IRS denies exemption to an employment-services organization formed to pay its founder

Plain-English summary

The IRS denied exemption under section 501(c)(3) to an organization that planned to provide employment services to people with disabilities through a government referral and payment program. The IRS concluded that the organization was formed to create a paid position for its founder, who would receive nearly all of the projected revenue, and that the organization operated in a commercial manner rather than for an exempt public purpose. The IRS also found that the applicant had submitted information apparently copied from an unrelated organization and had not substantiated those claimed activities. Contributions were not deductible under section 170, and the organization was required to file federal income tax returns.

Ruling snapshot

• Question: Did the organization qualify for exemption under IRC § 501(c)(3), and did it operate in a substantially commercial manner?
• Outcome: Denied
• Key authorities: IRC §§ 501(c)(3), 170, 6104(c), 6110, and 7428; Treas. Reg. §§ 1.501(c)(3)-1(a), 1.501(c)(3)-1(c)(1), and 1.501(c)(3)-1(d)(1)(ii)

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

OIVISION

Release Number: 201307009 Contact Person:

Release Date: 2/15/2013

Date: November 21, 2012 Identification Number:

UIL Code: 501.30-02

501.35-01 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.

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Catalog Number 4763258

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
Date: October 2, 2012 Contact Person:
Identification Number:
Contact Number:
FAX Number:
Employer Identification Number:
Legend: UIL:
B = date 501.30-02
C = state 501.35-00
D = government agency
F = individual
G = individual
H = individual
L = organization
M = web site
N = state

x = 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.

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

Facts
On B, you incorporated in the State of C. Your Articles of Incorporation indicate that you
are organized to provide “assistance to clients in obtaining community employment’, to

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provide “skills/abilities assessments” and to identify “available and appropriate
community employment opportunities for clients”.

You stated in your application for exemption that F, initially listed as your only governing
body member and your president, would be serving as an independent contractor for D,
a governmental division of C. F would be an employment consultant for people with
developmental disabilities, helping individuals with disabilities “prepare, find and
maintain employment”. In order to become a contractor with D, F would have to become
a 501(c)(3) and operate as such. Throughout your application, F refers to herself as
needing 501(c)(3) exempt status. No other activities were described in your application.

Originally, your governing body consisted of one person, F, referring to herself as
‘owner’. You have since added G and H. F and H are related. G is currently employed
as a group home manager and H is the owner of a for profit home care service, where
she manages the medical health, care, welfare and related services to clients.

Upon requesting a better description of your activities, you provided a copy of F’s daily
itinerary, consisting of checking email, returning calls, checking job postings and various
meetings with individuals and local businesses. You also submitted documents from D
describing their rehabilitative programs, their mission statement and vision and the
supported employment and employment services programs.

The supported employment program is designed to help individuals with psychiatric
disabilities obtain and maintain competitive employment. Each participant is paired with
an employment consultant. The employment consultant assesses the participant and
completes a plan, which includes identifying pre-employment needs/services, housing
needs, clothing needs, medical needs or any other ancillary problems that need to be
addressed prior to employment. The employment consultant contacts employers in the
community who offer the type of employment opportunities identified during the
assessment of the participant. The employment consultant works with the employers to
place the participant in a job. The employment consultant may also work on the job with
the participant to train them and ensure they get to and from work (including bus training
if needed) independently. Once the participant is stabilized on the job and is able to
perform all the necessary tasks, the employment consultant fades from the job site. The
employment consultant maintains contact with the employer and participant and
provides support if problems are identified.

Employment services is a program designed to help integrate individuals with
disabilities into competitive employment. The employment consultant helps the
participant identify appropriate employment goals, acts as a liaison with the employer
and provides support to both the participant and the employer. Other services offered
through this program are career exploration, transportation training and resume
development.

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Both programs serve people with the most significant disabilities by helping them
become employed in their community. The employment consultant provides continued
support to help the disabled individual maintain long-term employment.

After submitting these program documents, you indicated your intention to provide
supported employment and employment services through D. You will receive clients
through referrals from D, conduct the programs, and receive payment from D at x
dollars per client when they are placed at a job. F will be the only employment
consultant that you employ. No contracts or documents from D were provided indicating
terms of employment, nor were any documents provided from you regarding your
decision to employ F, terms of negotiation or compensation.

Your only listed source of income will come from payment by D for placing individuals
into employment. You have submitted four different sets of financial data, each showing
varying levels of revenue and expenses. However, consistently, given the revenue you
project, the majority, if not all, of the income received from D will pay F for her services.
Although we requested more detail on your revenues and expenses, you were unable to
provide any additional information.

You also submitted the names of two other entities, with their Federal Employer
Identification Numbers, indicating they provided like services.

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.

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) 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.

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

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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.

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.

Revenue Ruling 81-94, 1981-1 CB 330, held that a “church” operated to serve the
private interests of the founder was not operated exclusively for religious or charitable
purposes. The “church” was formed by a professional nurse (who was also the
“church’s” minister, director, and principal officer). It was used primarily as a vehicle for
handling the nurse’s personal financial transactions. The organization was found not to
be exempt from tax under section 501(c)(3) of the Code.

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.

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

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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 501(c)(3) purposes, but in a commercial
manner and for the private benefit of your founder, F. As more than an insubstantial part
of your activities are not in furtherance of an exempt purpose, you fail to meet the
operational test, and do not qualify for exemption under 501(c)(3).

You are not described in section 1.501(c)(3)-1(c)(1) of the regulations because you are
not primarily engaged in activities which accomplish one or more of such exempt
purposes specified in section 501(c)(3) of the Code. You are not distinguishable from
any commercial operation in that you were formed solely to accept payments directly in
correlation to services you are providing.

You are not described in section 1.501(c)(3)-1(d)(1)(ii) of the regulations because you
serve the private interest of F. You are controlled by interested parties, F and H, and
were formed and applied for exemption only to create an opportunity for F, which serves
to her private benefit. Further, it is noted that the reason you are requesting exemption
is so that you can receive compensation from D (as they require nonprofit distinction in
order for payments to be made in return for services rendered) in order to pay F.

You are similar to the organization denied exemption in Revenue Ruling 69-266 in that
you were formed to serve the private interests of F. Like that organization, you were
formed and initially controlled by one individual, F, your only employee is F, and your
financial projections indicate nearly all funds received will pay the salary of F.

You are similar to the organization described in Revenue Ruling 72-369 as you are
providing a service on a regular basis for a fee. Your operations are not distinguishable
from a regular commercial business. You do not base the rate of compensation paid to
F on the costs associated to her provision of services, but rather she will be paid a
market rate from D. Although the class served is one that can be characterized as
charitable, the manner in which you operate is commercial in nature as you lack the
donative element to be considered charitable.

You were formed to gain a contractual relationship with a government agency for one
individual, your president and founder, F, and to provide F with a salary for those
services.

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

You are also similar to the organization denied exemption in Revenue Ruling 81-94.
Like the organization in the ruling, you are operated to serve the private interests of your
founder, F. You were formed by F, who acts as a principle officer and sole employee. All
income received for securing employment is paid directly to F. Therefore, you are
operated primarily as a vehicle for F, to benefit her financially, and thus are not operated
exclusively for any exempt purpose defined under section 501(c)(3) of the Code.

As in B.S.W. Group and Airlie Foundation, supra, you are providing services in a
commercial manner. You have not received any contributions from private or public
sources. Your only source of income is fees for services. Further, there is no evidence
that you ever intend to provide services for less than the market rate D will pay you.
These factors show the commerciality of your services.

Since a more than insubstantial part of your operations are commercial and directly
benefit F, you are similar to Better Business Bureau of Washington D.C., supra.
Although your program of securing employment for disabled persons may serve certain
charitable and educational purposes, your overriding purpose is that of providing a
service for a fee and a benefit to F through service contracts. This precludes exemption
under section 501(c)(3) of the Code.

Applicant’s Position

You contend that you are organized and operated exclusively for exempt purposes. You
referred us to two other organizations that operate in a manner similar to you that are
recognized as exempt under section 501(c)(3) of the Code.

You provided additional information as well. You will recruit volunteers to attend events
in order to share information related to obtaining employment. You indicated that the
materials and gathered information are effective in educating the public about the risk
factors, warning symptoms, diagnosis, early detection and various treatment methods of
ovarian cancer.

Your time and resources are allocated for communal outreach (career fairs, support
groups, career skills lectures/trainings), media outlet maintenance, support group
preparation/community outreach preparation, administration (meeting, correspondence,
record keeping and accounting) and your web site.

You maintain articles of interest regarding ovarian cancer on a comprehensive website
(M). The website features the latest news regarding ovarian cancer, contact information,
announcements about L and events relevant to your mission, guidance for volunteers,
donors and sponsors and links to similar organization’s websites. By offering
educational materials and educating the public about ovarian cancer, L is instructing the
public on subjects useful to the individual and beneficial to the community.

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

You went on to indicate that L’s office and meeting space is located in N (and provided
a specific address).

You also provided new financial and fundraising information, which appears to relate to
L instead of to you. It shows that L expects to obtain income through fundraising efforts
by selling merchandise.

When we contacted you regarding the submission of information referencing another
unrelated organization, you submitted the same information with your name and
information inserted.

Service’s Response to Applicant’s Position

While providing services to those with disabilities can serve a 501(c)(3) purpose, the
manner in which you are structured and operated is serving private and not public
interests. You formed to benefit F by enabling her to secure payments for services
through D, and will operate in a commercial manner.

Regarding the additional information provided. It is clear that you have submitted
information prepared at some point by another entity, inserting your name into the
details of their operations, rather than providing your own descriptions. You were unable
to substantiate these activities as your own, and you continue to have a more than
insubstantial purpose as providing services for a fee with benefits to F. Further, your
comparison to two other exempt entities has no bearing on our ruling. The qualification
of another entity is not a basis for a similar ruling as each application for exemption is
reviewed on its own merits.

Conclusion

Based on the facts and information provided, you do not meet the operational test. You
are organized and operated for commercial purposes. Any public purposes for which
you may operate are only incidental to this primary nonexempt purpose. Further, you
have not demonstrated that you are serving public, rather than private purposes.
Therefore, you are not described in section 501(c)(3).

Accordingly, you do not qualify for exemption as an organization described in section
501(c)(3) of the Code. Contributions to your organization are not deductible under
section 170 of the Code.

You have the right to file a protest if you believe this determination is incorrect. To
protest, you must submit a statement of your views and fully explain your reasoning.
You must submit the statement, signed by one of your officers, within 30 days from the
date of this letter. We will consider your statement and decide if the information affects
our determination. If your statement does not provide a basis to reconsider our

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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, 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.

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

Sincerely,

Holly O. Paz

Director, Exempt Organizations

Rulings & Agreements
Enclosure: Publication 892

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