IRS denies exemption to a fee-based creditor-harassment service

Plain-English summary

The IRS issued a final adverse determination denying an organization's application for recognition under IRC § 501(c)(3). The organization charged fees to communicate with creditors on behalf of seniors and disabled people who were described as judgment proof. The IRS concluded that the services were commercial rather than charitable, that the organization lacked a valid exempt purpose and dissolution clause, and that its arrangements with a related for-profit law firm and its directors created private-benefit and inurement concerns. Contributions to the organization were not deductible under § 170, and it was required to file federal income tax returns.

Ruling snapshot

• Question: Does the organization qualify for exemption under IRC § 501(c)(3) when it provides creditor-communication services for fees?
• Outcome: Denied, the IRS issued a final adverse determination.
• Key authorities: IRC §§ 170, 501(c)(3), 6104(c), 6110, and 7428(b)(2); Treas. Reg. §§ 1.501(a)-1(c) and 1.501(c)(3)-1

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION

Release Number: 201305012 Contact Person:
Release Date: 2/1/2013

Date: November 9, 2012 Identification Number:

UIL: 501.32-00; 501.32-01; 501.33-00
Contact Number:

Employer Identification Number:
Form Required To Be Filed:

Tax Years:

Dear

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

Since you do not qualify for exemption as an organization described in Code section 501(c)(3),
donors may not deduct contributions to you under Code section 170. You must file Federal
income tax returns on the form and for the years listed above within 30 days of this letter, unless
you request an extension of time to file.

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

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 4763258

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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
Date: September 19, 2012 Contact Person:
Identification Number:
Contact Number:
FAX Number:
Employer Identification Number:
LEGEND: UIL:
B= Date 501.32-00
C= State 501-32-01
D= legal organization 501.33-00

E = founder/director/employee
F = related for-profit

G= program

L= director/employee 1

M = director/employee 2

h dollars = up front fee

j dollars = monthly fee

k dollars = salary

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

Letter 4036(CG) (11-2005)
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• Do you meet the operational test under section 501(c)(3) of the Code by operating
exclusively for an exempt purpose? No, for the reasons described below.

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

Facts

You are a non-profit corporation formed on B under the laws of the State of C. Your Articles of
Incorporation were amended to change the type of corporation from mutual benefit with
members to public benefit with members. Section 3 of the Articles describes your business as:
“services for the elderly and persons with disabilities.” Section 7 of the Articles provides that
your assets are to be disbursed to D upon dissolution.

You were formed to provide a program for seniors and disabled persons to prevent creditor
harassment. Your concept was originated by E, senior partner of F, a bankruptcy law firm
located in C. Many seniors and disabled persons are on limited income such as social security
and/or pensions, yet they carry significant credit card, medical and other unsecured debt which
they have insufficient income to pay. Creditors call, badger and harass such persons through
multiple letters and phone calls. Such individuals have two alternatives: deal with the
harassment or file bankruptcy. The cost of filing Chapter 7 bankruptcy has increased
significantly since the 2005 Bankruptcy Reform Act. Therefore, the individuals cannot afford to
pay the debt or to file for bankruptcy. Due to the fact that they are judgment-proof as a result of
their limited income, filing bankruptcy is not necessary. E developed a program within F called
G. G has been in existence for three years and includes more than 500 seniors. G takes
advantage of provisions in the law that provide that creditors are not permitted to contact a
debtor by telephone or mail once the individual is represented by an attorney. F charges an
upfront fee of h dollars and monthly fee of j dollars to clients wishing to stop harassment by
creditors.

The program is made available to judgment proof seniors and disabled persons receiving
primarily social security, pension or disability throughout multiple jurisdictions. Clients of G as
operated by F will be transferred to you. You will continue to charge the same fees as those
charged by F. You do not have a fee schedule. Fees will be modified down so this service can
be provided to all that need help. As the program grows you will bring in other attorneys as
necessary to represent judgment proof clients to prevent creditor harassment. The attorneys will
not represent clients in challenging lawsuits. The only service provided is to communicate with
creditors regarding the client's judgment proof status. As a section 501(c)(3) organization you
will be able to obtain referrals from legal aid organizations. You do not anticipate soliciting
contributions, you will be self-sustaining from the fees charged for services. The fees charged
will proviue funds for you to send out mail to fulfill your function, hire employees to communicate
with clients and creditors, and advertise your services in a limited manner.

Clients are interviewed over the phone or via a written application to determine if they qualify for
the program as being judgment proof. You then send a letter to each creditor as indicated by the
client advising that the client is now represented by an attorney. If a client is sued by a creditor

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you will contact the attorney representing the creditor and submit proof that the client's income
is exempt from judgment. You provide no other legal representation. Clients may contact you at
any time with questions. You maintain a website providing information about your services. You
also submitted a promotional flyer and brochure about your program. In addition, you submitted
a copy of your adopted conflict of interest policy.

E is the managing partner of F. E will receive compensation of k dollars annually to oversee
your operations, approximately 30 hours per week. The amount of E’s compensation is based
on his active experience as an attorney in the region. Your Board of Directors is composed of E,
L and M. L is a bankruptcy attorney and partner of F. M serves as an employee of F. M's
services are currently “leased” to you. L and M were voted onto your Board by E, acting as your
sole initial director. You also lease the services of three other employees from F. Eventually, M
as well as the other leased employees will cease to be employees of F and will work solely for
you. You sublease your facility from F. Under the lease agreement you and your visiting clients
will share parking lot space with F and have reasonable access to the designated client meeting
rooms for your clients. In addition, your employees and clients will have access to common
areas (break room/bathrooms), a main reception area and the computer service room. Two of
the rooms leased by you are segregated by doors and locks from F’s space. You also lease
office equipment from F, including desks, chairs, computers and a printer.

Law

Section 501(c)(3) of the Code provides that corporations may be exempted from tax if they are
organized and operated exclusively for charitable or educational purposes and no part of their
net earnings inures to the benefit of any private shareholder or individual.

Section 1.501(c)(3)-1(a)(1) of the Income Tax Regulations (“regulations”) provides 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.

Section 1.501(c)(3)-1(b)(1)(i) of the regulations provides that an organization is organized
exclusively for one or more exempt purposes only if its articles of organization:

(a) Limit the purposes of such organization to one or more exempt purposes; and
(b) Do not expressly empower the organization to engage, otherwise than as an
insubstantial part of its activities, in activities that in themselves are not in furtherance
of one or more exempt purposes.

Section 1.501(c)(3)-1(b)(4) of the regulations provides that an organization's assets must be
dedicated to an exempt purpose, either by an express provision in its governing instrument or
by operation of law.

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

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that 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. Section 1.501(a)-1(c) of the regulations defines
the words “private shareholder or individual” in section 501 of the Code 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 the applicant organization must
show that it serves a public rather than a private interest and specifically 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 1.501(c)(3)-1(d)(2) of the regulations provides that the term “charitable,” is used in
section 501(c)(3) in its generally accepted legal sense and includes the relief of the poor and
distressed or of the underprivileged.

In Revenue Ruling 69-441, 1969-2 C.B. 115, the Service found that a nonprofit organization
formed to help reduce personal bankruptcy by informing the public on personal money
management and aiding low-income individuals and families with financial problems was
exempt under section 501(c)(3) of the Code. Its board of directors was comprised of
representatives from religious organizations, civic groups, labor unions, business groups, and
educational institutions.

The organization provided information to the public on budgeting, buying practices, and the
sound use of consumer credit through the use of films, speakers, and publications. It aided low-
income individuals and families who have financial problems by providing them with individual
counseling, and if necessary, by establishing budget plans. Under the budget plan, the debtor
voluntarily made fixed payments to the organization, holding the funds in a trust account and
disbursing the funds on a partial payment basis to the creditors. The organization did not
charge fees for counseling services or proration services. The debtor received full credit against
his debts for all amounts paid. The organization did not make loans to debtors or negotiate
loans on their behalf. Finally, the organization relied upon contributions, primarily from the
creditors participating in the organization's budget plans, for its support.

The Service found that, by aiding low-income individuals and families who have financial
problems and by providing, without charge, counseling and a means for the orderly discharge of
indebtedness, the organization was relieving the poor and distressed. Moreover, by providing
the public with information on budgeting, buying practices, and the sound use of consumer
credit, the organization was instructing the public on subjects useful to the individual and
beneficial to the community. Thus, the organization was exempt from federal income tax under
section 501(c)(3) of the Code.

Revenue Ruling 72-124, 1972-1 C.B. 145, describes an organization that operated a home for

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the elderly. It qualified for exemption under 501(c)(3) as a charitable organization because it
met the special needs of the elderly for housing, healthcare and financial security. The need for
financial security, i.e., the aged person's need for protection against the financial risks
associated with later years of life, will generally be satisfied if two conditions exist. First, the
organization must be committed to an established policy, whether written or in actual practice, of
maintaining in residence any persons who become unable to pay their regular charges. As to
the second condition respecting the provision of financial security, the organization must
operate at the lowest feasible cost, taking into consideration its expenses.

Revenue Ruling 76-244, 1976-1 C.B. 155, describes a charitable organization that provided
home delivered meals to elderly and disabled persons. Volunteers delivered the meals. A
nominal fee that was insufficient to cover the costs of the meals and delivery was charged. In
some cases, no fees were charged depending on the recipients’ abilities to pay. The
organization qualified for exemption under section 501(c)(3) of the Code.

Revenue Ruling 77-246, 1977-2 C.B. 190, describes an organization that was formed to provide
low cost bus transportation for senior citizens and disabled persons in a community where
public transportation was unavailable or inadequate. Although the organization charged a
nominal fee, it was dependent upon contributions and federal and local governmental grants in
order to meet its operating expenses. The organization qualified for exemption under section
501(c)(3) of the Code.

In Better Business Bureau of Washington, D.C. v. U.S., 326 U.S. 279, 283, 66 S. Ct. 112, 90 L.
Ed. 67 (1945), the Supreme Court held that the “presence of a single . . . [nonexempt] purpose,
if substantial in nature, will destroy the exemption regardless of the number or importance of
truly .. . [exempt] purposes.”

The ruling in Leon A Beeghly v. Commissioner, 35 T.C. 490 (1960), provided that where an
exempt organization engages in a transaction with a related interest and there is a purpose to
benefit the private interest rather than the organization, exemption may be lost even though the
transaction ultimately proves profitable for the exempt organization.

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 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 P.P.L. Scholarship v. Commissioner, 82 T.C. (1984), an organization operated bingo at a bar
for the avowed purpose of raising money for scholarships. The board included the bar owners,
the bar accountant, also the director of the bar, as well as two players. The board was self-

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perpetuating. The Court reasoned that since the bar owners controlled the organization and
appointed the organization’s directors, the activities of the organization could be used to the
advantage of the bar owners

In Easter House v. U.S., 12 Cl. Ct. 476, 486 (1987), aff'd, 846 F. 2d 78 (Fed. Cir.) cert. denied,
488 U.S. 907, 109 S. Ct. 257, 102 L. Ed. 2d 246 (1988), the court found an organization that
operated an adoption agency was not exempt under section 501(c)(3) of the Code because a
substantial purpose of the agency was a nonexempt commercial purpose. The court concluded
that the organization did not qualify for exemption under section 501(c)(3) because its primary
activity was placing children for adoption in a manner indistinguishable from that of a
commercial adoption agency. The court rejected the organization's argument that the adoption
services merely complemented the health related services to unwed mothers and their children.
Rather, the court found that the health-related services were merely incident to the
organization's operation of an adoption service, which, in and of itself, did not serve an exempt
purpose. The organization's sole source of support was the fees it charged adoptive parents,
rather than contributions from the public. The court also found that the organization competed
with for-profit adoption agencies, engaged in substantial advertising, and accumulated
substantial profits. Accordingly, the court found that the "business purpose, and not the
advancement of educational and charitable activities purpose, of plaintiff's adoption service is its
primary goal" and held that the organization was not operated exclusively for purposes
described in section 501(c)(3). Easter House, 12 Cl. Ct. at 485-486.

In Orange County Agricultural Society, Inc. v. Commissioner, 893 F.2d 529, 534 (2d Cir. 1990), °
the appellate court affirmed the Tax court's holding that loans extended on advantageous terms
to its founders, or to an entity controlled by them, indicates private inurement. In Orange
County, the loans were interest-free and, while some payments were made, the repayments did
not match the loan amounts and there was no evidence in the record that the full amount loaned
would ever be repaid.

In Living Faith, Inc. v. Commissioner, 950 F.2d 365 (1991), the Court of Appeals upheld a Tax
Court decision that an organization operating restaurants and health food stores in a manner
consistent with the doctrines of the Seventh Day Adventist Church did not qualify for exemption
under section 501(c)(3) of the Code because the organization was operated for a substantial
nonexenipt commercial purpose. The court found that the organization's activities were
"presumptively commercial" because the organization was in competition with other restaurants,
engaged in marketing, and generally operated in a manner similar to commercial businesses.

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 non-
exempt commercial purpose, rather than for a tax exempt purpose. As the court stated:

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

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commercial promotional methods (e.g. advertising) and the extent to which the
organization receives charitable donations.

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). You fail both tests.

Organizational Test

To demonstrate that it is organized exclusively for exempt purposes, thus satisfying the
organizational test, an organization must have a valid purpose clause and a valid dissolution
provision, as specified in section 1.501(c)(3)-1(b)(1)(i) and section 1.501(c)(3)-1(b)(4) of the
regulations. You do not have a valid purpose clause. A valid purpose clause must limit your
purposes to those described in section 501(c)(3) of the Code. Your Articles of Incorporation in
section 2 identifies your “Description of Business” as “Services for the Elderly and Persons with
Disabilities’. You also do not have a valid dissolution clause. Section 7 of your Articles of
Incorporation states that your assets are to be disbursed to D upon dissolution. There is no
evidence that D is a section 501(c)(3) organization. In addition, your Articles do not contain a
provision to ensure that in the event D is not a section 501(c)(3) organization, the assets will be
distributed to another section 501(c)(3) organization or used for section 501(c)(3) purposes. You
do not have a valid purpose or dissolution clause. Therefore, you do not meet the organizational
test.

Operational Test

To satisfy the operational test of IRC section 501(c)(3), an organization must establish that it is
Operated exclusively for one or more exempt purposes as specified in section 1.501(c)(3)-
1(c)(1) of the regulations. As noted in Better Business Bureau of Washington, D.C. v. U.S., the
presence of a single non-exempt purpose precludes exemption regardless of any valid exempt
purposes. You failed to establish that you are operated exclusively for one or more exempt
purposes. Your proposed activities are not charitable as provided in section 1.501(c)(3)-1(d)(2)
of the regulations.

Your Activities Are Not Charitable

All of your time and resources are devoted to providing legal services, for a fee, to individuals on
limited income who are being harassed by creditors. Providing legal services for a fee does not
provide relief to the poor and distressed within the meaning of section 1.501(c)(3)-1(d)(2) of the
regulations or serve any other purpose recognized as charitable. Although your service is
limited to seniors or the disabled on limited income, providing a service for a fee is a commercial
activity, not a charitable one.

The legal services you provide to individuals do not further charitable purposes. You “represent”
individuals being harassed by creditors. Your clients cannot afford to pay their debts or file for

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bankruptcy due to their limited income. The service you provide is limited to notifying creditors
that the client is represented by an attorney thereby preventing the creditor from further contact
with the debtor (your client). You do not provide representation in the event a client is actually
sued by a creditor. Notifying creditors, for a fee, that you are a legal representative of a
charitable beneficiary does not relieve the poor and distressed. Accordingly, you are unlike the
organization described in Revenue Ruling 69-441, supra, which aided low-income individuals
and families who have financial problems, thereby relieving the poor and distressed. You do not
provide counseling or assistance in paying off the debts of your clients. In addition, you charge a
fee for your service. The organization in the revenue ruling provided their services free of
charge.

You are distinguishable from the organization described in Revenue Ruling 72-124. Although
you provide a service to stop verbal and written harassment of seniors by creditors, you do not
meet their special needs, such as financial security, housing or healthcare. While your services
are provided to low income seniors or disabled individuals, you charge an upfront fee and a
monthly fee for your services. Although you do waive or reduce fees for those who cannot afford
them, you do not have an established fee waiver policy. Nor have you submitted evidence that
you operate at the lowest feasible cost.

You are distinguishable from the organization described in Revenue Ruling 76-244. You are
dependent on the service fees you bill your clientele in order to operate. Your fees cannot be
described as nominal. You operate in a commercial manner like any law firm. You determine
your costs and set your fees to meet your financial obligations. Finally, you are not like the
organization described in Revenue Ruling 77-246 because you are dependent on the fees you
charge to cover your expenses. The majority of your expenses are salaries and wages. Thus,
you failed to establish that your activities are charitable within the meaning of section 501(c)(3)
of the Code.

You Have a Substantial Nonexempt Commercial Purpose

The courts have developed guidelines intended to help discern whether an organization has a
substantial nonexempt commercial purpose. See e.g., B.S.W. Group, supra; Easter House,
supra; Airlie, supra; Living Faith, supra. Generally, the factors proffered by courts focus on the
nature of the activities and how an organization conducts its business.

Your only activity consists of providing legal services for a fee. Providing legal services for a fee
is not an exempt purpose, as recognized by statute or by case law, but rather a substantial
nonexempt commercial purpose. You charge h dollars up front and j dollars monthly to provide
letters to the client's creditors notifying the creditor that the clients are judgment proof based
upon their incomes and are represented by you. These fees do not entitle your clients to any
educational programs or services beyond those that are offered by for-profit attorneys, a
situation similar to that found in Living Faith, supra. This is evidenced by the fact that F charged
exactly the same rates for exactly the same services. Adopting a fee structure that is identical
to that used by a for-profit also demonstrates that you are operating like a commercial
organization seeking to maximize profits, rather than a charitable or educational organization
seeking to serve the public. B.S.W. Group, supra. As you stated, you do not plan to solicit
donations or other contributions but will be self-sustaining on fees for services. You did not

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budget any money for educational or charitable activities. Thus, similar to the organization in
Easter House, supra, the profit-making fee structure of your consulting services overshadows
any of your other purposes.

Your financial structure further demonstrates that you operate for a substantial nonexempt
commercial purpose. You indicated that you will not fundraise or solicit government grants.
The only donation you received was from F. You do not have a plan to solicit donations in the
future as you expect to be self-sustaining based upon fees for services There is also no
evidence that you have received contributions or gifts from disinterested members of the public.
Accordingly, you are unlike the organizations described in Revenue Ruling 69-441, supra, that
received the bulk of their support from government and private foundation grants and
contributions. Your operations are financed entirely by revenue earned from selling services to
clients. Receiving support primarily from legal fees is indicative of a nonexempt, “business”,
purpose similar to the organization in Easter House, supra.

Like the organizations in Easter House, supra, Airlie, supra, and Living Faith, supra, you are in
direct competition with commercial businesses because you conduct activities generally
conducted for a profit. In fact, you share office space, supplies, directors, and employees with F,
a commercial firm that provides legal services including bankruptcy representation. In addition,
your program was begun and conducted in the same manner as a commercial enterprise. For
example, you use similar pricing, financial structure, advertising, and relationships with other for-
profit companies. Your activities evidence a substantial nonexempt commercial purpose. Thus,
more than an insubstantial part of your activities are in furtherance of a nonexempt purpose, in
contravention of section 1.501(c)(3)-1(c)(1) of the regulations and sufficient for disqualification of
exemption as noted in Better Business Bureau of Washington, D.C, supra. Therefore, you are
not operated for an exempt purpose.

Inurement

As stated in section 501(c)(3) of the Code and section 1.501(c)(3)-1(c)(2) of the regulations, 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.

You are similar to the organization in Leon A Beeghly v. Commissioner, supra, in that you
engage in transactions with a purpose to benefit a private interest. You provided a lease
agreement entered into between F and a Jessor as well as a sublease between you and F. The
sublease covers an office and a meeting room. The sublease calls for you to pay annual rent of
approximately 20% of the total lease amount paid by F. You indicated that F is charging a
“reduced rate”, although you did not submit any independent documentation of the fair market
rental value of the space. The sub lease states that the leased space is 800 square feet.
However, you stated elsewhere that the lease covers 1,500 square feet. F also leases office
equipment to you. No documentation has been submitted to establish the fair market rental
value of the leased equipment. Finally, you lease several employees from F. No information has
been submitted regarding how the amounts of compensation were determined. All three of your
directors are either employees or partners of F. You have not established that your net earnings
do not inure to the benefit of F through your sub-lease, employee lease and equipment lease
agreements.

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You are similar to the organization in P.P.L. Scholarship v. Commissioner, supra, where the bar
owners controlled the organization and appointed the organization’s directors. You submitted a
conflict of interest policy. However, all three of your directors are considered interested parties
under the policy. Your directors determine their own salaries. How much they pay themselves is
based on industry levels and the value they attach to their own experience. The amounts have
not been negotiated at arm’s length, nor are they based on objective factors or an independent
appraisal. Your initial aggregate fixed payments including compensation and lease payments to
F equal approximately 92% of your projected revenues. Like the organization in the P.P.L.
Scholarship decision, your activities could be used to the advantage of your directors.

You do not have adequate safeguards to protect you in your dealings with F. Under the terms
of your conflict of interest policy, all of your directors are prevented from determining whether a
conflict exists with regards to transactions or arrangements with F. In addition, your directors
are charged with determining each other's salary. Thus, you failed to demonstrate that insiders
will not benefit from your relationship with F. Despite your inability to determine whether a
conflict of interest exists with regard to dealings with F, you continue to share office space,
employees and equipment. You did not provide evidence your directors will be prevented from
using you to reduce the expenses of their for-profit business. You did not indicate how or when
you determine which potential clients are seeking your services as opposed to F’s services. As
was the case in Orange County Agricultural Society, supra, your directors have control over
financial decisions with F, and your directors stand to benefit from the decisions. Yet you
provided no evidence that net earnings will not inure to your directors’ benefit.

You failed to establish net earnings will not inure to the benefit of your directors. You failed to
establish that transactions with F are at “arm’s length.” You did not establish that you will
segregate your clients in a way that ensures F does not benefit.

Conclusion

Based on the facts and information provided, you are not organized or operated exclusively for
exempt purposes. You are not organized exclusively for exempt purposes because you do not
have a valid purpose or dissolution clause. You are not operated exclusively for an exempt
purpose because your primary purpose is the provision of legal services for a fee. You are
organized and operated for commercial purposes. Any public purposes for which you may
operate are only incidental to this primary non-exempt purpose. You have not demonstrated
that you do not allow your net earnings to inure to private individuals. You do not serve a public
rather than a private interest. Therefore, you are not described in section 501(c)(3) of the Code.

Accordingly, you do not qualify for exemption as an organization described in section 501(c)(3)
of the Code and you must file federal income tax returns. Contributions to you are not
deductible under section 170.

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

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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:

1. The organization’s name, address, and employer identification number;

2. Astatement that the organization wants to appeal the determination;

3. The date and symbols on the determination letter;

4. A statement of facts supporting the organization’s position in any contested factual
   issue;

5. Astatement outlining the law or other authority the organization is relying on; and

6. Astatement as to whether a hearing is desired.

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, 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.”

Your appeal will be considered incomplete without this statement.

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

An attorney, certified public accountant, or an individual enrolled to practice before the Internal
Revenue Service may represent you during the appeal process. If you want representation
during the appeal process, you must file a proper power of attorney, Form 2848, Power of
Attorney and Declaration of Representative, if you have not already done so. You can find more
information about representation in Publication 947, Practice Before the IRS and Power of
Attorney. All forms and publications mentioned in this letter can be found at www.irs.gov, Forms
and Publications.

If you do not file a protest within 30 days, you will not be able to file a suit for declaratory
judgment in court because the Internal Revenue Service (IRS) will consider the failure to appeal
as a failure to exhaust available administrative remedies. Code section 7428(b)(2) provides, in
part, that a declaratory judgment or decree shall not be issued in any proceeding unless the Tax
Court, the United States Court of Federal Claims, or the District Court of the United States for
the District of Columbia determines that the organization involved has exhausted all of the
administrative remedies available to it within the IRS.

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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

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Letter 4036(CG) (11-2005)
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