2012-2 I.R.B. 261, Section(4)(.03); 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 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 Code under which exemption is
claimed, the Service will generally issue a proposed adverse determination letter or
ruling.

In B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978), the court found that a
corporation formed to provide consulting services did not satisfy the operational test under
section 501(c)(3) of the Code because its activities constituted the conduct of a trade or
business that is ordinarily carried on by commercial ventures organized for profit. Its
primary purpose was not charitable, educational, or scientific, but rather commercial. In
addition, the court found that the organization's financing did not resemble that of the
typical section 501(c)(3) organizations. It had not solicited, nor had it received, voluntary
contributions from the public. Its only source of income was from fees from services, and
those fees were set high enough to recoup all projected costs and to produce a profit.
Moreover, it did not appear that the corporation ever planned to charge a fee less than
“cost.” And finally, the corporation did not limit its clientele to organizations that were
section 501(c)(3) exempt organizations.

In La Verdad v. Commissioner, 82 T.C. 215 (1984), an organization was formed to provide
education and charity, but failed to provide sufficient details regarding its proposed
operations. The court held that it failed to prove that it would operate exclusively for exempt
purposes under section 501(c)(3) of the Code.

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. Because of the commercial
manner in which this organization conducted its activities, the court found that it was
operated for a nonexempt commercial purpose, rather than for an exempt purpose. The
court stated that among the major factors courts have considered in assessing
commerciality are competition with for profit commercial entities; extent and degree of
below cost services provided; pricing policies; and reasonableness of financial reserves.
Additional factors include, inter alia, whether the organization uses commercial promotional
methods (e.g., advertising) and the extent to which the organization receives charitable
donations.

New Dynamics Foundation v. United States, 70 Fed. Cl. 782 (2006), was an action for
declaratory judgment that the petitioner brought to challenge the denial of his application for
exempt status. The court, in finding that the actual purposes displayed in the administrative
record supported the Service’s denial, stated “It is well-accepted that, in initial qualification
cases such as this, gaps in the administrative record are resolved against the applicant.”
The court noted that if the petitioner had evidence that contradicted these findings, it should
5

have submitted it as part of the administrative process. The court also highlighted the
principle that exemptions from income tax are matters of legislative grace.

Application of Law

Section 501(c)(3) of the Code sets forth two main tests for an organization to be recognized
as exempt. An organization must be both organized and operated exclusively for purposes
described in section 501(c)(3). Section 1.501(c)(3)-1(a)(1) of the regulations.

An organization will be regarded as “operated exclusively” for one or more exempt
purposes only if it engages primarily in activities that accomplish one or more of such
exempt purposes specified in section 501(c)(3) of the Code. Section 1.501(c)(3)-1(c)(1) of
the regulations. You did not provide sufficient information to permit us to determine how
your planned activities will advance these purposes. You have indicated you will offer
health and wellness workshops to anyone in the community, possibly for a fee, at an
undisclosed location. You have not distinguished your operations as any different from the
for profit entity owned and run by G. You do not meet the regulations and have failed to
establish your operations are exempt.

Rev. Proc. 2012-9 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 Code under which exemption is claimed. Despite
multiple requests for information, only short, terse and in some circumstances contradictory
responses were provided. We are unable to conclude the full details of the programs you
intend to conduct, who will conduct, or where. For example, you stated in your response
that you will drop the housing counseling activity and other community related activities
leaving health and fitness programs as your only activity. You were then asked to describe
your health and fitness activities in further details. You did not provide this information.
Similarly, you were asked to provide a fee schedule for your programs, J's involvement and
role within your organization, and multiple times requested financial data. You either failed
to provide information or submitted inadequate responses. Therefore, you failed to provide
an adequate basis for us to determine that you are organized and operated exclusively for
exempt purposes. See La Verdad v. Commissioner.

There are several contradictions and inconsistencies in your Application. For example, you
show no compensation or reimbursements to your governing members on pages 2 and 9 of
your Application. However, you stated that you would pay G and H for their services and
certifications in your response. Then you stated later that you did not pay for their
certification. Similarly, you stated in one response that there will be no fee for any of the
workshops. In another response, you stated that the fee depends on the class. You stated
activities would take place in the home of G and H, then indicated locations were unclear.
You are similar to the organization in New Dynamics Foundation v. United States, above

because of the inconsistent, vague, or nonspecific information you provided is not sufficient
enough to establish entitlement to tax-exempt status.

6

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. Your operations inure to the benefit of G
and H. Further, Section 1.501(c)(3)-1(d)(1)(ii) of the regulations provides that an
organization is not organized or operated exclusively for one or more exempt purposes
unless it serves a public rather than a private interest. There are several indicators in your
Application that you are operating for the benefit of G and H.

You have two related board members out of three. These two conduct almost all of your
activities with complete control over you. J is an unrelated minority in your board. In
addition, your board minutes do not indicate that J exercised her rights over any important
decisions such as business with insiders. In fact you failed to provide any board minutes
which shows how your board members were elected. You failed to show that you are an
independent organization from G's health and wellness business. Your sole activity is
providing health and wellness training performed by G, which is exactly what G does in her
for-profit business. You indicated personal certifications were paid for. You then submitted
contradictory statements that expenses and compensation were paid, then not paid. You
have been unable to document that you have not provided benefits to insiders. Overall,
through various contradictions and lack of complete information you have been unable to
document that G’s related for profit entity or G herself will not benefit from your operations.
You have failed to show how your operations serve a public rather than a private interest.

You are similar to the organizations in Airlie Foundation and B.S.W. Group in that you will
operate in a commercial manner. You do not limit your services to the poor or distressed.
G, your CEO, is a certified trainer as well as the founder and owner of M, a for profit entity
that provides health and wellness training services. You appear to be conducting the same
services as her for profit. While you have provided contradictions on the subject, it appears
you will be charging fees for these workshops as you expect only a small portion of
revenue through contributions. The location of these workshops was not made clear, but
you have previously stated activities would be conducted from the home of G and H, the
same as G's for profit entity. You are in competition with for-profit entities providing similar
services, for a fee, and operate in a manner similar to a commercial business. You have
been unable to fully distinguish yourself from the business owned and operated by G, a for
profit providing personal health and wellness programs. Accordingly, your operations are
indistinguishable from a commercial business.

Conclusion

Based on the facts and information provided, you are not operated exclusively for exempt
purposes. You operate in a commercial manner, your activities result in inurement to G and
H, and you have failed to establish your operations are tax exempt. Accordingly, you do not
qualify for exemption as an organization described in 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
7

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. These items include:

. The organization’s name, address, and employer identification number;
A statement that the organization wants to appeal the determination;
The date and symbols on the determination letter;
A statement of facts supporting the organization’s position in any contested factual
issue;

5. A statement outlining the law or other authority the organization is relying on; and
6. A statement as to whether a hearing is desired.

RON

The statement of facts (item 4) must be declared true under penalties of perjury. This may
be done by adding to the appeal the following signed 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.”

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. A\l 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

8

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,

Holly O. Paz
Director, Exempt Organizations
Rulings and Agreements

Enclosure, Publication 892