Determination 1350042: IRS denies exemption for Internet donation services benefiting related businesses

Plain-English summary

The IRS denied exemption under IRC § 501(c)(3) to an organization that planned to process donations through a related for-profit e-commerce and social-networking website. The organization expected most of its funding from transaction fees, planned to retain part of donations, and shared officers, directors, and office space with related businesses. It also planned free networking events for nonprofits and businesses. The IRS concluded that the articles were not limited to exempt purposes and that the organization’s administrative, fundraising, and networking activities primarily served commercial and private interests.

Ruling snapshot

• Question: Did the Internet donation, e-commerce, and networking model further exclusively charitable purposes under IRC § 501(c)(3)?
• Outcome: Denied
• Key authorities: IRC §§ 170, 501(a), 501(c)(3), 6104(c), 6110, and 7428; Treas. Reg. § 1.501(c)(3)-1

Full text (IRS public release)

Transcriber's note: this document is a scan. Obvious OCR misreads were corrected by comparison with the official PDF page images. Redacted placeholders remain as published, and source wording and source errors are otherwise preserved.

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

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Contact Person:

Number: 201350042
Release Date: 12/13/2013 Identification Number:

Contact Number:

Date: September 17, 2013
Employer Identification Number:

UIL: 501.03-00 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.

Because 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. File the returns in accordance with their
instructions, and do not send them to this office. Failure to file the returns timely may result in a
penalty.

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, 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.


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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,

Karen Schiller
Acting Director, Exempt Organizations
Rulings & Agreements

Enclosure
Notice 437
Redacted Proposed Adverse Determination Letter
Redacted Final Adverse Determination Letter


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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION
Date: April 12, 2013 Contact Person:
UIL: 501.03-00 Identification Number:
Contact Number:
FAX Number:
Employer Identification Number:
Legend:

Internet donation service
Networking event
Corporation

Website

Tech

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.

Facts:

You applied for tax-exempt status under section 501(c)(3), but failed to indicate the
type of public charity status you are requesting. Your amended Articles of Incorporation
state that your primary purpose is to:

[I]ncrease charitable giving from individuals and decrease the cost of
fundraising for nonprofits by providing the public with a safe, easy,
efficient way to give to the charity of their choice and by creating an
online community for nonprofits, profits and people; enabling non-
profits to engage supporters through low-cost online fundraising; and
helping profit market their business and products while supporting a
charitable or non-profit. [sic]

You also state that you are organized for charitable and educational purposes to
make distributions to section 501(c)(3) organizations. Furthermore, you will organize
weekly networking events for non-profits and businesses at which community


volunteers will speak about various business topics. You describe these as educational.

You entered into an agreement with Corporation, a for-profit entity that your
founders and officers created to manage a social network Internet site, including the
advertising and e-commerce on it. (See attachment) You plan to create and maintain a
web page for each charity registered with you on a website that Corporation manages
and maintains. Thus, you provide information about the non-profits participating in your
Internet donation service to the Corporation's clients. The Corporation will transfer
through you a percentage of its Internet sales as donations to various tax-exempt
organizations. Therefore, you will accept, process, and forward donations received
from the Corporation’s e-commerce website to your participating non-profits. A majority
of your time and resources are devoted to these activities. According to a fundraising
agreement you entered into, you only serve as the administrator of the funds donated
through the website.

The transaction works in the following manner. Corporation will donate 10
percent of transaction fees generated by activity on its e-commerce website. Either the
buyer or the seller of the product purchased on the website may select an exempt
organization registered with you to receive a portion of the transaction fee. If neither
party selects a registered tax-exempt organization, you will select one at random from
those registered with you. You will retain the donation for 45 days in case there is a
problem with a transaction which may require a refund of the donation You state that
you do not plan to charge any fees to your clients, but you plan to keep a portion of
each donation you received from the Corporation. At different times, you described
your share as 5 percent, 10 percent, or “no more than 20 percent.” So, for a $200.00
purchase on Corporation’s website, you will receive $20.00 (10 percent) from the
transaction. You may keep $1.00 (5 percent for example) as a fee and send $19.00 to
the registered tax-exempt organization. Users of the social network site may also
donate to one of the registered charities without transacting business. You will transfer
these donations as well, but will deduct 3.5 percent as a fee.

Only non-profits registered with you may receive donations that originate from
the Corporation’s e-commerce website. You plan to manage all web pages and
information about non-profits participating on Corporation’s e-commerce website.
Corporation will provide the hardware and software to facilitate the operation of the
Internet donation service, and_Tech will provide IT support. All non-profits wanting to
participate on Corporation’s e-commerce website must register with you.

You plan to organize free weekly Networking events for non-profits, for-profits,
and individuals to develop business-networking relationships and promote business
connections. The meetings will present training material and other information on
Internet marketing as well as sales and technology to ensure that nonprofits keep ahead
in technologies. Speakers from the community will provide advice. You will provide the
facilities and live forum for business people to exchange business ideas, referrals,


contact, services, and business.

Ninety-five percent of your funding will come from your share of the Corporation's
10 percent transaction fee as indicated above. You expect that the remaining 5 percent
of your revenue will come from direct donations.

You also have a close relationship with Tech, a for-profit technology company.
Your CEO and President is also the CEO and President of Tech. Your Vice President
and Treasurer is also the Vice President of Tech. These two individuals are husband
and wife, respectively, and receive their compensation from Tech, and are two of your
three directors. Furthermore, you share office space with Tech and Corporation.

You have an agreement with Tech that provides for IT support services as well
as administration and maintenance of your social networking internet site. The
agreement specifies that you will reimburse Tech for out-of-pocket expenses, such as
bank transfer fees, long-distance calls, photocopies, computer printouts, fax charges,
messenger services, and local or out-of-town travel incurred in connection with this
agreement. You indicated that Tech could serve non-profits that participate in your
services but you stated that you and Tech would not “cross market” one another nor
share customer information.

You initially stated that you plan to assist small for-profits with internet marketing
of their businesses and products. You subsequently indicated that you would limit your
fund raising activities to only nonprofits. However, you still plan to include small
businesses in your social networking activities and e-commerce. You will only offer
Internet donation services to non-profits recognized as tax-exempt by the Internal
Revenue Service, and the non-profits must agree to use all donations received from
you in accordance with their tax-exempt status.

You currently do not have any employees; and officers, directors, trustees are
uncompensated, with one exception. You project that the CEO will receive $20,000.00
in annual compensation. You, Corporation, and Tech share the same officers and
directors, as well as office space. Your principal officers, as previously stated, are
husband and wife.

Law:

Section 501(c)(3) of the Code provides for the exemption from federal income tax
of organizations which are organized and operated exclusively for charitable purposes,
no part of the net earnings of which inures to the benefit of any private shareholder or
individual.

Section1.501(a)-1(c) of the Income Tax Regulations states that “[t]he words


‘private shareholder or individual’ in section 501 refer to persons having a personal and
private interest in the activities of the organization.”

Section 1.501(c)(3)-1(b)(1)(iii) states that an organization is organized exclusively
for one or more exempt purposes only if its articles limit its purposes to one or more
exempt purposes and do not expressly empower it to carry on activities which are not in
furtherance of exempt purposes.

Section 1.501(c)(3)-1(c)(1) provides that an organization will be regarded as
“operated exclusively” for one or more exempt purposes only if it is engaged primarily in
activities which accomplish one or more of such exempt purposes specified in section
501(c)(3). 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(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.

Section 1.501(c)(3)-1(d)(3) defines the term ‘educational’ for the purposes of
section 501(c)(3) as including the instruction of the public on subjects useful to the
individual and beneficial to the community.

Rev. Rul. 76-206, 1976-1 C.B. 154, considered an organization formed to
promote broadcasting of classical music in a particular community. The organization
carried on a variety of activities designed to stimulate public interest in the classical
music programs of a for-profit radio station, including soliciting sponsors, soliciting
subscriptions to the station’s program guide, and distributing pamphlets and bumper
stickers encouraging people to listen to the station. The organization’s board of directors
represented the community at large and did not include any representatives of the for-
profit radio station. The revenue ruling concludes that the organization’s activities
enable the radio station to increase its total revenues and therefore benefit the for-profit
radio station in more than an incidental way. Therefore, the organization is serving a
private rather than a public interest and does not qualify for exemption.

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.


American Institute for Economic Research v. United States, 302 F.2d 934 (Ct. Cl.
1962), cert. denied, 372 U.S. 976 (1963), described an organization that had a stated
aim of teaching and disseminating economic knowledge, published two semi-monthly
periodicals available for subscription, and provided investment advice services for a fee.
The court held that this organization did not qualify for exemption under section
501(c)(3) of the Code, because its commercial purpose was primary and not incidental
to its educational purpose.

In American Campaign Academy v. Commissioner, 92 T.C. 1053 (1989), the
court held that an organization that operated a school to train individuals for careers as
political campaign professionals, but that could not establish that it operated on a
nonpartisan basis, did not exclusively serve 501(c)(3) purposes because it also served
private interests more than incidentally. The court found that persons affiliated with a
particular political party created and funded the organization and that most of the
organization’s graduates worked in campaigns for that party’s candidates.
Consequently, the court concluded that the organization conducted its educational
activities to benefit the party’s candidates and entities. Although the candidates and
entities benefited were not organization “insiders,” the court stated that the conferral of
benefits on disinterested persons who are not members of a charitable class may cause
an organization to serve a private interest within the meaning of section 1.501(c)(3)-
1(d)(1)(ii) of the regulations.

In Christian Manner Int'l, Inc. v. Comm’r, 71. T.C. 661, the petitioner organized
for religious and educational purposes, published and sold books that its founder wrote.
The Tax Court found that the organization’s actual purpose was to benefit the founder,
by publishing his books and promoting his theories. Even if the publication of his books
in part furthered religious or educational purposes, petitioner would still not qualify for
exemption under § 501(c)(3) because a substantial part of its activity benefited him
personally.

In Easter House v. United States, 12 Cl.Ct. 476 (1987), affd w/o opinion, 846
F.2d. 78 (Fed. Cir. 1988), the court found that an adoption agency was not entitled to
exemption from federal income tax under section 501(c)(3) of the code because it
operated in a manner not “distinguishable from a commercial adoption agency.” The
taxpayer did not solicit contributions, its operation made substantial profits, and there
was a substantial accumulation of capital surplus in comparison to direct expenditures
by the taxpayer.

In P.L.L. Scholarship v. Commissioner, 82 T.C. (1984), an organization operated
bingo at a bar for the avowed purpose of raising money for scholarships. The board
included the bar owners, the bar’s accountant, also a director of the bar, as well as two
players. The court reasoned that, because the bar owners controlled the organization
and appointed the organization’s directors, the activities of the organization could be
used to the advantage of the bar owners. The organization claimed that it was


independent because there was separate accounting and no payments were going to
the bar. The court was not persuaded:

A realistic look at the operations of these two entities, however, shows
that the activities of the taxpayer and the Pastime Lounge were so
interrelated as to be functionally inseparable. Separate accountings of
receipts and disbursements do not change that fact.

The court went on to conclude that, because the record did not show that the
organization was operated for exempt purposes, but rather indicates that it benefited
private interests, exemption was properly denied.

In Church By Mail, Inc. v. Commissioner, T.C. Memo 1984-349, affd 765 F. 2d
1387 (gt Cir. 1985), the Tax Court found that a church was operated with a substantial
purpose of providing a market for an advertising and mailing company owned by the
same people who controlled the church. The church argued that the contracts between
the two were reasonable, but the Court of Appeals pointed out 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.”

In International Postgraduate Medical Foundation v. Commissioner, T.C. Memo
1989-36 (1989), the court concluded that the petitioner was not described in section
501(c)(3). The petitioner was organized to provide continuing medical education to
physicians. To this end, it took physicians on three-week tours throughout the world.
The petitioner shared offices with a for-profit travel agency that the petitioners’ principle
officer controlled. It made all its travel arrangements through the agency. The court
found that a substantial purpose of the petitioner was benefiting the for-profit travel
agency. It also found that the tour activities served a substantial recreational purpose.

Rationale:

Based on the information you submitted, for the reasons explained below, we
have concluded that you are not operated exclusively for one or more tax-exempt
purposes within the meaning of §501(c)(3). We have also concluded that you benefit
private interests more than an insubstantial amount rather than furthering a public
purpose under §§ 1.501(c)(3)-1(c)(1) and 1.501(c)(3)-1(d)(1)(ii).

Organizational Test

To qualify for exemption from federal income tax, you must be organized
exclusively for tax-exempt purposes within the meaning of § 501(c)(3) and 1.501(c)(3)-


1(b)(1)(iii). You were formed to “increase charitable giving from individuals and
decrease the cost of fundraising for nonprofits by providing the public with a safe, easy,
efficient way to give ... and by creating an online community for nonprofits, profits and
people; and helping for-profit market their business....” None of these purposes
constitute a tax-exempt purpose as defined by the code and regulations. Therefore,
your Articles of Incorporation do not limit your purposes to those recognized as tax-
exempt, and you are not properly organized.

More than Insubstantial Non-Exempt Purpose

Although an organization may carry on activities that further one or more exempt
purposes, it will not be treated as operated exclusively for a tax-exempt purpose if more
than an insubstantial part of its activities is not in furtherance of an exempt purpose.

Section 1.501(c)(3)-1(c)(1); Better Business Bureau of Washington, D.C.., Inc.

Your administrative, fundraising, and networking, activities do not exclusively
further a tax-exempt purpose within the meaning of sections 501(c)(3), 1.501(c)(3)-
1(c)(1), and 1.501(c)(3)-1(d)(3). Your activities are primarily administrative and
commercial. You plan to manage Internet pages and process contributions made by
advertising and e-commerce customers of your related commercial entity on its Internet
social networking site. Collecting and transmitting donations made by customers on a
commercial website is not a tax-exempt purpose under § 501(c)(3), but is merely a
commercial function. Better Business Bureau, Easter House.

A minor activity you expect to engage in is to organize educational presentations
about business using the internet accompanied by social networking opportunities for
for-profits and non-profits. You plan to encourage and host social networking activities
immediately following your seminars between potential donors and exempt
organizations seeking contributions and funding. You will market these networking
activities to individuals and commercial businesses.

While there may be some educational content, these activities primarily foster
future commercial business transactions for the for-profit entities. The fact that you do
not plan to charge for the meetings does not make this activity charitable. The
educational purpose of the meetings is secondary to their commercial purpose. See
American Institute for Economic Research, supra at 939 (the court held that the
organization did not qualify for exemption under section 501(c)(3) because its
commercial purpose was primary and not incidental to its educational purpose). In any
case, you expect these meetings to be a minor activity.

Impermissible Private Benefit

An organization is not organized or operated exclusively for one or more tax-
exempt purposes unless it serves a public rather than a private interest. To meet this


requirement, 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. Section 1.501(c)(3) -1(d)(1)(ii) . You operate for the
benefit of private interests rather than for the community as a whole. Rev. Rul. 76-206.

The service that you offer to customers of the commercial website that your
founders and officers own and established presumably enhances its utility and appeal.
By attracting charities to use this commercial website, you increase its traffic, like the
entities in P.L.L. Scholarship Fund. Adding the “registered” nonprofits to the networking
events would increase their attendance, and thus attractiveness to the presenters and
commercial attendees. Even if some of your activities further a charitable purposes,
you would still not qualify for exemption under section 501(c)(3) because a substantial
part of your activity benefits the related for-profits rather than the public at large. See
Christian Manner Int'l, supra.

Common control of an exempt organization and a commercial business presents
a risk of private benefit, which is more serious if the entities engage in transactions with
each other. The law of exempt organizations has long recognized the possibility that an
exempt organization could be used to enhance a commercial business. Many court
opinions have denied exempt status because a related business benefited from an
affiliated exempt organization. For example: P.L.L. Scholarship Fund, 82 T.C. 196;
Church by Mail, 765 F.2d 1387;and Int'l Postgraduate Medical Foundation, T.C. Memo
1989-36.

Therefore, we conclude that the activities you conduct with the related for-profits
do not exclusively promote an exempt purpose, and thus you are not entitled to
exemption from federal income tax.

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.

Your protest statement should be accompanied by the following declaration:

Under penalties of perjury, I declare that I have examined this protest statement,
including accompanying documents, and, to the best of my knowledge and belief,
the statement contains all the relevant facts, and such facts are true, correct, and
complete.


You also have a right to request a conference to discuss your protest. This
request should be made when you file your protest statement. An attorney, certified
public accountant, or an individual enrolled to practice before the Internal Revenue
Service may represent you. If you want representation during the conference
procedures, you must file a proper power of attorney, Form 2848, Power of Attorney
and Declaration of Representative, if you have not already done so. For more
information about representation, see 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 protest 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 this address:

You may also 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.


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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, Rulings and Agreements