IRS denies exemption to a fundraising organization serving a for-profit club network

Plain-English summary

The IRS denied exemption to an organization that raised money for a for-profit youth sports club network and credited fundraising proceeds to club member fees. The organization's activities funded equipment and program costs for related clubs and provided financial benefits to participating families. Its directors and officers also held roles in the related clubs, and two directors were compensated for organizing fundraisers. The IRS concluded that the organization failed the organizational and operational tests, served private rather than public interests, and benefited a for-profit company and private individuals. The final letter says donors could not deduct contributions under section 170 and required federal returns.

Ruling snapshot

• Question: Did the organization qualify for exemption under IRC § 501(c)(3)?
• Outcome: Denied.
• Key authorities: IRC §§ 170, 501(c)(3), 6104(c), 6110, and 7428; Treas. Reg. §§ 1.501(c)(3)-1(a)(1), 1.501(c)(3)-1(c)(1), 1.501(c)(3)-1(c)(2), and 1.501(c)(3)-1(d)(1)(ii); Rev. Ruls. 67-149, 69-175, 76-206, and 80-302

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION
Release Number: 201407020 Contact Person:
Release Date: 2/14/2014
Date: June 21, 2013 Identification Number:
UIL Code: 501.33-00
501.35-00 Contact Number:
501.36-04
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: September 18, 2013 Contact Person:
Identification Number:
Contact Number:
FAX Number:
Employer Identification Number:

LEGEND:

S = State
B = Date
C = Name of Club
D = Name of Club
F = Name of Club
G = Name of Club
M = Director/President
N = Director
P = Director
Q = Director
X = Name of for-profit LLC

UIL:
501.03-30
501.33-00
501.32-01
501.36-04

Dear

We have considered your application for recognition of exemption from federal income
tax under Internal Revenue Code section 501(a). Based on the information provided,
we have concluded that you do not qualify for exemption under Code section 501(c)(3).
The basis for our conclusion is set forth below.

Issues

Are you organized and operated for an exempt purpose under section 501(c)(3) of the
Code? No, for the reasons set forth below.

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

Facts

You incorporated in the state of S on B. Your articles of incorporation state the
purposes for which you are organized are athletic.

An additional three page document titled Articles of Incorporation which has not been
executed and with no indication of filing with the appropriate state authorities’ states you
are:

Organized exclusively for charitable and educational purposes for the funding of
X, more specifically to assist young girls and boys of the X family of clubs play
club ball and to enhance their experience by providing supplies and equipment
and to provide fundraising and scholarships to athletes in need so they are able
to afford club ball.

X is a for-profit company that owns and operates several clubs in S. X owns and
operates clubs C,D, F and G. The relationship you have with X is that they operate the
clubs that you service. These clubs are the ones that you help families attend and play ~
for. Your director M is also the director of clubs F and G. Your director N is the director
of D as well as operations director of all the clubs. Your director Q is the business
manager of all the clubs. Your fourth director is P the spouse of N.

If you do not raise money for X they would raise the club dues passing the expenses to
families that you serve. Your work of raising funds for X prevents them from raising
their dues. If you did not support X then families you service would not be able to afford
to play club ball and X would have to conduct these fundraising efforts or pass the costs
to the families.

You are organized and operated solely to provide funding to X and its related programs.
You raise funds for these clubs through raffles, cookie dough sale, candle sales and
mixed bag fundraisers. Each member family is responsible for selling a certain number
of raffle tickets and returning the money collected to you. Members can sell the raffle
tickets to a third party or retain and pay for the tickets themselves. A drawing is
conducted at a prescribed date and time and prizes are distributed to winners. The
remaining funds are then handed over X to provide funding for its programs.

X uses the funds raised to purchase balls, carts, nets, poles; pads and other supplies
for the clubs. This keeps these costs from being borne by the families that participate
in the program.

X charges fees to participate in their programs. You allow your members to opt out of
the raffle participation but they have to pay the fees to X. If the members participate in
your fundraisers certain percentages of their participation can be credited to their

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accounts to offset their costs. You also conduct cookie dough sale, candle sale and
mixed bag fundraisers. The companies you use for these fundraisers usually offer from
25-50% of the sales back to the participants which can be used to pay their fees.

Compensation for directors M and Q are an estimated $12,000 and $ 9,000 respectively
for their efforts in organizing the fundraisers. Coaches who participate in your
fundraising program are given gifts and your directors M and Q are compensated based
on the hours spent on each fundraiser and the work done throughout the year to
organize the fundraisers.

You provided financial data indicating total revenue of approximately $75000.
Expenses for fundraising were approximately $3,000. Approximately $22,000 was paid
out in raffle prizes; approximately $18,000 was given to X and about $11,000 was paid
to members to offset their fees (tuition reimbursement) for participation in club
programs. Coaches’ gifts, professional fees and business credit card payments made
up the rest of the 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(c)(2) of the regulations provides that an organization is not
operated exclusively for one or more exempt purposes if its net earnings inure in whole
or in part to the benefit of private shareholders or individuals as defined in Section
1.501 (a)-1(c).

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

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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.

Revenue Ruling 67-149 1967-1 C.B. 133 held that an organization formed for the
purpose of providing financial assistance to several different types of organizations
which are exempt from Federal income tax under section 501(c)(3) of the Internal
Revenue Code of 1954 is exempt from Federal income tax under section 501(c)(3) of
the Code.

Revenue Ruling 69-175, 1969-1 CB 149, held that an organization formed by parents of
pupils attending a private school that provided bus transportation to and from the school
for those children whose parents belong to the organization is not exempt from Federal
income tax under section 501(c)(3) of the Code. Parents paid an initial family fee and an
additional annual charge for each child. The organization’s income approximately
equaled the expenses involved in its operations. When a group of individuals associate
‘to provide a cooperative service for themselves, they are serving a private interest. By
providing bus transportation for school children, under the circumstances described, the
organization enabled the participating parents to fulfill their individual responsibility of
transporting their children to school. Thus, the organization serves a private rather than
public interest.

Revenue Ruling 76-206 1976-1 C.B. 154 held a nonprofit organization formed to

generate community interest in the retention of classical music programs by a local for-
profit radio station by seeking program sponsors, encouraging continuation of contracts
by existing sponsors, urging the public to patronize the sponsors, soliciting subscriptions
to the station's program guide, and distributing materials promoting the classical music
programs, all of which activities tend to increase the station's revenues, does not qualify
for exemption under section 501(c)(3) of the Code.

Revenue Ruling 80-302 1980-2 C.B. 182 held that an organization that limits its
membership to descendants of a particular family, compiles family genealogical
research data for use by its members for reasons other than to conform to the religious
precepts of the family's denomination, presents the data to designated libraries,
publishes volumes of family history, and promotes social activities among family
members does not qualify for exemption under section 501(c)(3) of the Code.

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. The Court found that the trade association had an
“underlying commercial motive” that distinguished its educational program from that
carried out by a university.

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In est of Hawaii v. Commissioner, 71 T.C. 1067 (1979), several for-profit est
organizations exerted significant indirect control over est of Hawaii, a non-profit entity,
through contractual arrangements. The question for the court was not whether the
payments made to the for-profits were excessive, but whether they benefited
substantially from the operation of the applicant. The Tax Court concluded that the for-
profits were able to use the non-profit as an "instrument" to further their for-profit
purposes. Neither the fact that the for-profits lacked structural control over the
organization nor the fact that amounts paid to the for-profit organizations under the
contracts were reasonable affected the court's conclusion. Consequently, est of Hawaii
did not qualify as an organization described in section 501(c)(3).

In Church by Mail, Inc. v. Commissioner, T.C. Memo 1984-349, affd 765 F. 2d 1387 (9th
Cir. 1985), the Court affirmed a Tax Court decision. Church by Mail sent out sermons in
numerous mailings. This required a great deal of printing services. A for-profit
company, controlled by the same ministers, provided the printing and the mailing. The
services were provided under two contracts. The contracts were signed by the two
ministers for both the organization and the for-profit company. The organization’s
business comprised two-thirds of the overall business done by the for-profit company.
The court determined that there was ample evidence in the record to support the finding
that the organization was operated for the substantial non-exempt purpose of providing
a market for the services of the for-profit company. 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." Moreover, the ministers’ dual control of
both the Church and the for-profit company enables them to profit from the affiliation of
the two entities through increased compensation.

Application of Law

Organizational test

You do not meet the organizational test requirements of section 501(c)(3) of the code
and Section 1.501(c)(3)-1(a)(1) of the regulations since the filed copy of your articles of
incorporation does not contain the necessary purpose and dissolution clause required
for exemption. Also additional documentation provided by you titled Articles of
Incorporation do not indicate they were filed with the appropriate state officials. Article II
of your articles of incorporation states you are formed for the purpose of funding X and
to assist boys and girls who are members of X family of clubs. Neither the funding of
for-profit X or the support provided to its member families are charitable purposes within
the meaning of section 501(c)(3) of the code.

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• 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 for the non-exempt purpose of raising funds for a for-profit entity and
  to help offset member fees and expenses..

You are not described in Section 1.501(c)(3)-1(c)(1) of the regulations. Your activities
do not further any exempt purposes. In fact they provide funds to a for-profit club and
benefits to private individuals who are the members of these clubs.

You are operated for the private benefit of X and its various clubs for whom you raise
funds. The funds you raise are also used to pay for equipment used at these clubs and
to subsidize the fees of the members of the clubs. You are therefore not operated
exclusively for exempt purposes as described in Section 1.501(c)(3)-1(d)(1)(ii) of the
regulations.

Your net earnings from your fundraisers are transferred to for-profit company X. Your
directors M and Q are compensated from the proceeds of these fundraisers and your
coaches are also given gifts for raising funds. In addition you have member accounts to
which a portion of the fundraising proceeds are credited for use towards their member
dues. Therefore your net earnings inure in whole or in part to the benefit of private
shareholders or individuals as defined in Section 1.501(a)-1(c) and you are not as
described in Section 1.501(c)(3)-1(c)(2) of the regulations.

You are not like the organization in Revenue Ruling 67-149 that provided financial
assistance to organizations exempt under section 501(c)(3). Your assistance is
provided to a for-profit club.

Like the organization in Revenue Ruling 69-175 you were formed to benefit a group of
individuals who are members at the various clubs owned by X. By raising funds to
provide for the financial obligations of the members you are operating for their
respective private interests.

Like the organization in Revenue Ruling 76-206 you are operated for the benefit of the
for-profit X and the various clubs that X operates.

You limit your membership to members who belong to the clubs owned by X. You use
the funds raised by your fundraising operations to provide these members with funds to
meet their members’ financial obligations at the various clubs owned by X. Like the
organization in Revenue Ruling 80-302 you serve private interests of your members and
do not qualify for exemption under section 501(c)(3) of the code.

You are similar to Better Business Bureau of Washington, D.C., Inc. because you too
have a substantial non-exempt purpose. Your primary purpose is to operate for the

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benefit of private business interests by raising funds for a for-profit entity and the
interests of your members.

You are similar to est of Hawaii, supra, because X, a related for-profit, has indirect
control over you. Your officers and directors are all directors or officers of the various
clubs operated by X. They will raise funds through members who participate in activity
in the various clubs. The directors and officers use you as an instrument to enhance
the profits of the for-profit X.

Further, as shown in Church by Mail, supra, your governing body's dual control over you
and X shows the entire enterprise is carried on in such a manner that the for-profit
organization benefits substantially from your operations. Moreover, the directors and
officers dual control of both you and X enables them to profit from the affiliation of the
two entities through increased compensation.

Applicant’s Position

Your work prevents the clubs from having to raise the dues of their participants. Many of
the participant's families would not be able to afford club volleyball and X would need to
conduct fundraising. efforts on their own or pass the costs on to the families. If you did
not raise the money, then X would have to raise their club dues and pass on the
expenses to the families you serve. Without your support the families you service will
be unable to afford to play ball at the clubs. You are requesting exemption to enable
you to help defer these costs while helping others save money.

Services Response to Applicants Position.

Raising funds to provide for the expenses of a for-profit club is not an exempt purpose.
In addition the use of funds raised by your members through raffles and other
fundraisers to pay their financial obligations offers a private benefit to your members.
As a result, you do not meet the requirements for tax exemption.

Conclusion

Based on the facts, we have concluded that you fail to qualify for exemption under
section 501(c)(3) of the Code. Your activities of raising funds for X a for-profit
organization do not further an exempt purpose. The raising of funds by member
families and the use of such funds to cover the costs of membership confer private
benefit to the member families. Your earnings also inure to the benefit of your directors
and officers who are also directors and officers of the various clubs operated by X, to X

Letter 4036(CG) (11-2011)
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8

the for-profit business, and to your member families who receive direct financial benefits
from you.

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.
e 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.

“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.

Letter 4036(CG) (11-2011)
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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:

Mail to: Deliver to:
Internal Revenue Service Internal Revenue Service
EO Determinations Quality Assurance EO Determinations Quality Assurance

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.

Letter 4036 (CG) (11-2011)
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10

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
Rulings and Agreements

Enclosure: Publication 892

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