IRS finalizes denial of tax-exempt status for a financial education organization

Plain-English summary

The IRS finalized its proposed adverse determination that an organization did not qualify for exemption under IRC § 501(c)(3). The organization planned to provide financial education and financial assistance, but the IRS found problems with its organizational and operational structure. The IRS concluded that the organization’s net earnings could benefit private insiders, its board was composed of related and compensated individuals, and its activities did not sufficiently serve a public rather than private interest. The IRS also concluded that the organization did not meet the special requirements for credit-counseling organizations under § 501(q). Because the organization did not file a protest within 30 days, the proposed adverse determination became final.

Ruling snapshot

• Question: Did the organization qualify for federal tax exemption under IRC § 501(c)(3)?
• Outcome: Revocation, the IRS finalized its denial of exemption.
• Key authorities: IRC §§ 501(c)(3), 501(q), 170, and 6104(c); Treas. Reg. §§ 1.501(c)(3)-1 and 1.501(a)-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: 201311033 Contact Person:
Release Date: 3/15/2013
Date: December 18, 2012 Identification Number:
UIL Code: 501.32-00
501.32-01 Contact Number:
501.33-00
Employer Identification Number:
Form Required To Be Filed:
Tax Years:
Dear

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

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

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

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 476328

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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: November 1, 2012 Contact Person:
Identification Number:
Contact Number:
FAX Number:
Employer Identification Number:

LEGEND: UIL:

B= Date 501.32-00

E= State 501-32-01

F= Board Member 501.33-00

G= Board Member

H = Board Member

J = Board Member

M= For-Profit Company

s = dollar amount

t = dollar amount

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

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

e Do you meet the requirements under section 501(q) of the Code? No, for the
reasons described below.

Facts

You were incorporated on B under E law. Your Articles of Incorporation state, in Article
Il, that your specific purpose is: “To enhance the financial education of Children and
Adults. And to provide financial assistance to children and adults in need of food,
shelter, and clothing.”

Article VI of your Articles of Incorporation states: “Disposition of assets upon dissolution
of corporation will be contributed to a worthy nonprofit at the discretion of F.”

You have not adopted bylaws.

You have four board members (directors) who are all related. F is your president and is
married to G. H is the mother of F, and J is F’s sister. F is a financial professional, G is
an insurance claims assistant and H and J are auto workers. J is also a musical
performer who will conduct fundraising concerts for you.

F will receive base compensation of s. He will also receive incentive pay at 25% of
gross revenues from investment gains, donations, grants and other fundraising
activities. F’s total compensation is capped at v.

The other three board members will also be compensated. You do not plan to have any
employees other than the four board members. Your board members will perform
appointed tasks and will be compensated for being on the board and performing
services and functions as required.

M is a for-profit entity owned by F. M engages in manufacturing, sale and distribution of
various products, financial consulting, financial services, process improvement and
entertainment production and management.

You will buy novelty items (t-shirts, mugs, key chains, etc...) from M at fair market
pricing (defined as the market price for materials and services with a mark-up by M not
to exceed %). Also, you plan to hire F and M as independent contractors to instruct
and present seminars, consult, train, solicit funds, conduct raffles and provide
investment advice.

Your planned activities include conducting seminars, workshops, and classes to
educate children and adults on personal finance and providing financial assistance to
children and adults in need of food, shelter and clothing. You estimate you will spend

% of your time raising funds, | % conducting workshops and % providing
donations.

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You will limit your need based financial assistance to t increments. Financial assistance
recipients are required to attend your financial seminars. Recipients that refuse to
attend your seminars will not receive any future support.

You will obtain clients via public service announcements, advertising, e-mail blasts,
radio announcements and other public advertising. You will primarily target families
making % or less of poverty level income per federal guidelines. You will also target
seniors (aged 60 and older) making % or less of poverty level.

All financial education will be conducted in a group setting. You will not charge any fees
for your services. The free financial education will include budgeting, saving,
understanding interest rates, compound interest, foreclosures, mortgages and investing.

Most of your programs and services will be handled by independent contractors,
including F and M. You will enter into joint ventures with for-profit entities, on a project
basis, to raise funds, create economies of scale or if it makes good business sense.
For example, F or M will invest funds into stocks and options on your behalf.

You plan to own or purchase license rights for copyrights, patents or trademarks. Fees
may be charged for the use of the properties and revenue may be collected by you as
part of the sale or use of intellectual properties. The items may be produced by F or M.

You do not have a facility. You will conduct your seminars and other services at
churches and other public facilities.

You submitted budgets for the next three years that indicate the following sources of
revenue: contributions, investment income, raffle revenue and the sale of merchandise.
Your projected expenses include fundraising, donations, incentive pay for F, officer
compensation and other expenses. Fundraising expenses primarily consist of artist
fees and facility rental.

Law

Section 501(a) of the Code provides that an organization described in section 501(c)(3)
shall be exempt from taxation.

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 501(q) of the Code provides that organizations which provide “credit counseling
services” as a substantial purpose shall not be exempt from taxation under section
501(a) unless they are described in sections 501(c)(3) or 501(c)(4) and they are
organized and operated in accordance with the following requirements:

(A)

(B)

(C)

(D)

The organization--

(i) provides credit counseling services tailored to the specific needs and
circumstances of consumers,

(ii) makes no loans to debtors (other than loans with no fees or interest)
and does not negotiate the making of loans on behalf of debtors,

(iii) provides services for the purpose of improving a consumer's credit
record, credit history, or credit rating only to the extent that such services
are incidental to providing credit counseling services, and

(iv) does not charge any separately stated fee for services for the purpose
of improving any consumer's credit record, credit history, or credit rating.

The organization does not refuse to provide credit counseling services to a
consumer due to the inability of the consumer to pay, the ineligibility of the
consumer for debt management plan enrollment, or the unwillingness of
the consumer to enroll in a debt management plan.

The organization establishes and implements a fee policy which--

(i) requires that any fees charged to a consumer for services are
reasonable,

(ii) allows for the waiver of fees if the consumer is unable to pay, and

(iii) except to the extent allowed by State law, prohibits charging any fee
based in whole or in part on a percentage of the consumer's debt, the
consumer's payments to be made pursuant to a debt management plan,
or the projected or actual savings to the consumer resulting from enrolling
in a debt management plan.

At all times the organization has a board of directors or other governing
body--

(i) which is controlled by persons who represent the broad interests of the
public, such as public officials acting in their capacities as such, persons
having special knowledge or expertise in credit or financial education, and
community leaders,

(ii) not more than 20 percent of the voting power of which is vested in
persons who are employed by the organization or who will benefit
financially, directly or indirectly, from the organization's activities (other
than through the receipt of reasonable directors' fees or the repayment of
consumer debt to creditors other than the credit counseling organization or
its affiliates), and

(iii) not more than 49 percent of the voting power of which is vested in
persons who are employed by the organization or who will benefit

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financially, directly or indirectly, from the organization's activities (other
than through the receipt of reasonable directors’ fees).

(F) The organization receives no amount for providing referrals to others for
debt management plan services, and pays no amount to others for
obtaining referrals of consumers.

Section 501(q)(4)(A) defines, for purposes of section 501(q), the term “credit counseling
services” to mean (i) the providing of educational information to the general public on
budgeting, personal finance, financial literacy, saving and spending practices, and the
sound use of consumer credit; (ii) the assisting of individuals and families with financial
problems by providing them with counseling; or (iii) a combination of the activities
described above. .

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 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 an applicant 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 Rev. Rul. 61-170, 1961-2 C.B. 112, an association composed of professional private
duty nurses supported and operated a nurses' registry to help make the nurses’ services
more readily available to the general public. The association's bylaws stated that its
specific purposes were to provide employment for its members as well as to organize an
adequate and available nursing placement service for the community. Its membership was
open to both registered and practical nurses who met specified requirements. The
organization maintained a registry of its members showing their respective qualifications
and the types of services they perform. Reference and placement from the register were
made on a rotating basis upon request for nursing services. The association was operated
primarily to afford greater employment opportunities for its members, and only incidentally
for the benefit of the general public. This was evidenced by the fact that it drew its support
primarily from members and was controlled by a board of trustees composed of
professional nurses, without public participation of any kind. Thus, the association was not
organized or operated exclusively for exempt purposes as described in section 501(c)(3) of
the Code.

In Rev. Rul. 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

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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.

In Church by Mail, 765 F. 2d 1387 (9th Cir. 1985), affg. TCM 1984-349, Tax Court
concluded that the extent of the integration between the operations of a non-profit entity
and related for-profit entities controlled by the non-profit directors precluded exemption.
Furthermore, the Tax Court found it unnecessary to consider the reasonableness of
payments made by the applicant to a business owned by its officers. The 9th Circuit
Court of Appeals, in affirming the Tax Court's decision, stated that “the critical inquiry is
not whether particular contractual payments to a related for-profit organization are
reasonable or excessive, but instead whether the entire enterprise is carried on in such
a manner that the for-profit organization benefits substantially from the operation of the
Church’.

Application of Tax 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. Based on the information you provided in your application and
supporting documentation, we conclude that you fail both tests.

Organizational Test

To satisfy the organizational test, an organization must have a valid purpose clause and
ensure that assets are dedicated to an exempt purpose, either by an express provision
in its governing instrument or by operation of law. 1.501(c)(3)-1(b)(1)(i) and 1.501(c)(3)-
1(b)(4) of the regulations.

A valid purpose clause limits the organization's purposes to one or more exempt
purposes and does 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. Your Articles do not limit your purposes
to one or more exempt purposes.

An organization's assets must be dedicated to an exempt purpose. Your articles do not
ensure that upon dissolution assets will be dedicated to an exempt purpose.

Operational Test

To satisfy the 501(c)(3) operational test, an organization must establish that it is
operated exclusively for one or more exempt purposes. Section 1.501(c)(3)-1(c)(1) of
the regulations. You failed to establish that you are operated exclusively for one or more
exempt purposes.

Inurement

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 501(c)(3) of the Code; Section 1.501(c)(3)-1(c)(2) of the regulations.

You confer a direct benefit on your director, F, who owns M. You will subcontract most
of your workshops to M. Also, you will purchase items from Mat % above their
wholesale cost to use in your fundraising operations.

You willpayF % of gross revenues from investment gains, donations, grants and
other fundraising activities. This payment to F is non-fixed compensation based on
business results. While F’s compensation will be capped at v you provided no evidence
that v was reasonable.

Your relationship with M and the payment of non-fixed compensation to F allows your
net earnings inure to the benefit of your director. Therefore, you are not operated
exclusively for one or more exempt purposes as described in section 501(c)(3) of the
Code.

Private Benefit

An organization is not organized or operated exclusively for exempt purposes unless it
serves a public rather than a private interest. See section 1.501(c)(3)-1(d)(1)(ii) of the
regulations.

It is unnecessary for us to determine that your payments to the related for-profit entity M
are unreasonable. Church by Mail, supra. Your entire enterprise is carried on in such a
manner as to substantially benefit the related for-profit entity.

You are controlled by a board of directors composed of related individuals, without
public participation of any kind. All four members receive compensation and are related
to F, who is the owner of M. Members of your board of directors as well as related for-
profit M will also be hired as independent contractors. These factors and the manner in
which you operate suggest that you are operated for the benefit of your individual board
members rather than the public, as in Rev. Rul. 61-170, supra.

Your board of directors is composed entirely of persons who stand to gain financially
from your organization’s activities, unlike the organization in Rev. Rul. 69-441, supra,
whose board of directors was comprised of representatives from religious organizations,
civic groups, labor unions, business groups, and educational institutions.

Therefore, you have not demonstrated that your operations serve a public rather than a
private interest as required by section 1.501(c)(3)-1(d)(1)(ii).

Section 501(q) of the Code

An organization that provides educational information on financial topics or financial
counseling to homeowners who are at risk of foreclosure is providing “credit counseling
services” within the meaning of section 501(q)(4)(A) of the Code. Thus, even if you had
established that you meet the organizational and operational tests, you would also have
to comply with the provisions of section 501(q). You do not comply with certain
provisions of section 501(q) of the Code.

You are governed by a four person related board that will receive compensation. Credit
counseling organizations must be governed by a board controlled by persons
representing the broad interests of the public rather than by persons who benefit from
the organization’s activities. Section 501(q)(1)(D). Accordingly, you do not have a
board of directors that is controlled by persons who represent the broad interests of the
public as required by section 501(q)(1)(D)(i). .

You also fail to meet the requirements of sections 501(q)(1)(D)(ii) and (ii), which
generally specify the percentage of voting power that is allowed to be vested in
financially interested persons. Since your entire board is related and compensated,
100% of your voting power is vested in financially interested persons.

Therefore, had you otherwise met the requirements of section 501(c)(3), your failure to
satisfy the requirements of section 501(q) would prevent you from being exempt from
taxation under section 501(a).

Conclusion

Based on the facts and information provided, you are not organized or operated
exclusively for exempt purposes. You do not pass the organizational test because your

you do not ensure that your assets are dedicated to an exempt purpose. Likewise, you
do not pass the operational test because your net earnings inure to the benefit of private
shareholders or individuals. Therefore, you have not established that your operations
serve a public rather than a private interest. Even if these two tests were met, you still
would not qualify for exemption under section 501(c)(3) because you do not meet the
requirements of section 501(q).

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.

Appeal Rights

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

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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:

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

2. A statement 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;

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

Dn

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. 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

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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 & Agreements

Enclosure, Publication 892