Trust loses exemption after lending all assets to its creator

View official IRS release (PDF)

Plain-English summary

A supporting organization received contributed assets and, within about a year, lent its entire asset balance to its creator and trustee. The IRS found no evidence that the loan was secured, that payments were made, or that the organization enforced repayment, while the funds paid the creator's business and personal expenses. The IRS concluded that the arrangement caused charitable assets to inure to a private person and showed that the trust operated for the creator's benefit rather than for exempt purposes. It revoked the trust's section 501(c)(3) status retroactively to December 1 of the redacted year. The organization agreed to the revocation.

Ruling snapshot

• Question: Did lending all of the trust's assets to its creator cause private inurement and loss of exemption?
• Outcome: Revocation
• Key authorities: IRC §§ 170 and 501(c)(3); Treas. Reg. § 1.501(c)(3)-1; Better Business Bureau v. United States; Western Catholic Church v. Commissioner

Full text (IRS public release)

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Release Number: 201447049
Release Date: 11/21/2014
UIL Code: 501.03-03

CERTIFIED MAIL — RETURN RECEIPT

Dear

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE

Date: June 19, 2009

Taxpayer Identification Number:
Person to Contact:
Employee Identification Number:

Employee Telephone Number:

LAST DATE TO FILE A PETITION
IN TAX COURT: September 17, 20XX

This is a final adverse determination regarding your exempt status under section 501(c)(3) of the
Internal Revenue Code (the Code). Our favorable determination letter to you dated May 20XX is
hereby revoked and you are no longer exempt under section 501(a) of the Code effective

December 1, 19XX.

The revocation of your exempt status was made for the following reason(s):

Organizations described in IRC 501(c)(3) and exempt under section 501(a) must be both organized
and operated exclusively for exempt purposes. You did not operate exclusively for exempt
purposes because your assets inured to, and served the private interests of, your creators. The
entire amount of your assets was loaned to your creator. There was no indication that the loan
was secured or the creator ever made any payments. The loan was used to pay for the business
and personal expenses of your creator. The loan was made at a favorable rate and terms which
served the financial interests of your creator. He has operated you for his own personal benefit.
You were controlled by your creator and you were established and operated to enable your creator
to engage in financial activities which are beneficial to him. Facts that show a charity’s
investments are decided in part by the needs of private interests indicate the charity may not be
operated exclusively for exempt purposes. Western Catholic Church v. Commissioner, 73 T.C.

196, 214 (1979), aff’d 631 F. 2d 736 (7th Cir. 1980).

Contributions to your organization are no longer deductible under IRC §170 after December 1,

19XX.

You are required to file income tax returns on Form 1120. These returns should be filed with the
appropriate Service Center for the tax year ending November 30, 20XX, and for all tax years
thereafter in accordance with the instructions of the return.

Processing of income tax returns and assessments of any taxes due will not be delayed should a
petition for declaratory judgment be filed under section 7428 of the Internal Revenue Code.

If you decide to contest this determination under the declaratory judgment provisions of section
7428 of the Code, a petition to the United States Tax Court, the United States Claims Court, or the
district court of the United States for the District of Columbia must be filed before the 91st Day
after the date this determination was mailed to you. Please contact the clerk of the appropriate
court for rules regarding filing petitions for declaratory judgments by referring to the enclosed
Publication 892. You may write to the United States Tax Court at the following address:

United States Tax Court
400 Second Street, NW
Washington, DC 20217

You also 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:

See the enclosed Notice 1546, Taxpayer Advocate Service - Your Voice at the IRS, for Taxpayer
Advocate telephone numbers and addresses.

We will notify the appropriate State Officials of this action, as required by Code section 6104(c).
You should contact your State officials if you have any questions about how this final
determination may affect your State responsibilities and requirements.

If you have any questions, please contact the person whose name and telephone number are
shown in the heading of this letter.

Sincerely,

Sunita Lough
Director, EO Examinations

Enclosures:
Publication 892
Publication 1546

Internal Revenue Service Department of the Treasury

Date: November 24, 2008
Taxpayer Identification Number:

Form:

Tax Year(s) Ended:
November 30, 20XX and 20XX

Person to Contact/ID Number:

Contact Numbers:
Telephone:

Fax:

Certified Mail - Return Receipt Requested

Dear

We have enclosed a copy of our report of examination explaining why we believe revocation of your exempt
status under section 501(c)(3) of the Internal Revenue Code (Code) is necessary.

If you accept our findings, take no further action. We will issue a final revocation letter.

If you do not agree with our proposed revocation, you must submit to us a written request for Appeals Office
consideration within 30 days from the date of this letter to protest our decision. Your protest should include a
statement of the facts, the applicable law, and arguments in support of your position.

An Appeals officer will review your case. The Appeals office is independent of the Director, EO Examinations.
The Appeals Office resolves most disputes informally and promptly. The enclosed Publication 3498, The
Examination Process, and Publication 892, Exempt Organizations Appeal Procedures for Unagreed Issues,
explain how to appeal an Internal Revenue Service (IRS) decision. Publication 3498 also includes information
on your rights as a taxpayer and the IRS collection process.

You may also request that we refer this matter for technical advice as explained in Publication 892. If we issue
a determination letter to you based on technical advice, no further administrative appeal is available to you
within the IRS regarding the issue that was the subject of the technical advice.

Letter 3618 (Rev. 11-2003)
Catalog Number: 34809F

If we do not hear from you within 30 days from the date of this letter, we will process your case based on the
recommendations shown in the report of examination. If you do not protest this proposed determination within
30 days from the date of this letter, the IRS will consider it to be a failure to exhaust your available
administrative remedies. Section 7428(b)(2) of the Code provides, in part: "A declaratory judgment or decree
under this section shall not be issued in any proceeding unless the Tax Court, the Claims Court, or the District
Court of the United States for the District of Columbia determines that the organization involved has exhausted
its administrative remedies within the Internal Revenue Service." We will then issue a final revocation letter.
We will also notify the appropriate state officials of the revocation in accordance with section 6104(c) of the

Code.

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

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

Thank you for your cooperation.

Sincerely,

Vicki L. Hansen
Acting, Director Exempt Organizations Examinations

Enclosures:
Publication 892
Publication 3498
Report of Examination

Letter 3618 (Rev. 11-2003)
Catalog Number: 34809F

Name of Organization: Agent:
Form: FYE: Date: 1/30/20XX

W/P Index L-4

OTHER
EXEMPT STATUS

The following is the Revenue Agent Report sent to the taxpayer via 30 day letter,
L3618, on November 24, 20XX. The Organization agreed to the retroactive revocation
and submitted a signed Form 6018 on 12/22/20XX.

ISSUE: Whether the IRC § 501(c)(3) tax exempt status of the
should be revoked because it is not operated exclusively for tax exempt purposes.

FACTS:

Trust Instrument

The (the “Organization”) was created with a Declaration of Trust
(Declaration) by (hereinafter collectively referred to as the “Donor” and
sometimes referred to as “Trustee”), on December 27, 19XX. The Declaration
provides that the Organization was created for the purpose of establishing an
organization which is described in IRC §§ 501(c)(3) and IRC 509(a)(3). The Declaration
states that it shall be irrevocable, and the Donor hereby expressly waives the right and
the power to alter, amend, revoke, or terminate the Trust or any of the terms of this
Declaration. The Declaration provides that the Donor hereby renounces any power to
determine or control, by alteration, amendment, revocation, termination, or otherwise,
and the Donor renounces any interest in, either vested or contingent, including any
reversionary interest or possibility of reverter, the income or principle of the trust estate.

The Declaration requires that each year the Trustee shall distribute % of the adjusted
net income of Organization to , (the “Primary Charity”). It
is intended that the distributions to will help

perform its functions and carry out its purposes. In order to insure that this
happens, the Board shall meet with the governing body of

, or a representative thereof, to determine the use of such distributions. It is
intended that the distributions will be used in a similar fashion each year to fund a

project or carry out a function . Prior to making
any donation, grant or distribution to , the organization
shall obtain written confirmation that is then currently

recognized as a tax exempt organization under Section 501(c)(3) of the Code.

In addition to the distribution to be made pursuant to the above regarding the required

distribution, each year, the Trustee shall distribute a total of of the
net income of this Trust to one or more of the organizations listed on , which by
this reference is made a part hereof, or to as is directed by the

Board in writing signed by at least members of the Board, provided that each such

Name of Organization: Agent:
Form: FYE: Date: 1/30/20XX

W/P Index L-4

distribution shall be a distribution which can be made by an organization described in
Section 509(a)(3) of the Code. Each such distribution shall be made on or before the

end of the month immediately following the year in which the income was earned.
There are charities listed on to the Declaration, including the primary
charity,

Upon winding up and dissolution of this Trust, after paying or adequately providing for
the debts and obligations of the Trust, the remaining assets shall be distributed to a
non-profit fund, foundation, or corporation which is organized and operated exclusively
for charitable, educational, religious, and/or scientific purposes and which has
established its tax exempt status under Section 501(c)(3) of the Code. In the event that
the Trust does not obtain exempt status under 501(c)(3) and 509(a)(3) of the Code, the
assets of the Trust shall go to the , as defined, as a contingent remainder.

In the event the Trustee determines, in the Trustee’s sole and complete discretion, that
the Trust Fund is too small to economically administer, then in such event the Trustee
shall distribute the Trust Fund in its entirety outright to such organization or
organizations as described in §170(c)(2) of the Code.

The Declaration provides that the Board shall be the governing body of the Trust and
that the members of the Board shall consist of members and be determined as
follows:

Board member shall be appointed by

Board members shall be from the class consisting of and
and each of their descendants (the ), provided that there are then at least
members of the who are willing and able to so act.

Other remaining members of the Board, including any vacancies caused by not having
at least members as designated from the , shall be appointed by a
majority vote by the remaining members of the Board. The initial remaining Board
members shall be

Governance
is the Organization’s trustee. is a substantial contributor and,
therefore, a disqualified person with respect to the Organization. The Organization’s

initial board of directors was comprised of | members as follows:

, a disqualified person because he is a substantial contributor;
' also a disqualified person;

Name of Organization: Agent:
Form: FYE: Date: 1/30/20XX

W/P Index L-4
All Board members were disclosed on the Form 990, for the tax year ended

November 30, 19XX. On the 20XX through 20XX tax returns only and
were disclosed as Board members, no other Board members were disclosed.

Operations

Application for Recognition of Exempt Status

By letter dated May 30, 20XX, the Organization was recognized by the Service as
exempt from Federal income tax under section 501(a) as an organization described in
section 501(c)(3). The Service also determined that the Organization met the
requirements of section 509(a)(3) and classified it as a supporting organization rather
than a private foundation. The Service’s determination letter was based on the
Organization's representations made in its application and supplemental materials.
During the application process, the Organization did not disclose that it would lend all of
its assets to disqualified persons.

Years Before Exam

19XX

The Organization provided a copy of the Board meeting minutes for December 27,
19XX. These were the only meeting minutes provided by the Organization.

The Organization filed its initial tax return on October 18, 20XX, for the year ended
November 30, 19XX.

Initial Contributions to the Organization Per Form 990 for the year ended November 30,
19XX.

Cash
Stock

Dividends
From Stock

Gain on Sale of
Contributed
Stock

Total

K-4-3

Name of Organization: Agent:
Form: FYE: Date: 1/30/20XX

W/P Index L-4

On November 19, 19XX, the Organization issued a loan¹ to the Trustee in the amount of
. This was the total amount of assets for the Organization. A copy of the Note,
dated November 19, 19XX, provided by the Organization indicated the following terms:

Amount: $
Rate: % apr
Due upon demand.

The loan to Trustee was disclosed on line , page , of the Form 990 for the year ended
November 30, 19XX, and on the . The information disclosed on
was “Loan to .

20XX

There was no income or expenditures reported on the Form 990, for the year ended
November 30, 20XX, filed by the Organization.

The loan to Trustee was disclosed in the same manner as described above for the year
ended November 30, 19XX.

20XX

There was no income or expenditures reported on the Form 990, for the year ended
November 30, 20XX, filed by the Organization. The loan was reported as a receivable
from officers on , page _, of the tax return. On a statement attached to the tax return
the Organization disclosed the name of the borrower and terms of the loan.

20XX

The 20XX tax return was filed identical to the 20XX return. No income or expenditures
disclosed and the loan was disclosed on a statement attached to the return.

There was no indication the Organization made any grants to the Primary Charity or any
other charity. The returns do not indicate that any income was received or any
expenditures were made.

---

1 Through the course of the initial interview and the examination of the books and records there was no indication the Trustee made
any payments on the loan to the Organization and the money received by the Trustee was used to pay for his business and
personal living expenses.

K-4-4

Name of Organization: Agent:
Form: FYE: Date: 1/30/20XX

W/P Index L-4

Years under Exam

20XX and 20XX

Through the course of the initial interview and examination of the books and records
there was no indication the Organization made any grants or received any income. The
Organization did file Forms 990 disclosing the receivable from the Trustee.

Tax return information 20XX 20XX
Line

Total revenue $ $
Line

Total expenses $ $

Balance Sheet

Line

Receivables from officers, directors,

Trustees, and key employees $ $
Line

Total assets $ $
Line

Total liabilities $ $
Line

Paid in capital surplus $ $
Line

Total liabilities and net assets $ $
LAW:

IRC § 501(c)(3) exempts from Federal income tax: corporations, and any community
chest, fund, or foundation, organized and operated exclusively for religious, charitable,
scientific, testing for public safety, literary, or educational purposes, or for the prevention
of cruelty to children or animals, no part of the net earnings of which inures to the
benefit of any private shareholder or individual, no substantial part of the activities of
which is carrying on propaganda, or otherwise attempting to influence legislation and
which does not participate in, or intervene in (including the publishing or distributing of
statements), any political campaign on behalf of any candidate for public office.

Name of Organization: Agent:
Form: FYE: Date: 1/30/20XX

W/P Index L-4

Regulation 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 engages 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.

Regulation section 1.501(c)(3)-1(c)(2) 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. The words “private shareholder or
individual” refer to persons having a personal and private interest in the activities of the
organization.

Regulation section 1.501(c)(3)-1(d)(1)(ii) provides an organization is not organized or
operated exclusively for one or more exempt purposes 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 the creator or his family, shareholders of the organization, or
persons controlled, directly or indirectly, by such private interests.

In Better Business Bureau v. United States, 326 U.S. 279 (1945), the United States
Supreme Court held that regardless of the number of truly exempt purposes, the
presence of a single substantial non-exempt purpose will preclude exemption under
section 501(c)(3).

In Revenue Ruling 67-5, 1967-1 C.B. 123, it was held that a foundation controlled by the
creator’s family was operated to enable the creator and his family to engage in financial
activities which were beneficial to them, but detrimental to the foundation. It was further
held that the foundation was operated for a substantial non-exempt purpose and served
the private interests of the creator and his family. Therefore, the foundation was not
entitled to exemption from Federal income tax under section 501(c)(3).

GOVERNMENT’S POSITION:

Issue

The IRC § 501(c)(3) tax exempt status of (the “Organization” )
should be revoked because it is not operated exclusively for tax exempt purposes.

The Organization was funded with in Cash and Stock by the Trustee,

, from December 28, 19XX, through November 30, 19XX. On November 19,
19XX, a loan was issued from the Organization to the Trustee in the amount of

the entire amount of the Organization’s assets. There was no indication of any
board approval. The lack of a board approval process prior to the transactions
demonstrate that , Donor, had full control of the assets.

K-4-6

Name of Organization: Agent:
Form: FYE: Date: 1/30/20XX

W/P Index L-4

There was no indication that the loan was secured or the Trustee ever made any
payments. The Organization provided documentation stating the loan was used to pay
for the business and personal expenses of , Trustee.

The entire contribution by was loaned back to him, the Donor and disqualified
person at a favorable rate and terms which served the financial interests of the Trustee.
Facts that show a charity’s investments are decided in part by the needs of private
interests indicate the charity may not be operated exclusively for exempt purposes.
Western Catholic Church v. Commissioner, 73 T.C. 196, 214 (1979), aff'd 631 F.2d 736
(7th Cir. 1980).

The facts show that the Organization is not operated exclusively for a tax exempt
charitable purpose. Rather, , has operated the Organization for his own
personal benefit. The facts of the case show that established the
Organization and claimed tax benefits in the form of charitable contribution deductions
under IRC § 170.

The Organization, which is controlled , was established and operated to
enable to engage in financial activities which are beneficial to him.
Accordingly, it is operated for a substantial non-exempt purpose. See Revenue Ruling
67-5.

An organization is described in section 501(c)(3) only if no part of its net earnings inures
to the benefit of any private shareholder. The inurement prohibition is designed to
insure that charitable assets are dedicated to exclusively furthering public purposes. An
organization is not operated exclusively for exempt purposes if its net earnings inure to
the benefit of private shareholders or individuals.

A gift to a charitable organization must be a voluntary transfer of money or property
without the receipt of adequate consideration, made with charitable intent. Hernandez
v. Commissioner, 490 U.S. 680, 690 (1980). To claim a deduction under section 170, a
donor must surrender dominion and control over the gift. United States v. Estate
Preservation Services, 202 F.3d 1093, 1101 (9th Cir. 2000). transferred assets
to the Organization and claimed a deduction under section 170. A charity's assets are
required to be irrevocably dedicated to charitable purposes. Treas. Reg. § 1.501(c)(3)-
1(b)(4). The inurement prohibition serves to prevent the individuals who operate the
charity from siphoning off any of a charity's income or assets for personal use. By
transferring the assets back to a disqualified person, purportedly as a loan but as a
distribution, the Organization breached the dedication requirement and its net earnings
have inured to the benefit of the disqualified person.

Whether a particular transaction actually constitutes a loan is determined upon
consideration of all the facts. Fisher v. Commissioner, 54 T.C. 905, 909 (1970). For a
payment to constitute a loan, when the payments are received, the recipient must intend
to repay the amounts and the transferor must intend to enforce payment. Haag v.

Name of Organization: Agent:
Form: FYE: Date: 1/30/20XX

W/P Index L-4

Commissioner, 88 T.C. 604, 615 (1987), aff'd without published opinion, 855 F.2d 866
(8th Cir. 1988); Beaver v. Commissioner, 55 T.C. 85, 91 (1970). In Greg R. Vinikoor v.
Commissioner, T.C. Memo 1998-152, the Tax Court provided the following factors to
determine whether a transfer was made with a real expectation of repayment and an
intention to enforce the debt:

(1) There was a promissory note or other evidence of indebtedness;

(2) Interest was charged;

(3) There was security or collateral;

(4) There was a fixed maturity date;

(5) A demand for repayment was made;

(6) Any actual repayment was made;

(7) The transferee had the ability to repay;

(8) Any records maintained by the transferor and/or the transferee reflected
the transaction as a loan; and

(9) The manner in which the transaction was reported for Federal tax
purposes is consistent with a loan.

There was no intent by the Trustee to pay the loan back and no demand by the
Organization to demand payment. The Trustee made no payments on the loan which
was issued in 19XX, the Note states “Due upon demand”, there was no interest
charged or accrued, no fixed maturity date, and no collateral, the entire amount
constitutes a distribution.

Although the inurement prohibition is stated in terms of net earnings, it applies to any of
a charity's assets that serve the interests of its private shareholders. Harding Hospital,
Inc. v. United States, 505 F.2d 1068, 1072 (6th Cir. 1974). The transfer of funds directly
to the disqualified person, served the financial interests of the disqualified person and/or
his business. Facts that show a charity’s investments are decided in part by the needs
of private interests indicate the charity may not be operated exclusively for exempt
purposes. Western Catholic Church v. Commissioner, 73 T.C. 196, 214 (1979), aff'd
631 F.2d 736 (7th Cir. 1980).

Conclusion

Accordingly, the Organization’s status as an organization described under section
501(c)(3) should be revoked because it did not operate exclusively for exempt purposes
because its assets inured to, and it served the private interests of, its creators and other
private persons.

K-4-8

Name of Organization: Agent:
Form: FYE: Date: 1/30/20XX

W/P Index L-4

This determination is effective beginning December 1, 19XX. The Organization did not
disclose in its exemption application that it would be making a loan with all of its assets.
It failed to disclose that it would distribute monies to the Trustee, a disqualified person.

Thus, retroactive revocation is applicable.

Form , U.S. Income Tax Return for Estates and Trusts should be filed for tax years
ending November 30, 20XX, 20XX, 20XX and 20XX. Subsequent returns are due no
later than the 15th day of the 4th month following the close of the trust’s accounting
period.
Returns should be sent to the following mailing address:

Internal Revenue Service
For tax year ending November 30, 20XX Form is due March 15, 20XX, should be

sent to the following address:

Internal Revenue Service

RETROACTIVE DATE OF REVOCATION

The effective date of revocation is retroactive because the Organization did not disclose
in its application for exempt status that it would loan essentially all of its assets to the
Founder within a year of his contribution to the Organization. Therefore, retroactive
revocation to the first taxable year which begins December 1, 19XX, is appropriate.

Memo to File

A memo was created to memorialize the actions required by the Organization to accept
agreement. It was later determined through conference call with

and manager that the Org was not required to substantiate repayment of the loan prior
to agreeing to revocation. The Org submitted Form 6018 on 12/22/20XX. Results of
examination is Disposal Code , agreed revocation.

Refer to Exhibit L-4-1 for copy of Memo to File.

Conclusion: The result of the examination is proposed revocation based on inurement.
The Founder, Donor and Trustee, created the Organization in late 19XX,
and contributed about to the Organization. A year later the Organization
issued a loan to the Founder for all of its assets, , and did not make any

K-4-9

Name of Organization: Agent:
Form: FYE: Date: 1/30/20XX

W/P Index L-4

payments on the loan. The statute of limitations for the IRC § 4958 issue had expired
prior to the opening of the examination. See workpaper J-8 for more more information
on this issue.

The Organization agreed to retroactive revocation to the first taxable year of the
Organization which is December 1, 19XX. The Organization submitted a signed Form
6018 on 12/22/20XX. Retroactive revocation is applicable in this case as the
Organization did not disclose in its application for exempt status that it would loan all of
its assets to a Disqualified Person, the Founder, , at favorable terms;

made no payments on the loan. IRC § 501(c)(3), Treas. Reg. 1.501(c)(3)-1(c)(1 -2),
and 1.501(c)(3)-1(d)(1)(ii), Revenue Ruling 67-5, 1967-1 C.B. 123, and Better Business
Bureau v. United States, 326 U.S. 279 (1945).

K-4-10