Internet consulting organization denied section 501(c)(3) exemption

Plain-English summary

The IRS issued a final adverse determination to an organization that provided internet training, website development, and related consulting services to small and medium-sized businesses. The organization argued that its educational programs and work with minority-owned and women-owned businesses served charitable or educational purposes. The IRS concluded that substantial fee-based consulting activity operated in a commercial manner and benefited private business interests. It also found that the educational programs were incidental to the organization's effort to attract paying clients. The IRS denied exemption under IRC § 501(c)(3), so contributions would not be deductible under IRC § 170.

Ruling snapshot

• Question: Did the organization qualify for exemption under § 501(c)(3) despite its fee-based internet consulting and educational activities?
• Outcome: Denied.
• Key authorities: IRC §§ 170, 501(c)(3), 6104(c), 6110(k)(3), and 7428(b)(2); Treas. Reg. §§ 1.501(c)(3)-1(a)(1), 1.501(c)(3)-1(c)(1), 1.501(c)(3)-1(d)(1)(ii), 1.501(c)(3)-1(d)(2), and 1.501(c)(3)-1(d)(3)(i); Rev. Ruls. 71-529, 72-369, 74-587, and 76-419.

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION

Release Number: 201403017 Contact Person:
Release Date: 1/17/2014

Date: October 24, 2013 Identification Number:

UIL Code: 501.36-01 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.

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.

2

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,

Kenneth Corbin
Acting Director, Exempt Organizations

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: 8/9/13 Contact Person:
Identification Number:
Contact Number:
FAX Number:
Employer Identification Number:
LEGEND: UIL:
O = State
P = City 501.33-00
Q = Date 501.36-01

S = Name of Company

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.

Issue

Do you qualify for exemption under section 501(c)(3) of the Code? No for the reasons
described below.

Letter 4036(CG) (11-2011)
Catalog Number 47630W

Facts

You were established as S in 1994 under a university's economic development
outreach program. You changed to your current name in 1996 with the mission to
promote economic development and competitiveness by educating, sponsoring,
developing and implementing electronic commerce (e-commerce) activities and
programs to small and medium-sized businesses and non-profit groups.

You incorporated with the state of O on Q as a new separate entity. Your purpose in
pertinent part is: “charitable scientific and educational purposes within the meaning of
Section 501(c)(3)...”

Your core mission since inception has been to train and educate small businesses and
organizations to learn how to use and implement internet technology for growth and
expansion of their businesses. You provide a variety of specialized courses in a variety
of subjects. Your goal has always been to first provide training and classes and then
provide technical assistance as needed. You help “hand-hold businesses through
internet complexities”. Approximately 55% of your activity is conducting your
educational courses, training and consulting.

The other 45% of your activities are focused on providing technical services and
consulting. You meet with a prospective client and evaluate their knowledge and
experience with technology. You provide a review of existing websites and make
recommendations on what technology will help to grow their business, improve sales
and make them more efficient. You do not have set fees but you approach each client
based on their needs. Your hourly fees range from $50 to $90 per hour. You also
charge project fees that range from $500 to $3500. A typical consulting contract will
include website development, database development, and internet marketing such as
on-line shopping carts, logo and corporate identity design, search engine optimization
and social media implementation. Additional fees for web hosting, support, e-mail
accounts and training will be charged. Projects undertaken by you require your clients
to remit 50-75% of the project cost along with a signed statement of work before work
can begin. Web hosting services automatically renew on an annual basis unless
terminated by either party. When comparing fees to the industry, you state your fees
are not the most expensive nor are they the cheapest charged for similar technical
assistance support.

You also provide consulting and technical assistance to two of your board members.
This service is provided at arms length and these board members pay full costs for any
work provided by you.

You have partnered with government entities and other organizations in O to solicit

Letter 4036(CG) (11-2011)
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small and medium size businesses through “matching grants” programs. You will solicit
small to mid-sized businesses to offer your technology, educational and developmental
services. The programs are primarily targeted towards small and disadvantaged
businesses to provide matching funds to these businesses within the participating
localities. The municipality or economic development authority is solicited to participate
for the benefit of businesses within their areas. You also work with large banks and
business enterprises that offer matching grants to grow businesses in their areas of
influence. You do not operate particularly in an area that is blighted or economically
backward. Although you provided a listing of the economically distressed regions and
federal unemployment data for O, you operate throughout O, wherever you are able to
obtain matching grants. Your activities are not aimed at combating community
deterioration and you do not provide loans to start-up businesses.

Businesses located within participating localities who request your consulting and other
services are provided with matching grants that fund up to 50% of the project costs
available to businesses through these entities. Payments of matching grants are made
through you based on a 50-50 match basis with a maximum cap. The matching
program is not limited to you. Any vendor who is approved and provides internet
technology services can participate in this program.

For example, you have an agreement with an agency of P that provides “E-Commerce
Business Assistance Grants” to eligible businesses to fund technology improvement or
development projects that expand and grow their businesses. The grants reimburse
you up to 50 percent of the project costs. The business clients pay you the remaining
project costs. Certain large companies also provide these grants that target vendors of
their products. Your project contracts identify these matching grants as reductions to
the total fees due from your clients.

You collaborate with various business assistance organizations such as the Small
Business Administration (SBA) and other such departments across O as well as other
businesses to sponsor your educational classes. When sponsorship grants are not
available for a particular seminar or class, you might charge participants a minimum fee
which helps offset expenses of the classes. You state your technical service fees also
help in part to underwrite your educational classes.

You operate throughout the O. You tend to focus on small, women owned and minority
owned businesses and assist them by providing education and technical support. You
attract clients through the matching grants program and a word of mouth marketing
program. Current and previous clients also refer new business to you. You also use
your education classes to attract new clients that are looking for consulting and
technical assistance. Approximately 70% of your client base is made up of small,
minority owned and women owned businesses.

Letter 4036(CG) (11-2011)
Catalog Number 47630W

You conduct one to four educational programs a month. Depending on your program
locations, you estimate 20 to 30 people attend your educational classes and sessions,
with lesser in the rural locations. Some individuals may attend several of your
educational classes since your topics provide relevant information meant to improve
their business and increase their profits.

To complete your package of services to your clients you also publish and sell a book
written by a best selling author which your clients can buy by clicking on a link on your
website.

You have no specific criteria for a business to obtain your services. However you will
rely on the business being eligible for a matching grant that is available in a particular
locality.

Your first fiscal year shows income received from clients for new projects and renewals
account for approximately 70% of your income. Matching grants and contributions etc
make up approximately 30% of total income. For your next two fiscal years your
estimates show your gross receipts are approximately 79% and 83% of total income
respectively. Payments to contractors and payroll expenses constitute the bulk of your
expenses.

Law

Section 501(c)(3) of the Code provides, in part, for the exemption from federal income
tax to organizations organized and operated exclusively for charitable, religious,
scientific, or educational purposes.

Section 1.501(c)(3)-1(a)(1) of the Income Tax Regulations (regulations) provides that in
order to be exempt under section 501(c)(3) of the Code, an organization must be both
organized and operated exclusively for one or more purposes specified in such section.
An organization that fails to meet either the organizational test or the operational test is
not exempt.

Section 1.501(c)(3)-1(c)(1) of the regulations provides that an organization operates
exclusively for exempt purposes if it engages primarily in activities that accomplish
exempt purposes specified in section 501(c)(3) of the Code. An organization will not
meet exemption if more than an insubstantial part of its activities fails to further an
exempt purpose.

Section 1.501(c)(3)-1(d)(1)(ii) of the regulations provides that an organization is not
organized or operated exclusively for exempt purposes unless it serves a public rather

Letter 4036(CG) (11-2011)
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5

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.

Section 1.501(c)(3)-1(d)(2) of the regulations defines the term “charitable” as used in
section 501(c)(3) of the Code. It includes the relief of the poor and distressed,
lessening the burdens of government, and the promotion of social welfare by
organizations designed to lessen neighborhood tensions, eliminate prejudice and
discrimination or combat community deterioration and juvenile delinquency.

Section 1.501(c)(3)-1(d)(3)(i) of the regulations defines the term “educational” when
used in section 501(c)(3) of the Code as the instruction or training of an individual for
the purpose of improving or developing his capabilities or the instruction of the public on
subjects useful to an individual and beneficial to the community.

Revenue Ruling 71-529 held that a nonprofit organization that provided assistance in
the management of participating colleges' and universities' endowment or investment
funds for a fee substantially below the cost of providing such service, qualified for
exemption under IRC 501(c)(3). Membership was restricted to colleges and
universities exempt under section 501(c)(3) of the Code, and its board of directors was
composed of representatives of the member organizations.

Revenue Ruling 72-369, 1972-2 C.B. 245, states that an organization formed to provide
managerial and consulting services at cost to unrelated exempt organizations does not
qualify for exemption. Providing managerial and consulting services on a regular basis
for a fee is a trade or business ordinarily carried on for profit. The fact that the services
in this case are provided at cost and solely for exempt organizations is not sufficient to
characterize this activity as charitable within the meaning of section 501(c)(3) of the
Code. Furnishing the services at cost lacks the donative element necessary to
establish this activity as charitable.

Revenue Ruling 74-587, 1974-2 C.B. 162, held that a nonprofit organization formed to
relieve poverty, eliminate prejudice, reduce neighborhood tensions, and combat
community deterioration through a program of financial assistance in the form of low-
cost or long-term loans to, or the purchase of equity interests in, various business en-
terprises in economically depressed areas is exempt under section 501(c)(3) of the
Code.

Revenue Ruling 76-419, 1976-2 C.B. 146, held that a nonprofit organization that
purchased blighted land in an economically depressed community and converted the
land into an industrial park and encourages industrial enterprises to locate new facilities
in the park in order to provide employment opportunities for low income residents of the
area, is operated exclusively for charitable purposes and qualifies for exemption under
section 501(c)(3) of the Code.

Letter 4036(CG) (11-2011)
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6

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 a claim for exemption regardless of the number or
importance of truly exempt purposes.

In B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978), the court found that a
corporation formed to provide consulting services did not satisfy the operational test
under section 501(c)(3) of the Code because its activities constituted the conduct of a
trade or business that is ordinarily carried on by commercial ventures organized for profit.
Its primary purpose was not charitable, educational, or scientific, but rather commercial.
In addition, the court found that the organization's financing did not resemble that of the
typical section 501(c)(3) organizations. It had not solicited, nor had it received, voluntary
contributions from the public. Its only source of income was from fees from services, and
those fees were set high enough to recoup all projected costs and to produce a profit.
Moreover, it did not appear that the corporation ever planned to charge a fee less than
“cost.” And finally, the corporation did not limit its clientele to organizations that were
section 501(c)(3) exempt organizations.

In Airlie Foundation v. Internal Revenue Service, 283 F.Supp.2d 58, the court held that
Airlie Foundation did not meet the requirements as an organization described in section
501(c)(3) of the Code because its operation of a conference facility was a commercial
activity. The foundation charges conference fees comparable to or lower than other
nonprofit conference centers and substantially lower than commercial conference
centers. It advertises only from their website and it retains very small earnings from
their operations. While many of their clients were exempt and nonprofit organizations
and government entities, many others were corporate or private clients conducting
special events and weddings. The court conceded that certain factors, including their
fee structure and subsidization practice, emulate noncommercial characteristics;
however, other factors, such as the nature of their clients and industry competition, gave
the activities a commercial hue. Thus, the court concluded their manner of operations
furthered substantial nonexempt purposes.

In Asmark Institute, Inc. v. Commissioner of Internal Revenue, 486 Fed.Appx. 566, TC
Memo 2011-20, the appeals court upheld the tax court decision that Asmark Institute is
not entitled to exempt status under section 501(c)(3) of the Code because the institute’s
operations were commercial rather than charitable. Its activities consist mainly of
compliance services for a fee. The court also found that Appellant's free services are
relatively small in relation to all of its services and are, in fact, tied in some manner to
fee-based membership. The court also found that the appellant's largely fee-based
business plan and its competition within a for-profit market were also strong evidence of
the predominance of their nonexempt commercial purposes. The tax court concluded it
was apparent from the record that appellant's consulting services are mainly associated

Letter 4036(CG) (11-2011)
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7

with the fees appellant receives through its various retainer agreements, membership
agreements, and service packages. The sale of services, including consulting services,
is commonly considered to be a non-exempt, commercial purpose.

Application of Law

You are not described in section 501(c)(3) of the Code and section 1.501(c)(3)-1(a)(1)
of the regulations. You fail the operational test for exemption under 501(c)(3) because
you are operated in a commercial manner.

A substantial part of your activities are commercial. You provide services to your clients
such as website development, database development and internet marketing tools to
increase their business and profits. You charge an hourly fee as well as a project fee
which are based on your cost. At times your cost is subsidized by local economic
development agencies or corporations at the rate of 50%. Although a portion of your
clientele are small businesses and women owned and minority owned business you
provide your services at or above cost. These facts demonstrate a commercial and
substantially non-exempt purpose inconsistent with section 501(c)(3) of the Code and
Section 1.501(c)(3)-1(c)(1) of the regulations.

You operate for the private interests of your client businesses for whom you provide
various website services for a fee. You also operate for the private interest of the
author of the book that you sell to your clients through a link on your website. Therefore
you are not organized or operated exclusively as described in Section 1.501(c)(3)-
1(d)(1)(ii) of the regulations.

Your services are not designed for the relief of the poor and distressed, to lessen the
burdens of government or the promotion of social welfare. Your services are provided
to any business that can afford your services or obtain a matching grant for 50% of the
cost of the project and can pay the other 50% of the cost directly to you. Therefore,
your activities are not charitable as described in section 1.501(c)(3)-1(d)(2) of the
regulations.

Although you provide educational seminars, these seminars are a way for you to obtain
additional clients for whom you can provide your services for a fee. Your educational
activity is incidental to your primary activity which is to provide website and other related
technical services to your clients for a fee. You conduct your educational activities from
the perspective of possibly bringing in more paying clients whose revenue sources will
help fund your educational programming. Therefore you are not as described in
section 501(c)(3)-1(d)(3)(i) of the regulations.

Your fee-based service activities are similar to those described in Revenue Ruling 72-
369 and in the court cases BSW Group, Inc., Airlie Foundation, and Asmark Institute.

Letter 4036(CG) (11-2011)
Catalog Number 47630W

8

As in these four situations, you operate in a commercial manner. You provide technical
and consulting services and support to clients who seek your services for a fee. Most,
if not all, of your clients are for-profit businesses and you assist them to increase their
business and their profits. You do not restrict your clients to other organizations exempt
under section 501(c)(3) of the Code. In addition, your fees are not substantially below
cost. You are operating a trade or business with the public similar to and in competition
with commercial operations providing similar technical, consulting and marketing
services and support.

You are not similar to the organization described in Revenue Ruling 71-529 because
you are not providing services for a fee substantially below cost to other organizations
exempt under section 501(c)(3) of the Code. You are also not similar to the
organizations described in Revenue Ruling 74-587 or 76-419 because you do not
operate in an economically depressed area or a distressed area. You do work with and
provide services to some minority-owned businesses, but it is because they meet the
criteria set by the matching grant programs. In those programs, the matching grant
funds are paid as direct reimbursements of the service costs. You do not provide loans
or provide assistance to businesses that have trouble obtaining such assistance
because they operate in economically distressed or deteriorated areas. Your
assistance is available to any business including minority owned and women owned
businesses that can afford your hourly and project fees either wholly or with matching
grant funds.

You are similar to Better Business Bureau of Washington, D.C., Inc. because you too
have a substantial non-exempt purpose. Even though you have some educational
activities, the facts overwhelmingly show you operate for a substantial non-exempt
commercial purpose and you also operate for the benefit of private business interests.

Applicant’s Position

Your goal is to first provide training and classes and then provide technical assistance
as needed. Your fees are not the most expensive nor are they the cheapest fees that
companies charge for similar technical assistance support. Your unique mission of
providing education, consulting and technical assistance makes it difficult to compare
your fees with services provided by other providers. You provide hours of educational
support to potential clients or existing clients for which they never receive a bill.

Your mission is to provide e-commerce education, internet training, consulting and
technical assistance specifically targeted to minority businesses. These minority
businesses will hire other individuals after their business has grown as a result of the
internet capabilities provided by you thereby saving existing jobs and creating new jobs
to handle the growth in their respective businesses. You have oftentimes been referred
to as an incubator.

Letter 4036(CG) (11-2011)
Catalog Number 47630W

9

Service Response to Applicant’s Position

The fees you charge are based on market rates depending on your client needs. The
provision of some free consultations or education does not take away from the fact that
you are similar to other for-profit consulting companies that charge a fee for services.

The fact that your services assist business growth and creates jobs does not alone
justify exemption or overcome the commercial nature of your operations.

Conclusion

Based on the above facts and analysis you do not qualify for exemption under section
501(c)(3) of the code because you are not operated exclusively for a 501(c)(3) purpose.
The facts show you operate for a substantial non-exempt commercial purpose as you
were formed to provide various internet related services to your clients for a fee.
Accordingly we conclude you do not qualify for exemption under section 501(c)(3).

You have the right to file a protest if you believe this determination is incorrect. To
protest, you must submit a statement of why you disagree. Your protest statement
must be filed within 30 days of the date of this letter and should include:

• Your organization’s name, address, EIN number and a daytime phone number.
• A statement that the organization wants to protest the proposed determination.
• A copy of this letter showing the findings that you disagree with (or the date and
IRS office symbols from the letter.
• An explanation of your reasons for disagreeing including any supporting
documents.
• The law or authority if any, on which you are relying.

The protest statement may be signed by one of your officers or your representative.
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, How to Appeal an IRS Decision on Tax-
Exempt Status.

The protest statement should also include the following declaration.

Letter 4036(CG) (11-2011)
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10

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

The declaration must be signed by an officer or trustee of the organization who has
personal knowledge of the facts.

Your protest will be considered incomplete without this statement.

If an organization’s representative signs and submits the protest, a substitute
declaration must be included stating that the representative prepared the protest and
any accompanying documents, and whether the representative personally knows (or
does not know) that the statement of facts in the protest and any accompanying
documents are true, correct.

An attorney, certified public accountant, or an individual enrolled to practice before the
Internal Revenue Service may represent you. In that case you must file a 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 seek a declaratory
judgment in court at a later date because the court requires that you first exhaust
administrative remedies. At the IRS. Code section 7428(b)(2) provides, in part, that a
declaratory judgment or decree shall not be issued in any proceeding unless the Tax
Court, the United States Court of Federal Claims, or the District Court of the United
States for the District of Columbia determines that the organization involved has
exhausted all of the administrative remedies available to it within the IRS.

If you do not intend to protest this determination, you do not need to take any further
action. If we do not hear from you within 30 days, we will issue a final adverse
determination letter. That letter will provide information about filing tax returns and other
matters.

Please send your protest Statement, Form 2848, and any supporting documents to the
applicable address:

Letter 4036(CG) (11-2011)
Catalog Number 47630W

11

Mail to: Deliver to:

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,

Kenneth Corbin
Acting Director, Exempt Organizations

Enclosure: Publication 892