Determination 1338051: IRS revokes exemption for an organization that did not operate as an insurance company

Plain-English summary

The IRS revoked an organization’s exemption under IRC § 501(c)(15) after concluding that it was not providing insurance to its policyholders. The organization had issued only two policies, did not issue new policies after they expired, and therefore did not achieve sufficient risk shifting or risk distribution. The IRS also concluded that the organization did not qualify under the gross-receipts and premium requirements for small insurance companies. The organization was required to file taxable returns, and the IRS denied relief from retroactive revocation under IRC § 7805(b).

Ruling snapshot

• Question: Did the organization operate as an insurance company that qualified for exemption under IRC § 501(c)(15), and could it claim related relief under IRC § 831(b) or § 7805(b)?
• Outcome: Revocation. The IRS revoked the organization’s exemption effective January 1 of the redacted year.
• Key authorities: IRC §§ 11, 501(c)(15), 7805(b), 801, 816, 831, 834; Treas. Reg. §§ 1.501(a)-1(a)(2), 1.801-3(a)(1), 301.9100-8, 601.201.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE

Attn: Mandatory Review, MC 4920 DAL 501.15-00
1100 Commerce St.
TAX EXEMPT AND Dallas, TX 75242
GOVERNMENT ENTITIES
DIVISION Date: November 15, 2010

Number: 201338051
Release Date: 9/20/2013
LEGEND Employer Identification Number:
ORG - Organization name Person to Contact/ID Number:
XX - Date Address - address Contact Numbers:

Voice
ORG Fax
ADDRESS

CERTIFIED MAIL — RETURN RECEIPT REQUESTED
Dear
:

In a determination letter dated May 17, 20XX, you were held to be exempt from
Federal income tax under section 501(c)(15) of the Internal Revenue Code (the
Code).

Based on recent information received, we have determined you have not
operated in accordance with the provisions of section 501(c)(15) of the Code.
Accordingly, your exemption from Federal income tax is revoked effective
January 1, 20XX. This is a final adverse determination letter with regard to your
status under section 501(c)(15) of the Code.

We previously provided you a report of examination explaining why we believe
revocation of your exempt status is necessary. At that time, we informed you of
your right to contact the Taxpayer Advocate, as well as your appeal rights. On
August 19, 20XX, you signed Form 6018-A, Consent to Proposed Action,
agreeing to the revocation of your exempt status under section 501(c)(15) of the
Code.

You have filed taxable returns on Form[s] 1120, U.S. Corporation Income Tax Return,
for the years ended March 31, 20XX & 20XX with us. For future periods, you are
required to file Form 1120 with the appropriate service center indicated in the
instructions for the return.

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 contact the person whose name and telephone
number are shown at the beginning of this letter.

Sincerely,

Nanette M Downing
Director, EO Examinations

cc:

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
3251 North Evergreen Dr., N.E.
Grand Rapids, MI 49525

TAX EXEMPT AND

GOVERNMENT ENTITIES DATE: July 14, 2010
DIVISION

Taxpayer Identification Number:
ORG Form:
ADDRESS Tax Year(s) Ended:
Person to Contact/ID Number:
Contact Numbers:
Telephone:
Fax:

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.

We have also enclosed Publication 892, Exempt Organization Appeal Procedures for
Unagreed Issues, and Publication 3498, The Examination Process. These
publications include information on your rights as a taxpayer, including administrative
appeal procedures within the Internal Revenue Service.

If you request a conference with Appeals, 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, the Appeals Office will advise you of its final decision

If you elect not to request Appeals consideration but instead accept our findings, please
sign and return the enclosed Form 6018-A, Consent to Proposed Adverse Action. We
will then send you a final letter modifying or revoking your exempt status under I.R.C. §
501(c)(15). If 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 send a final letter advising of our determination.

In either situation outlined in the paragraph above (execution of Form 6018-A or failure
to respond within 30 days), you are required to file federal income tax returns for the tax
period(s) shown above, for all years still open under the statute of limitations, and for all
later years. File the federal tax return for the tax period(s) shown above with this agent
within 60 days from the date of this letter, unless a request for an extension of time is
granted. File returns for later tax years with the appropriate service center indicated in
the instructions for those returns.

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 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,

Nanette M Downing

Nanette M. Downing
Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Form 6018-A

Report of Examination
Envelope

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN
12/31 /20XX
LEGEND
ORG - Organization name EIN - ein City - city State - state

CO-1, CO-2, CO-3 & CO-4 — 1ST, 2ND, 3RD & 4TH COMPANIES
ISSUES:

1. Is ORG providing insurance to its policyholders?

2. Does ORG qualify as an insurance company under Internal Revenue Code
   Section 501(c)(15), for the years beginning January 1, 20XX?

3. Is ORG exempt from Federal tax as an organization described under Internal
   Revenue Code (IRC) section 501(c)(15) for the years beginning January 1,
   20XX?

4. If ORG does not qualify for tax exempt status for years beginning January 1,
   20XX, what are the consequences?

5. Is ORG entitled to relief pursuant to IRC § 7805(b)?

6. If ORG does not qualify for exemption from Federal Tax as an organization
   described under IRC 501(c)(15), was is the effective date of revocation.

7. If ORG does qualify as an insurance company under Internal Revenue Code
   Section 501(c)(15), does it meet the other requirements under Internal Revenue
   Code Section 501(c)(15) for tax exemption?

8. If ORG does qualify as an insurance company under Internal Revenue Code
   Section 501(c)(15), but does not meet the other requirements under Internal
   Revenue Code Section 501(c)(15), what are the consequences.

9. If ORG does not meet the other requirements under Internal Revenue Code
   Section 501(c)(15), is it entitled to file an election under IRC 831(b) and be taxed
   only on its investment income?

FACT:

ORG (ORG) was formed in the State of State as an unincorporated association on
December 30, 20XX. ORG has three members, CO-1., J. CO-2, both State limited
partnerships, and CO-3, a State corporation. Each member gave $ as the initial capital
of the organization.

The purpose as stated in the Articles of Association is to provide property and casualty
insurance on a nonprofit basis for its members.

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

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN
12/31/20XX

ORG filed the Application Form 1024, Application for Recognition of Exemption Under
Section 501(a), with the Internal Revenue Service in 20XX. Its purpose as stated in the
application form is to provide limited mutual insurance protection for owner/investors
who do their own repairs. Aim is to provide insurance to numerous small real estate
investors who typically own 3-20 single family houses. These investors are priced out
of the commercial insurance market due to regulation and litigation. These small
investors are the do-it-yourselfers who perform their own maintenance on the properties
they own. First policies issued in 20XX. Organization will initially operate in the City,
State area. Each member contributes $.

Benefits of this type of insurance are publicized in the CO-4.

Based on the information provided in Application Form 1024, ORG received a
determination letter dated May 17, 20XX granting exemption under Internal Revenue
Code (IRC) 501(c)(15). The determination letter states the new requirements for
exemption under this code section that became effective for tax years beginning on or
after January 1, 20XX

ORG filed the Form 990-EZ for year ending December 31, 20XX. On the Form 990-EZ,
ORG reported the following financial Information:

FORM 990-EZ INFORMATION 12/31/20XX

Premiums

Investment Income

Total Revenue

Total Expenses

Total Excess/(Deficit)

Total Assets

Total Liabilities

Two policies were issued for the 8/1/20XX — 7/31/20XX time frame. All premiums were
collected during the 20XX calendar year. No premiums received during 20XX. No
other policies issued after these two expired. ORG was not involved in any reinsurance
agreements.

LAW AND ANALYSIS:

1. Is ORG providing insurance to its policyholders?
   The first issue is whether ORG is providing insurance. Determining whether this

qualifies as insurance will assist in determining whether ORG can qualify for exemption
pursuant to IRC § 501(c)(15).

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 EIN
12/31/20XX

Neither the Internal Revenue Code nor the Regulations specifically define the term
“insurance contract.” The courts have generally required that a transaction involve both
risk shifting (from the insured’s perspective) and risk distribution (from the insurer’s
perspective) in order to be characterized as insurance. Helvering v. LeGierse, 312 U.S.
531, 539 (1941); Gulf Oil Corp. v. Commissioner, 914 F.2d 396, 411 (3d Cir. 1990).

Risk shifting occurs when a person facing the possibility of a loss transfers some or all
of the financial consequences of the loss to the insurer. Rev. Rul. 88-72, 1988-2 C.B.
31, clarified by Rev. Rul. 89-61, 1989-1 C.B. 75. The risk transferred pursuant to an
insurance contract must be a risk of economic loss. Allied Fidelity Corp. v.
Commissioner, 66 T.C. 1068 (1976), aff’d., 572 F.2d 1190 (7th Cir. 1978), cert. denied,
439 U.S. 835 (1978).

Risk shifting issues frequently arise in the case of captives. In Clougherty Packing Co.
v. Commissioner, 811 F.2d 1297 (9th Cir. 1987), the court defined a “captive” in footnote
1 on page 1298 as,
a corporation organized for the purpose of insuring the liabilities of its owner. At
one extreme is the case presented here, where the insured is both the sole
shareholder and only customer of the captive. There may be other permutations
involving less than 100% ownership or more than a single customer, although at
some point the term “captive” is no longer appropriate.

Risk distribution refers to the operation of the statistical phenomenon known as the “the
law of large numbers.” When additional statistically independent risk exposure units
are insured, although the potential total losses increase, there is also an increase in the
predictability of average loss. This increase in the predictability of the average loss
decreases the amount of the capital that an insurance company needs per risk unit to
remain at a given solvency level. See Rev. Rul. 89-61, 1989-1 C.B. 75.

The Courts have not spent a great deal of time explaining what they mean by risk
distribution. No court has squarely held that there can be no risk distribution if there is
only one, or a few, insureds. A fair reading of the court opinions addressing the issue,
however, supports the IRS’s position. See Barnes v. United States, 801 F.2d 984, 985
(7th Cir. 1986) (“Risk distributing is the spreading of the risk of loss among the
participants in an insurance program.”). See also, Commissioner v. Treganowan, 183
F.2d 288, 291 (2d Cir. 1950). Such spreading is effectuated by pooling among
unrelated insureds. “ [R]isk distribution means that the party assuming the risk
distributes his potential liability, in part, among others.” Beech Aircraft Corp. v. United
States, 797 F.2d 920, 922 (10th Cir. 1986). Risk distribution is accomplished where the
risk is distributed among insureds other than the entity that incurred the loss. See Ross
v. Odem, 401 F.2d 464 (5th Cir. 1968).

Form 886-A rev.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 EIN
12/31/20XX

The Sixth Circuit touched on the issue of risk distribution in Humana, Inc. v.
Commissioner, 881 F.2d 247, 257 (6th Cir. 1989), noting that there was adequate risk
distribution, “where the captive insures several separate corporations within an affiliated
group and losses can be spread among the several distinct corporate entities.” The
Ninth Circuit has also measured risk distribution by explaining, “[i]nsuring many
independent risks in return for numerous premiums serves to distribute risk. By
assuming numerous relatively small, independent risks that occur randomly over time,
the insurer smoothes out losses to match more closely its receipt of premiums.”
Clougherty Packing Co. v. Commissioner, 811 F.2d 1297, 1300 (9th Cir. 1987)

In Revenue Ruling 20XX-90, 20XX-2 CB 985, the question was raised on whether a
subsidiary’s arrangement to provide liability insurance coverage to 12 of its parent
company’s subsidiaries constituted insurance contracts for federal tax purposes and
thus, the amounts paid as premiums by each subsidiary were deductible as business
expenses. Under the arrangement, the subsidiaries were charged arm’s length
premiums, according to customary industry ratings, and none had liability coverage of
less than 5 percent or more than 15 percent, of the total risk insured by the subsidiary.

As a result, the professional liability risks of the 12 subsidiaries were shifted to the
insurer subsidiary as required to constitute an insurance contract for federal tax
purposes. The common ownership of the subsidiaries, including the insurer, by the
parent, did not affect the determination that the arrangements constituted insurance
contracts.

As explained in the Revenue Ruling, that organization issued 12 policies and shifted the
risk to the subsidiaries as required. ORG issued 2 policies in 20XX and none in 20XX.
As in the Revenue Ruling, the risk shifted from the two insured to ORG in 20XX but
there was not adequate risk distribution with only two policies issued. In 20XX these
policies expired and no new policies were issued so there was no risk shifting or risk
distribution because there were no policies.

It is the Service position that since ORG did not issue any policies in 20XX there was no
insurance provided, therefore, no risk shifting or risk distribution.

As stated before, the courts have generally required that a transaction involve both risk
shifting (from the insured’s perspective) and risk distribution (from the insurer's
perspective) in order to be characterized as insurance. With ORG there were no
policies to have risk shifting or risk distribution.

As stated in Revenue Ruling 89-61, 1989-1 C.B. 75, risk distribution refers to the
operation of the statistical phenomenon known as the “the law of large numbers.”
When additional statistically independent risk exposure units are insured, although the
potential total losses increase, there is also an increase in the predictability of average

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

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN
12/31/20XX

loss. This increase in the predictability of the average loss decreases the amount of the
capital that an insurance company needs per risk unit to remain at a given solvency
level.

With ORG, there was not the phenomenon known as the “the law of large numbers”. In
issuing only two policies in 20XX that carried over to 20XX, there was inadequate risk
distribution due to the lack of a number of policies to help cover any losses. With no
policies issued in 20XX, there was no risk shifting or risk distribution for 20XX.

Therefore, it is the Service’s position that since there were only 2 policies in 20XX that
carried over to 20XX and no new policies issued in 20XX, ORG was not providing
insurance to any policyholders.

2. Does ORG qualify as an insurance company under Internal Revenue Code
   Section 501(c)(15), for the years beginning October 1, 20XX?

Definition of an Insurance Company.

Neither I.R.C. 501(c)(15) nor its corresponding regulations define an “insurance
company.” Subchapter L of the Code (I.R.C. sections 801-848), however, addresses
the taxation of insurance companies. The term “insurance company” has the same
meaning under section 501(c)(15) as it does in Subchapter L. See H. Conf. Rep. No.
99-841, 99th Cong., 2nd Sess. (Vol. II) 370-71, reprinted in 1986-3 (Vol. 4) C.B. 370-71.

I.R.C. section 816 (formally I.R.C. section 801) defines a life insurance company. As
part of this definition, I.R.C. section 816 provides, “the term ‘insurance company’ means
any company more than half of the business of which during the taxable year is the
issuing of insurance or annuity contracts or the reinsuring of risks underwritten by
insurance companies.”

Treas. Reg. section 1.801-3(a)(1) defines an insurance company as,

A company whose primary and predominant business activity during the taxable

year is the issuing of insurance or annuity contracts or the reinsuring of risks
underwritten by insurance companies. Thus, though its name, charter powers, and
subjection to State insurance laws are significant in determining the business which a
company is authorized and intends to carry on, it is the character of the business
actually done in the taxable year which determines whether a company is taxable as an
insurance company under the Internal Revenue Code.

The courts and the IRS have also, at times, looked to whether the transaction has
characteristics traditionally associated with insurance, and whether the company
conducts business like an insurance company. In order for ORG to be considered an

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 EIN
12/31/20XX

“insurance company’ entitled to tax exempt status under I.R.C. 501(c)(15) for the
taxable years beginning October 1, 20XX, its primary and predominant business activity
during that year must have been issuing insurance contracts or reinsuring insurance
risks. See I.R.C. section 816; Treas. Reg. section 1.801-3(a)(1).

Based on the conclusions made regarding Question 1 above, that only two policies
were issued in 20XX that carried over to 20XX and no policies were issued in 20XX,
ORG was not providing insurance. With ORG not providing insurance, it can not
qualifying as an insurance company.

3. Is ORG exempt from Federal tax as an organization described under internal
   Revenue Code (IRC) section 501(c)(15) for the years beginning October 1,
   20XX?

Internal Revenue Code section 501(c)(15)(A) exempts from Federal income tax
insurance companies (as defined in section 816(a)) other than life (including
interinsurers and reciprocal underwriters) if-

(i.) (I) the gross receipts for the taxable year do not exceed $600,000, and
(II) more than 50 percent of such gross receipts consist of premiums, or

(ii.) in the case of a mutual insurance company-
(I) the gross receipts of which for the taxable year do not exceed $150,000

and,
(II) more than 35 percent of such gross receipts consist of premiums.

Clause (ii) shall not apply to a company if any employee of the company, or a member
of the employee’s family (as defined in section 2032(A)(e)(2), is an employee of another
company exempt from taxation by reason of this paragraph (or would be so exempt but
for this sentence).

Based on the conclusion that ORG is not an insurance company, ORG does not qualify
for exemption from Federal income tax under IRC 501(c)(15) for years starting January
1, 20XX. IRC 501(c)(15)(A) specifically exempts insurance companies. With ORG not
qualifying as an insurance company, ORG can not qualify as an organization exempt
from Federal income tax under IRC 510(c)(15).

4. If ORG does not qualify for tax exempt status for year ending January 1, 20XX,
   what are the consequences?

Since ORG did not qualify for tax exemption per IRC 501(c)(15), for years beginning,
January 1, 20XX, the tax exempt status is hereby revoked starting January 1, 20XX.

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

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN
12/31/20XX

In revoking ORG’s tax exemption, ORG must file Forms 1120 for years beginning
January 1, 20XX.

5. Is ORG entitled to relief pursuant to IRC § 7805(b)?

An organization may ordinarily rely on a favorable determination letter received from the
Internal Revenue Service. Regulations 1.501(a)-1(a)(2); Rev. Proc. 20XX-4, 14.01
(cross-referencing 13.01 et seq.) 20XX-1 C.B. 514. An organization may not rely on a
favorable determination letter, however, if the organization omitted or misstated a
material fact, in its application or in supporting documents. In addition, an organization
may not rely on a favorable determination if there is a material change, inconsistent with
exemption, in the organization’s character, purposes, or methods of operation after the
determination letter is issued. Regulations 601.201(n)(3)(ii); Rev. Proc. 90-27, 13.02,
1990-1 C.B. 514. Any such changes must be reported to the Service so that continuing
recognition of exempt status can be evaluated.

The Commissioner may revoke a favorable determination letter for good cause.
Regulations 1.501(a)-1(a)(2). A favorable determination letter may be revoked by
written notice to the organization to whom the determination originally was issued.
Regulations 601.201(m) (cross-referencing Reg. 601.201(l)); Rev. Proc. 90-27, 14,
1990-1 C.B. 514, 518.

If the Commissioner revokes the tax exempt status of an organization, the remaining
question is whether the revocation should be applied prospectively or retroactively.
Generally, revocation of a determination letter is prospective. Rev. Proc. 20XX-4, 14.01
(cross-referencing 13.01 et seq.). Revocation of a determination letter may, however,
be retroactive if the organization omitted or misstated a material fact or operated in a
manner materially different from that originally represented. Regulations
601.201(n)(6)(i); Rev. Proc. 90-27, 14.01; Rev. Proc. 20XX-4 14.01 (cross-referencing
13.01 et seq.).

In cases where the organization omitted or misstated a material fact, revocation may be
retroactive to all open years under the statute. Regulations 601.201(l)(1). In cases
where revocation is due to a material change, inconsistent with exempt status, in the
character, the purpose, or the method of operation, revocation will ordinarily take effect
as of the date of the material change. Regulations 601.201(n)(6)(i); Rev. Proc. 90-27.
In any event, revocation will ordinarily take effect no later than the time at which the
organization received written notice that its exemption ruling or determination letter
might be revoked. Regulations 601.201(n)(6)(i).

Under certain circumstances, however, the Commissioner may, in his discretion grant
relief from retroactive revocation under I.R.C. 7805(b) of the Code. Section 7805(b)(8)
of the Internal Revenue Code provides:

Form 886-A rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -7-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN
12/31/20XX

APPLICATION TO RULINGS. The Secretary may prescribe the extent, if any, to
which any ruling (including any judicial decision or any administrative
determination other than by regulation) relating to the internal revenue laws, shall
be applied without retroactive effect. Section 301.7805-1(b) of the regulations
delegates authority granted by I.R.C. 7805(b) to the Commissioner (or the
Commissioner’s delegate).

To request I.R.C. 7805(b) relief, the organization must submit a statement in support of
this application of I.R.C. 7805(b), as described in Rev. Proc. 20XX-4, 14.02. See also
Rev. Proc. 20XX-5, 19. The organization’s statement must expressly assert that the
request is being made pursuant to I.R.C. 7805(b). The organization’s statement must
also indicate the relief requested and give reasons and arguments in support of the
relief requested. It must also be accompanied by any documents bearing on the
request. The organization’s explanation and arguments should discuss the five factors
bearing on retroactivity listed in Rev. Proc. 20XX-4, 14.02(1) (cross-referencing 13.05),
as they relate to the situation at issue. These five items are, in effect, the same as the
factors provided in Regulations 601.201(l)(5) and 601.201(m), Statement of Procedural
Rules, which states:

Except in rare or unusual circumstances, the revocation or modification of a
ruling will not be applied retroactively with respect to the taxpayer to whom the
ruling was originally issued or to a taxpayer whose tax liability was directly
involved in such a ruling if:

1. there has been no misstatement or omission of material facts;

2. the facts at the time of the transaction are not materially different from the
   facts on which the [determination letter] was based;

3. there has been no change in applicable law;

4. the [determination letter] was originally issued for a proposed transaction,
   and

5. the taxpayer directly involved in the [determination letter] acted in good
   faith in reliance upon the [determination letter] and revoking or modifying
   the [determination letter] retroactively would be to the taxpayer’s
   determinant.

If relief is granted under I.R.C. 7805(b), the effective date of revocation of a
determination letter is no later than the date on which the organization first received
written notice that its exemption might be revoked. Regulations 601.201(n)(6)(i);
Virginia Education Fund v. Commissioner, 85 T.C. 743, 7522-3 (1985), affd 799 F.2d
903 (4th Cir. 1986). This does not preclude the effective date of revocation being earlier
than the date on which the organization first received written notice that its exemption
might be revoked. Virginia Education Fund v. Commissioner, 85 T.C. at 753.

Form 886-A rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -8-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN
12/31/20XX

The Supreme Court has held that the Commissioner has broad discretion under I.R.C.
7805(b) (and its predecessor) in deciding whether to revoke a ruling retroactively.
Automobile Club of Michigan v. Commissioner, 353 U.S. 180, 184 (1957). See also
Dixon v. United States, 381 U.S. 68, 74-75 (1965). The Commissioner’s determination
is reviewable by the courts only for abuse of that discretion. Virginia Education Fund v.
Commissioner, 85 T.C. 743, 752 (1985).

In this case, ORG issued only 2 policies in 20XX that carried over to 20XX and did not
issue any new policies in 20XX. Also, ORG was not involved in any reinsurance
agreements during 20XX. ORG’s activities are considerably different from the activities
that were described in its Application Form 1024. ORG has not been providing
insurance to small investors as the application form stated. Therefore, it is the
Service’s position that ORG is not entitled to relief under IRC 7805(b).

6. If ORG does not qualify for exemption from Federal Tax as an organization
   described under IRC 501(c)(15), was is the effective date of revocation?

Since ORG does not qualify for tax exempt status under IRC 501(c)(15), the effective
date of revocation is for years beginning January 1, 20XX. Organization is liable for
Forms 1120 for years beginning January 1, 20XX.

7. If ORG does qualify as an insurance company under Internal Revenue Code
   Section 501(c)(15), does it meet the other requirements under Internal Revenue
   Code Section 501(c)(15) for tax exemption?

If for some reason ORG is considered an insurance company under IRC 501(c)(15),
then the question is whether ORG meets the other requirements to qualify under IRC
501(c)(15).

Internal Revenue Code section 501(c)(15)(A) exempts from Federal income tax
insurance companies (as defined in section 816(a)) other than life (including
interinsurers and reciprocal underwriters) if-

Form 886-A rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -9-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN
12/31/20XX

(i.) (I) the gross receipts for the taxable year do not exceed $600,000, and
(II) more than 50 percent of such gross receipts consist of premiums, or

(ii.) in the case of a mutual insurance company-
(I) the gross receipts of which for the taxable year do not exceed $150,000
and,
(II) more than 35 percent of such gross receipts consist of premiums.

Clause (ii) shall not apply to a company if any employee of the company, or a member
of the employee’s family (as defined in section 2032(A)(e)(2), is an employee of another
company exempt from taxation by reason of this paragraph (or would be so exempt but
for this sentence).

Sec. 206, Clarification of Exemption from Tax for Small Property and Casualty
Insurance Companies, of the Pension Funding Equity Act of 20XX, P.L. 108-218,
amended section 501(c)(15)(A) to change the definition of small property and casualty
insurance companies (insurance companies other than life insurance companies)
exempt from income taxes to: (1) a company whose gross receipts for the taxable year
do not exceed $600,000, and over half such gross receipts consist of premiums
(currently, whose net written premiums (or, if greater, direct written premiums) for the
taxable year do not exceed $350,000); or (2) a mutual insurance company (a) whose
gross receipts for the taxable year do not exceed $150,000 and more than 35 percent
of which consist of premiums and (b) none of whose employees (or member of the
employee’s family) is an employee of another company exempt from tax under section
501(c)(15). These changes were applicable after December 31, 20XX.

Notice 20XX-42, IRB, 20XX-19 provides guidance as to the meaning of “gross receipts”
for purposes of section 501(c)(15)(A) of the Internal Revenue Code. This notice advises
taxpayers that the Service will include amounts received from the following sources
during the taxable year in “gross receipts” for purposes of § 501(c)(15)(A):

A. Premiums (including deposits and assessments), without reduction for return
premiums or premiums paid for reinsurance;

B. Items described in § 834(b) (gross investment income of a non-life insurance
company); and

C. Other items that are properly included in the taxpayer's gross income under
subchapter B of chapter 1; subtitle A, of the Code.

Thus, gross receipts include both tax-free interest and the gain (but not the entire
amount realized) from the sale or exchange of capital assets, because those items are
described in § 834(b). Gross receipts do not, however, include amounts other than
premium income or gross investment income unless those amounts are otherwise
included in gross income. Accordingly, the term gross receipts does not include
contributions to capital excluded from gross income under § 118, or salvage or
reinsurance recovered accounted for as offsets to losses incurred under

§ 832(b)(5)(A)(i).

Section 834(b)(1)(D) of the Internal Revenue Code includes under gross receipts the
gains from the sale or exchanges of capital assets to the extent provided in subchapter
P (section 1201 and following, relating to capital gains and losses).

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

Page: -10-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN
12/31/20XX

Section 834(c)(6) of the Internal Revenue Code allows a deduction for Capital Losses
to the extent provided in subchapter P (section 1201 and following) plus losses from
capital assets sold or exchanged in order to obtain funds to meet abnormal insurance
losses and to provide for the payment of dividends and similar distributions to
policyholders.

9/30/20XX

Premiums Written

Total Premiums

Investment Income

Total Gross Receipts

Percentage- Gross
Premium/Reinsurance
Income to Gross Receipts

Based on the changes in the limitations under IRC 501(c)(15)(A), and the operation of
ORG during the year ending December 31, 20XX, it was determined by the chart
above, that ORG did not qualify for tax exempt status for years starting January 1,
20XX. ORG was able to meet the $ and $ gross receipts limitation ($). ORG was not
able to meet the % or % requirements (%). Therefore, ORG did not qualify for tax
exempt status under IRC 501(c)(15).

8. If ORG does qualify as an insurance company under Internal Revenue Code
   Section 501(c)(15), but does not meet the other requirements under Internal
   Revenue Code Section 501(c)(15), what are the tax consequences.

To qualify for tax exempt status under IRC 501(c)(15), an organization must be
operating as an insurance company as well as meet the other requirements under this
code section. Since ORG did not meet the other requirements, it does not qualify for
tax exempt status under IRC 501(c)(15).

Since ORG did not qualify for tax exemption per IRC 501(c)(15), for years beginning,
January 1, 20XX, the tax exempt status is hereby revoked starting January 1, 20XX.
In revoking ORG’s tax exemption, ORG is liable for Forms 1120-PC.

9. If ORG does not meet the other requirements under Internal Revenue Code
   Section 501(c)(15), is it entitled to file an election under IRC 831(b) and be
   taxed only on its investment income?

IRC 831 discusses tax on insurance companies other than life insurance companies.

Form 886-A rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -11-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN
12/31/20XX

IRC 831(a) states as a general rule, “Taxes computed as provided in section 11 shall
be imposed for each taxable year on the taxable income of every insurance company
other than a life insurance company.”

IRC 831(b) provides an alternative tax for certain small companies. it states in IRC
831(b)(1) that, in general, “In lieu of the tax otherwise applicable under subsection (a),
there is hereby imposed for each taxable year on the income of every insurance
company to which this subsection applies a tax computed by multiplying the taxable
investment income of such company for such taxable year by the rates provided in
section 11(b).”

IRC 831(b)(2) discusses the companies to which this subsection applies.

(A) In general. This subsection shall apply to every insurance company other
than life (including interinsurers and reciprocal underwriters) if-
(i) the net written premiums (or, if greater, direct written premiums) for
the taxable year do not exceed $ and
(ii) such company elects the application of this subsection for such
taxable year.
The election under clause (ii) shall apply to the taxable year for which made and
for all subsequent taxable years for which the requirements of clause (1) are
met. Such election, once made, may be revoked only with the consent of the
Secretary.

Regulations (Regs.) 301.9100-8(a)(2) discusses the time for making elections. Under
(i) it states in general that except as otherwise provided in this section, the elections
described in paragraph (a)(1) of this section, must be made by the later of-

(A) The due date (taking into account any extensions of time to file obtained by
the taxpayer) of the tax return for the first taxable year for which the election
is effective, or

(B) January 22, 1990 (in which case the election generally must be made by
amended return)

Regs. 301.9100-8(a)(1) mentioned above includes IRC 831(b)(2)(A).

Regs. 301.9100-8(a)(3) describes the manner of making elections. It states, “ Except
otherwise provided in this section, the elections described in paragraph (a)(1) of this
section must be made by attaching a statement to the tax return for the first taxable
year for which the election is to be effective.”

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

Page: -12-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN
12/31/20XX

Based on the Code and Regulation sections above, ORG is not entitled to the relief
under IRC 831(b), for 20XX forward, because it did not meet the requirements of Regs
301.9100-8(a)(2), and therefore would be required to report all income and expenses
on Form 1120-PC for each year. As of this writing, the election has never filed, either
with the filing of the Form 990/990-EZ or separately. When an election is filed, it would
only allow the organization to receive relief under IRC 831(b) in the year it is filed and
all future years. The election would not be retroactive to any prior years.

TAXPAYER’S POSITION
Unknown at the time of this writing.

SUMMARY

It is the Service’s position, based on the above facts, law and analysis, that the tax
exemption status of ORG for the years beginning January 1, 20XX should be revoked
based on ORG not providing insurance and therefore not operating as an insurance
company, thereby failing to meet the qualifications for exemption under IRC 501(c)(15).
Forms 1120 would be required to be filed for years beginning January 1, 20XX.

If it is determined that ORG was operating as an insurance company, the tax exempt
status should still be revoked for years beginning January 1, 20XX because ORG has
not met the other requirements of IRC 501(c)(15). Then Forms 1120-PC would be
required to be filed for years beginning January 1, 20XX.

Form 886-A Rev.4-68 Department of the Treasury - Internal Revenue Service