Other 1318020: IRS revokes a neighborhood patrol association's exemption

Plain-English summary

The IRS revoked a neighborhood patrol association's exemption under section 501(c)(4). The association hired off-duty police officers to patrol a residential subdivision, provided emergency contact access to members, and distributed local crime and community information. The IRS concluded that the association did not operate primarily for social welfare because its security services served participating homeowners rather than the community as a whole. The examination also considered relief under section 7805(b) and recommended recognition under section 528, with Form 1120-H filings for the year of the change and future years.

Ruling snapshot

• Question: Whether the association continued to qualify under section 501(c)(4), and whether section 7805(b) relief or section 528 treatment applied.
• Outcome: Revocation.
• Key authorities: IRC §§ 501(c)(4), 528, 7805(b); Treas. Reg. §§ 1.501(c)(4)-1(a), 1.528-2, 1.528-5, 1.528-6, 1.528-9; Commissioner v. Lake Forest, Inc., 305 F.2d 814 (1962); Rev. Rul. 69-280; Rev. Rul. 73-306; Rev. Rul. 74-17; Rev. Rul. 74-99; Rev. Rul. 77-273.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
TE/GE EO Examinations
MS:4957:DAL
1100 Commerce Street 501.04-00
Dallas, TX 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION
September 11, 2009
Number: 201318020 Taxpayer Identification Number
Release Date: 5/3/2013
LEGEND
ORG — Organization name
XX — Date Address — address Form:
Tax Year(s) Ended:
ORG Person to Contact/ID Number:
ADDRESS
Contact Numbers:
Telephone:
Fax:

CERTIFIED MAIL — RETURN RECEIPT REQUESTED

Dear

We have enclosed a copy of our report of examination explaining why we believe an
adjustment of your organization’s exempt status is necessary.

If you accept our findings, please sign and return the enclosed Form 6018-A, Consent to
Proposed Action. We will then send you a final letter revoking your exempt status.

lf we do not hear from you within 30 days from the date of this letter, we will process
your case on the basis of the recommendations shown in the report of examination and
this letter will become final. In the event of revocation, you will be required to file Federal
income tax returns for the tax period(s) shown above. If you have not yet filed these
returns, please file them with the examiner as soon as possible, unless a report of
income tax liability was issued to you with other instructions. File returns for later tax
years with the appropriate service center indicated in the instructions for those returns.

If you do not agree with our position, you may appeal your case. The enclosed
Publication 3498, The Examination Process, explains how to appeal an Internal
Revenue Service (IRS) decision. Publication 3498 also includes information on your
rights as a taxpayer and the IRS collection process. Please note that Fast Tract
Mediation Services referred to in Publication 3498, do not apply to Exempt
Organizations.

2
If you request a conference, we will forward your written statement of protest to the
Appeals Office and they will contact you. For your convenience, an envelope is
enclosed.

If you and Appeals do not agree on some or all of the issues after your Appeals
conference, or if you do not request an Appeals conference, you may file suit in the
United States Tax Court, the United States Court of Federal Claims, or the United States
District Court, after satisfying procedural and jurisdictional requirements as described in
Publication 3498.

You may also request that we refer this matter for technical advice as explained in
Publication 892, Exempt Organizations Appeal Procedures for Unagreed Issues. Ifa
determination letter is issued to you based on technical advice, no further administrative
appeal is available to you within the IRS on the issue that was the subject of the
technical advice.

You have the right to contact the office of the Taxpayer Advocate. Taxpayer Advocate
assistance is not a substitute for established IRS procedures, such as the formal
appeals process. The Taxpayer Advocate cannot reverse a legally correct tax
determination, or extend the time fixed by law that you have to file a petition in a United
States court. The Taxpayer Advocate can, however, see that a tax matter that may not
have been resolved through normal channels gets prompt and proper handling. You
may call toll-free, 1-877-777-4778, and ask for Taxpayer Advocate Assistance. If you
prefer, you may contact your local Taxpayer Advocate at:

If you have any questions, please call the contact person at the telephone number
shown in the heading of this letter. If you write, please provide a telephone number and
the most convenient time to call if we need to contact you.

Thank you for your cooperation.

Sincerely,

Sunita B. Lough
Director, EO Examinations
Enclosures:
Publication 892
Publication 3498
Form 6018-A Report of Examination
Envelope

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG December 31,
20XX

LEGEND .
ORG ~ Organization name XX - Date City - city CO-1 - 1°* COMPANY
ISSUES

1. Does ORG continue to qualify for tax exempt status under IRC section 501(c)(4)?

2. In the event ORG does not meet the requirements for recognition of exemption under the
   above mentioned subsection of the Code, should ORG be granted relief under section 7805(b) in
   connection with the revocation of its tax-exempt status under IRC section 501(c)(4)?

FACTS

The ORG (“ORG”) was incorporated in 20XX to provide security in the form of police patrol for
the homeowners of the CO-1. ORG was granted exemption as an organization described in IRC
section 501(c)(4) in April 20XX.

The subdivision of ORG is comprised of 200 homeowners. In 20XX, about 104 homeowners
are members of this association. Participation is not mandatory. Members pay yearly dues of $.

ORG has contracted with the off-duty City police officers to provide police patrol during the day
time and night time in the neighborhood. ORG rented the patrol cars from the City Police
Department. ORG provides a cell phone to the police officer who is on duty so that any of the
members can call the police officer in case of emergency. Non-members are not provided with
the cell phone number. They will have to call 911 incase of an emergency.

ORG sends out fliers about the crime statistics in the area, Easter egg hunt, July 4" celebrations
etc.

% of ORG’s receipts are from membership dues. The only other income ORG has is interest
income from its saving account. % of their expenses are program services related.

LAW
Issue 1 |

Internal Revenue Code Section 501(c)(4) organizations exempt from federal income tax are those
“civic leagues or organizations not organized for profit but operated exclusively for the
promotion of social welfare, or local associations of employees, the membership of which is
limited to the employees of a designated person or persons in a particular municipality, and the

Form 886-A rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -1-

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG December 31,
20XX

net earnings of which are devoted exclusively to charitable, educational, or recreational
purposes.”

Section 1.501(c)(4)-1(a) of the regulations further states that “an organization is operated
exclusively for the promotion of social welfare if it is primarily engaged in promoting in some
way the common good and general welfare of the people of the community. An organization
embraced within this section is one which is operated primarily for the purpose of bringing about
civic betterments and social improvements.”

Revenue Ruling 74-99, 1974-1 C.B.131 concluded that a homeowners association, to qualify for
exemption under section 501(c)(4) of the Code, (1) must serve a “community” which bears a
reasonable recognizable relationship to an area ordinarily identified as governmental, (2) it must
not conduct activities directed to the exterior maintenance of private residences, and (3) the
common areas or facilities it owns and maintains must be for the use and enjoyment of the
general public

Revenue Ruling 69-280, 1969-1 C.B. 152 concluded that an organization that provides
maintenance of exterior walls and roofs of members’ homes in a housing development does not
qualify for tax-exempt status under IRC section 501(c)(4). The organization was operating
primarily for the benefit of individual members rather than the community as a whole.

Revenue Ruling 74-17, 1974-1 C.B. 130 provided that an organization formed by the unit owners
of a condominium housing project to provide for the management, maintenance, and care of the
common areas of the project, as defined by State statute, with membership assessments paid by
the unit owners does not qualify for exemption under section 501(c)(4) of the Code. Since the
organization’s activities are for the private benefit of its members, it cannot be said to be
operated exclusively for the promotion of social welfare. Accordingly, it does not qualify for
exemption from Federal income tax under section 501(c)(4) of the Code.

Rev. Rul. 73-306, 1973-2 C.B. 179 provided that a nonprofit organization formed to protect the
rights of tenants in one rental complex did not benefit the community in general, but rather a
select group of individuals. Therefore, exemption under 501(c)(4) was denied.

Rev. Rul. 77-273, 1977-2 C.B. 195 concerned an organization that provides security services for
residents and property owners of a particular community whose residents donate money at a
specified hourly rate to pay for the services. The Service found that an entity that provided
private security services, such as emergency rescue, guards for homes, businesses and
construction projects, on a regular basis in return for certain compensation was carrying on a
business with the general public in a manner similar to organizations operated for profit. The fact
that the organization occasionally provided free services did not satisfy the requirements of the
regulations.

Form 886-A Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -2-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or

: Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG December 31,
20XX

In Commissioner v. Lake Forest, Inc., 305 F. 2d 814(1962), it was held that the organization, a
housing cooperative for World War II veterans and others, did not meet the requirements for tax-
exempt status under IRC section 501(c)(4). The court found that the organization was not
operating exclusively for “social welfare” purposes, but as a private economic enterprise. The
court also determined that the organization was organized and operated for the benefit or
convenience of its members by performing services that its members would otherwise have to
provide for themselves,

Issue 2

Internal Revenue Code section 7805(b) provides relief to an organization if the initial recognition
of exemption was erroneous because of a misinterpretation of the applicable law by the Service,
and the organization has relied on its exemption letter. If IRC section 7805(b) relief is granted,
the revocation will be prospective.

Section 15.06 of Rev. Proc. 20XX-2, 20XX-1 IR.B. 86 provides that generally, in all other
circumstances, a Technical Advice Memorandum (TAM) or Technical Expedited Advice
Memorandum (TEAM) revoking or modifying a letter ruling or will not be applied retroactively
to the taxpayer for whom the letter ruling was issued or to a taxpayer whose tax liability was
directly involved in the letter ruling, provided that —

1. there has been no change in the applicable law;
2. in the case of a letter ruling, it was originally issued for a proposed transaction; and
3. the taxpayer directly involved in the letter ruling, TAM, or TEAM acted in good faith in
   relying on the letter ruling, TAM, or TEAM and revoking or modifying it retroactively
   would be to the taxpayer's detriment.

GOVERNMENT?’S POSITION

Civic leagues or organizations not organized for profit but operated exclusively for the promotion
of social welfare, or local associations of employees, the membership of which is limited to the
employees of a designated person or persons in a particular municipality, and the net earnings of
which are devoted exclusively to charitable, educational, or recreational purposes qualify for tax-
exempt status under IRC section 501(c) (4). The subject organization contracts with the off-duty
City police officers to provide police patrol services for the homeowners in the CO-1. The
organization also sends out a flyer with latest crime statistics, forwards crime alerts from the City
police to the members etc. As a result of our examination of your Form 990 for the period ended
December 31, 20XX, we have determined that your organization no longer qualifies as an
exempt social club described in IRC section 501(c)(4).

Form 886-A cev.4-68) Department of the Treasury - Internal Revenue Service
Page: -3-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or

Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG December 31,
20XX

We are also requesting that IRC section 7805(b) relief be provided to the organization. The
organization was granted tax-exempt status under IRC section 501(c)(4) in April 20XX and has
since relied on that ruling. Section 7805(b) relief may be granted to an organization when there
is a misinterpretation or misapplication of the law and the organization obtained an erroneous
ruling. The organization must have relied on that erroneous ruling, acting in good faith, and
complied with all applicable law surrounding the ruling granted by the Service.

TAXPAYER’S POSITION

ORG applied for and was granted tax-exempt status in 20XX. The organization has since relied
on that ruling and filed the appropriate Form 990. The organization consents to the proposed
revocation.

CONCLUSION

As a result of our examination of your Form 990 for the period ended December 31, 20XX, we
have determined that your organization no longer qualifies as an exempt social club described in
IRC section 501(c)(4) as of January 1, 20XX.

ALTERNATIVE ISSUE
ISSUE

Does ORG meet the requirements for recognition as a homeowners’ association as described in
IRC section 528?

FACTS

The ORG (“ORG”) was incorporated in 20XX to provide security in the form of police patrol for
the homeowners of the CO-1. ORG was granted exemption as an organization described in IRC
section 501(c)(4) in April 20XX.

The subdivision of ORG is comprised of 200 homeowners. In 20XX, about 104 homeowners
are members of this association. Participation is not mandatory. Members pay yearly dues of $.

ORG has contracted with the off-duty City police officers to provide police patrol during the day
time and night time in the neighborhood. ORG rented the patrol cars from the City Police
Department. ORG provides a cell phone to the police officer who is on duty so that any of the
members can call the police officer in case of emergency. Non-members are not provided with
the cell phone number. They will have to call 911 incase of an emergency.

Form 886-A rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -4-

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG December 31,
20XX

ORG sends out fliers about the crime statistics in the area, Easter egg hunt, July 4" celebrations
etc.

% of ORG’s receipts are from membership dues. The only other income ORG has is interest
income from its saving account. % of their expenses are program services related.

LAW

Internal Revenue Code section 528 provides an elective exemption for certain homeowners’
associations. IRC § 528 exempts from income tax any dues and assessments received by a
qualified homeowners’ association that are paid by property owners who are members of ORG,
where the assessments are used for the maintenance and improvement of association property.

Treasury Regulation §1.528-2 states that in order for an organization to meet the requirements of
IRC section 528, the organization “must be organized and operated primarily for the purpose of
carrying on one or more of the exempt functions of a homeowners’ association.” Exempt
functions include “the acquisition, construction, management, maintenance, and care of
association property.”

Treasury Regulation §1.528-5 requires that at least sixty percent of a homeowners’ association’s
gross income be that of exempt function income as defined in §1.528-9.

Section 1.528-6 of the regulations requires that at least ninety percent of a homeowners’

association’s expenditures must be “qualifying expenditures”. Examples of qualifying

expenditures may include the following:

1. “salaries of an association manager and secretary;

paving of streets;

street signs;

security personnel;

legal fees;

upkeep of tennis court;

swimming pools;

recreation rooms and halls;

replacement of common building, facilities, air conditioning, etc.;

10. insurance premiums on association property;

11. accountant’s fees;

12. improvement of private property to the extent it is association property; and

13. real estate and personal property taxes imposed on association property by a State or local
    government.”

CP RARDMSYWN

Form 886-A rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -5-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG December 31,
20XX

Treasury Regulation §1.528-9 excludes from federal income tax, receipts considered exempt
function income. Examples of exempt function income include dues and assessments for the
purposes of-

“paying the principal and interest on debts incurred for the acquisition of association
property,

paying real estate taxes on association property,

maintaining association property,

removing snow from public areas, and

removing trash.”

ry

AWN

GOVERNMENT’S POSITION

Based on the facts and circumstances of the organization, we recommend the organization elect
recognition under IRC section 528 and file Form 1120-H, U.S. Income Tax Return for
Homeowners’ Associations, for the fiscal year ended December 31, 20XX and all future years.

TAXPAYER’S POSITION

The organization has agreed to complete Form 1120-H, U.S. Income Tax Return for
Homeowners’ Associations, for the fiscal year ended December 31, 20XX and all future years.
The organization has been notified of the requirements for recognition as a homeowners’
association under IRC section 528.

CONCLUSION

We recommend ORG elect recognition under IRC section 528 as a qualified homeowners’
association. Form 1120-H, U.S. Income Tax Return for Homeowners’ Associations, must be
filed for the year ended December 31, 20XX and all future years.

Form 886-A crev.4-68) Department of the Treasury - Internal Revenue Service
Page: -6-