IRS revokes supporting trust that transferred funds for private investment

View official IRS release (PDF)

Plain-English summary

A charitable supporting trust accepted contributions from its founder, who claimed charitable deductions, but made no grants to its designated supported organizations for years. The trust had no board meeting minutes or elections, and the purported supported organizations exercised no meaningful control. Instead, the trust transferred all of its funds to an attorney who invested them in a company where he was a shareholder and board chairman and his daughter was an officer. The IRS found that the trust conferred a substantial private benefit, lacked proper internal controls, and was controlled by a disqualified person rather than by its supported charities. It retroactively revoked the trust's § 501(c)(3) status, with private-foundation reclassification presented as an alternative. The taxpayer agreed to revocation.

Ruling snapshot

• Question: Should the supporting trust retain § 501(c)(3) status when it made no charitable grants and transferred its funds for an attorney's private investment activity?
• Outcome: Revocation
• Key authorities: IRC §§ 501(c)(3), 509(a)(3), and 4946; Treas. Reg. §§ 1.501(c)(3)-1 and 1.509(a)-4

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
TE/GE - EO Mandatory Review
1100 Commerce Street, MC 4920-DAL
Dallas, TX 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION
Release Number: 201451035 Employer Identification Number:
Release Date: 12/19/2014
Date: January 7, 2009 Person to Contact:

UIL Code: 501.03-03
Identification Number:

Contact Telephone Number:
In Reply Refer To:
LAST DAY FOR FILING A

CERTIFIED MAIL — Return Receipt Requested PETITION WITH TAX COURT:
April 7, 20XX

Dear

This is a Final Adverse Determination revoking your exempt status under section
501(c)(3) of the Internal Revenue Code.

Our adverse determination was made for the following reasons:

The Foundation has failed to provide evidence you are currently operated
exclusively for exempt purposes within the meaning of Internal Revenue Code section
501(c)(3). You are not a charitable organization within the meaning of Treasury
Regulations 1.501(c)(3)-1(d) in that you failed to establish that you were operated
exclusively for an exempt purpose. We determined that your activities confer a
substantial private benefit upon your founders, your internal controls are deficient,
and there was no evidence of any qualified charitable activity, therefore, you do not
operate exclusively for exempt purposes.

Based upon the above, we are revoking your organization's exemption from Federal
income tax under section 501(c)(3) of the Internal Revenue Code effective November 5,
19XX.

Contributions to your organization are no longer deductible under section 170 of the
Internal Revenue Code.

You are required to file Federal income tax return Form 1041. These returns should be
filed with the appropriate Internal Revenue Campus for the year ending December 31,

20XX and for all years thereafter, the prior year returns were previously submitted to the
District Office.

-2-

Processing of income tax returns and assessment 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 in court, you must initiate a suit for
declaratory judgment in the United States Tax Court, the United States Claim Court or
the District Court of the United States for the District of Columbia before the 91st day
after the date this determination was mailed to you. Contact the clerk of the appropriate
court for the rules for initiating suits for declaratory judgment.

You also have the right to contact the office of the Taxpayer Advocate. However, you
should first contact the person whose name and telephone number are shown above
since this person can access your tax information and can help you get answers. You
can call 1-877-777-4778 and ask for Taxpayer Advocate assistance. Or you can
contact the Taxpayer Advocate from the site where the tax exempt status was
determined by calling, faxing or writing to: Internal
Revenue Service, Taxpayer Advocates Office, ,

Taxpayer Advocate assistance cannot be used as a substitute for established IRS
procedures, formal appeals process, etc. The Taxpayer Advocate is not able to reverse
legal or technically correct tax determinations, nor extend the time fixed by law that you
have to file a petition in the United States Tax 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.

We will notify the appropriate State Officials of this action, as required by section
6104(c) of the Internal Revenue Code.

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

Sincerely,

Renee B Wells
Acting Director, EO Examinations

DEPARTMENT OF THE TREASURY
Internal Revenue Service
TE/GE: EO Examinations
1100 Commerce Street

TAX EXEMPT AND
GOVERNMENT ENTITIES Dallas, TX 75242
DIVISION

August 1, 2007

Taxpayer Identification Number:

Form:

Tax Year(s) Ended:
December 31, 20XX & 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 (04-2002)
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,

Marsha A. Ramirez
Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Report of Examination

Letter 3618 (04-2002)
Catalog Number 34809F

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

PRIMARY ISSUE:
Should the IRC section 501(c)(3) tax exempt status of the Foundation be
revoked because it is not operated exclusively for tax exempt purposes?
FACTS:
During the Interview with , he stated that sometime prior to the
creation of the Foundation, he attended a seminar conducted by

, an attorney from . The seminar covered

estate planning and different ways to protect investment income. According to
, the main focus of the estate planning consisted of creating charitable

supporting trusts.

The Foundation was created with a Trust Agreement dated
November 5, 19XX. In the Trust Agreement, and an organization
referred to as the were listed as the initial
. trustees. Pursuant to the Trust Agreement, was created exclusively as a
supporting organization as described under section 509(a)(3) of the Code. “was to
be the supported organization and have 60% control over the activities and operation of
was to have 40% control over and was

acknowledged to be a disqualified person and, as such, a disqualified trustee.

The Trust Agreement calls for a prohibition on political activity, inurement and private
benefit. There were to be no substantial legislative activities.

Article 6 of the Trust Agreement states that at all times the Board of Trustees shall
consist of a sixty-forty split with regard to non-disqualified and disqualified trustees. The
article further states that a trustee may resign at any time, by written instrument, to the
extent that the resignation does not cause any disqualified person to be put in control of

the Trust.

Article 12 of the Trust Agreement also covers resignation, removal or absence of non-
disqualified or disqualified trustees. In the event that a non-disqualified trustee decides
to withdraw or resign, the remaining disqualified trustee is not allowed to make
distributions until a new non-disqualified trustee is appointed.

The Trust Agreement states that both non-disqualified and disqualified trustees have
the power to make investments, or cause monies or assets to be invested at any time.
The Trust Agreement further states that distributions to supported organizations can
only be made by non-disqualified trustees.

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

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

filed an application for Recognition of Exemption, Form 1023, on November 5,
19XX. It requested exempt status under 501(a), as an organization described in section
501(c)(3) of the Code with a foundation status of 509(a)(3). The purposes of
as listed on the application were consistent with the Trust Agreement. However, the
supported organization on the application is different from the supported organization
as listed in the original Trust Agreement. The Trust Agreement called for to be the
supported organization. The application states that

was to be the supported organization.

According to , at some point between the time that the original Trust

Agreement was signed and the filing of the application, it became evident to Attorney
that was not going to receive tax exempt status under section 501(a) of the

Code as an organization described in section 501(c)(3). As such, Attorney

identified as the supported organization. was never recognized as exempt.

The Trust Agreement was amended on March 26, 20XX, to add as a supported
organization. remained on the Trust Agreement at that time. The Trust Agreement
was amended a second time on December 4, 20XX. This amendment removed

from the Trust Agreement and left as the sole supported organization.

On January 31, 20XX, was issued a determination letter and received exempt
status under section 501(a) of the Code as an organization described in section
501(c)(3). The foundation status was determined to be 509(a)(3).

The Trust Agreement was amended for the third time on December 1, 20XX. This
amendment removed . as the supported organization and added

lost its tax exempt status in 20XX.
remained the sole supported organization per the Trust Agreement for the period
beginning December 1, 20XX and ending sometime after the conclusion of the 20XX tax

year.

In correspondence received from , acting
as the representative for the organization, stated that was
briefly associated with Attorney from the Fall/Winter of 20XX as a supported
organization. In the Spring of 20XX it terminated any association with and

. She further stated that her organization never received any distributions from
and that there were no board meetings or elections of any type with regard to

The Trust Agreement was never amended to reflect the fact that
. terminated their association with . In fact, Trust

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -2-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibic
Name of Taxpayer Year/Period Ended
20XX/20XX
Agreement kept . as the supported organization for over
eighteen months after it requested to have its association terminated.
In 19XX, transferred $ from his personal bank account to
an account established in the name of the Foundation.
19XX Form 1040, Schedule A, shows that claimed the $ as a
charitable contribution deduction.
In 20XX, transferred an additional $ from his personal
bank account to an account established in the name of the Foundation.
20XX Form 1040, Schedule A, shows that claimed
$ as a charitable contribution deduction.
In 20XX, transferred another $ from his personal bank
account to an account established in the name of the Foundation.
20XX Form 1040, Schedule A, shows that claimed the
$ as a charitable contribution deduction.

For the period of December 19XX through the end of the tax year ended December 31,
20XX, there had been no grants to any of the above referenced supported
organizations.

During the period of the examination from January 1, 20XX through December 31,
20XX, there are no Board of Director's minutes for any meetings. There are no records
of any meetings of any kind. There were no elections of any board members. There are
no documents explaining why grants were not made. There is no documentation
indicating that there were any transactions other than the transfers of funds
to Attorney described below.

In the December 8, 20XX telephone interview with , he stated that he
relied on Attorney to take care of all business matters as well as

investing funds.

also stated that at some point after he donated the funds to ,
Attorney called and requested that the money in the account
be transferred to . There is no written documentation of this conversation, only

the written explanation provided by Attorney . In the December 8, 20XX,
telephone interview with , he confirmed that the transfer of funds

occurred with his permission via a telephone conversation with

does not have records that provide any detail of legal fees that

received for establishing and investing for . In the interview with
he had no recollection for how much got paid or any recollection as to
Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service

Page: -3-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or

Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
20XX/20XX

what the original agreement called for. Attorney did not respond to inquiries into
how much he received.

Attorney states in an email to , CPA and Power of Attorney for

, that Trust account records show receipt of funds on three
separate dates. The first being February 17, 20XX in the amount of $ , the
second being on June 25, 20XX in the amount of $ and the third being on

August 13, 20XX in the amount of $

In that same email message, states that the $ received from
was invested in of . At an undisclosed date,

sold its assets to . The date is
undisclosed because has no records detailing any investment transactions.

In a letter from to this office, disclosed that he is on the Board of
Directors for . and is also a shareholder.

disclosed that he received verbal confirmation from to invest the
money from in

has produced a stock certificate that shows ownership of shares of
. That same stock certificate shows '

Attorney daughter, as the Secretary for

An unrelated U.S. District Court Case 3:05-cv-1328-(BD) references the value of
stock and the low value that it has. The court agreed to a value of $

per share. Therefore, the total value of stock held by has a
current value of $

During the interview was asked if he knew that was a stock
holder and Chairman of the Board for , and stated that
he did not know that. daughter, , is Secretary for

LAW:

Section 501(c)(3) of the Code exempts from federal income tax organizations
organized and operated exclusively for charitable, educational, and other exempt
purposes, provided that no part of the organization’s net earnings inures to the benefit

of any private shareholder or individual.

Section 1.501(c)(3)-1(a)(1) of the regulations provides that in order to be exempt as an
organization described in section 501(c)(3) of the Code, the organization must be one

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

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

that is both organized and operated exclusively for one or more purposes specified in
that section. If an organization fails to meet either the organizational or operational test,

it is not exempt.

Section 1.501(c)(3)-1(c)(1) of the regulations provides that an organization will not be
regarded as operated exclusively for exempt purposes if more than an insubstantial part
of its activities is not in furtherance of exempt purposes.

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.

Section 1.501(c)(3)-1(d)(1)(ii) of the regulations provides that 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, it is necessary for an organization to
establish that it is not organized or operated for the benefit of private interests such as
designated individuais, the creator or his family, shareholders of the organization, or
persons controlled, directly or indirectly, by such private interests.

Section 1.509(a)-4(e)(1) of the regulations addresses permissible beneficiaries in that it
specifies that a supporting organization will be regarded as “operated exclusively” to
support one or more specified publicly supported organizations only if it engages solely
in activities which support or benefit the specified publicly supported organizations. An
organization will be regarded as “operated exclusively” to support or benefit one or
more publicly supported organizations if it supports or benefits an organization, other
than a private foundation, which is described in section 501(c)(3).

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

IRC section 501 (c)(3).

American Campaign Academy v. Commissioner, 92 TC 1053 (1989): Defines private
benefit as “non-incidental benefits conferred on disinterested persons that serve private

interests.”

Securities and Exchange Commission v. Megafund Corporation, Stanley A.
Leitner, Sardaukar Holdings, IBC., and Bradley C. Stark, CIG, LTD., and James A.
Rumpf, Individually and d/b/a Cilak International, 3:05-cv-01328: Sets value of

Moondoggie stock.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -5-

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

Revenue Ruling 76-206: Service provided to a private party that they would have
otherwise had to purchase.

In Rev. Rul. 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 IRC section 501(c)(3).

GOVERNMENT'S POSITION:

The section 501(c)(3) tax exempt status of the Foundation should be revoked,
effective November 5, 19XX, because it is not operated exclusively for tax exempt

purposes.

In contrast to section 1.501(c)(3)-1(d)(ii) of the regulations which calls for an

organization to be organized and operated for a public rather than a private benefit,
has indulged in substantial acts of private benefit with regard to its dealings

with Attorney . The activities of also stand in contrast to

section 1.501(c)(3)-1(c)(1) of the regulations in that more than an insubstantial part of
its activities have been for the private benefit of Attorney

has not engaged in any charitable activities since its inception and has made
no charitable grants from its inception until late 20XX donated
$ to over the three year period from 19XX through 20XX and received
the tax benefit on his personal federal tax return in the form of charitable contribution
deductions totaling $ . The only other activity engaged in by was the
transfer of money from the bank account to Attorney over that same
time frame. This transfer of funds was accomplished, not with written documentation,
but by verbal approval from to Attorney

During the two year period beginning January 1, 20XX and ending December 31, 20XX,
did not make any grants to any section 501(c)(3) charity. in fact, according to

there never were any grants to a section 501(c)(3) charity prior to the

two year period being examined, and there were no grants to a section 501(c)(3) charity

until sometime in the later half of 20XX.

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

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

funds, instead of being distributed to a legitimate and designated section

501(c)(3) charity, went to Attorney who in turn invested these funds in a
company called purportedly for
At some undisclosed point in time, transferred its assets to a
company called Attorney is a
shareholder of and has admitted to being the Chairman of the Board for
. A further connection between Attorney and is that
daughter is an officer of where she holds the position of

Secretary.
Further evidence of the private benefit to Attorney is the fact that from the time
that transferred their funds to in 19XX, 20XX and 20XX, until sometime
after the end of the tax year ended December 31, 20XX, had exclusive access to

funds to invest or do with as he pleased. claims it was unable to

locate and maintain a relationship with a qualified section 501(c)(3) charity to whom to
distribute money. It is beyond any reasonable measure to accept as fact that
could not find one single qualified organization to support since inception.

As the only activity of was the transfer of funds for Attorney personal

use, private benefit to Attorney made up more than an insubstantial part of
activities. With the only activity of being the transfer of funds to

Attorney , has operated more for a private rather than a public benefit.

As in the case of Better Business Bureau of Washington, D.C. v. United States, the
private benefit present in this case is substantial and destroys the exempt status of the

organization. The only activity and only apparent purpose of was the transfer
and subsequent use of funds by Attorney to invest as he saw fit for his personal
gain.

As in the case of American Campaign Academy v. Commissioner, there were non-
incidental benefits conferred on disinterested persons that serve private interests. The

benefit enjoyed by Attorney is not incidental but is more reasonably construed
as a purposeful event caused by Attorney and , trustee for
. The benefit enjoyed by Attorney constitutes private benefit in that the

public was denied the receipt of any benefit because no grants were distributed to a
supported organization.

As has not operated exclusively for charitable purposes and considering the
extensive private benefit enjoyed by Attorney , the tax exempt status of

should be revoked. Retroactive revocation is appropriate because failed to
disclose in its application that it would be operated primarily for the benefit of Attorney

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

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

and/or an organization which he owns and controls. It failed to disclose that it
would make no grants to public charities.

TAXPAYER'S POSITION:

The taxpayer has agreed to revocation of exempt status.

ALTERNATIVE ISSUE #1: Should The Foundation be reclassified as a
private foundation?

FACTS:

The Foundation was created with a Trust Agreement dated November 5,
19XX. In the Trust Agreement, and the

. were listed as the initial trustees. Pursuant to the Trust Agreement,
was to be a supporting organization and was to support the
exclusively. The supported organization was to have 60% control over the
activities and operation of . was to have 40% control over

From March 26, 20XX through December 1, 20XX, the Trust Agreement was amended
three times. Each amendment changed the organization that was to be supported.
Each new supported organization was to have 60% contro! over the Trust.

The December 1, 20XX amendment added as the sole
supported organization.
In correspondence received from ; acting as
the representative for the organization stated the following:
was briefly associated with Attorney from the Fall/Winter of 20XX as a supported
organization. When told by IRS agents in the Spring of 20XX that Attorney
was under investigation, she terminated any association with and the
Foundation. She further stated that her organization never received any distributions
from and that there were no board meetings or elections of any type with
regard to
The Trust Agreement was never amended to reflect the fact that

. terminated its association with In fact, Trust
Agreement kept . as the supported organization for over
eighteen months after it requested to have its association terminated.
Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service

Page: -8-

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

There were no grants made to any supported organization. There was no measure of
control provided by any supported organization. There were no elections of directors by
any supported organization, and there were no board meetings of any kind attended by
any of the above referenced supported organizations.

has stated that at some point after he “contributed” the funds to

, Attorney called and requested that the money in the
account be transferred to ; complied with verbal request and
transferred all of the money in the account, $ , to

There is no written documentation of this conversation, only the written explanation
provided by Attorney . In the December 8, 20XX telephone interview with

he confirmed that the transfer of funds occurred with his permission
via a telephone conversation with

The only activity ever conducted by was to transfer funds to the
promoter so that he could “invest” the funds as he saw fit. The funds were ultimately
“invested” in a company in which Attorney held stock and was the Chairman of

the board and his daughter was an officer.

At no time from inception through the years under examination did any of the
above listed supported organizations attend meetings, elections or exert any measure
of control over

For additional facts, see Facts section of the primary position (revocation).

LAW:

Code section 509(a)(3) defines a supporting organization as an organization which:
509(a)(3)(A)- is organized, and at all times thereafter is operated, exclusively for

the benefit of, to perform the functions of, or to carry out the purposes of one or
more specified organizations described in paragraph 509(a)(1) or 509(a)(2) and:

509(a)(3)(B) is —

509(a)(3)(B)(i) operated, supervised, or controlled by one or more
organizations described in paragraph 509(a)(1) or 509(a)(2),

509(a)(3)(B)(ii) supervised or controlled in connection with one or more such
organizations, or

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

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

509(a)(3)(B)(iii) operated in connection with one or more such organizations,
and

509(a)(3)(C)- is not controlled directly or indirectly by one or more disqualified
persons (as defined in Code section 4946) other than foundation managers and
other than one or more organizations described in paragraph (1) or (2).

Code section 4946(a)(1)(A) states that the term “disqualified person” means, with
respect to a private foundation, a person who is a substantial contributor to the

foundation.

Code section 4946(d) defines disqualified persons as members of the family of an
individual as ones spouse, ancestors, children, grandchildren, great grandchildren, and
the spouses of children, grandchildren, and great grandchildren.

Regulation section 1.507-6(a)(1) defines the term “substantial contributor’ as, except as
provided in subparagraph (2) of this paragraph, with respect to a private foundation, any
person (within the meaning of section 7701(a)(1)), whether or not exempt from taxation
under section 501(a), who contributed or bequeathed an aggregate amount of more
than $5,000 to the private foundation, if such amount is more than 2 percent of the total
contributions and bequests received by the private foundation before the close of the
taxable year of the private foundation in which a contribution or bequest is received by
the foundation from such person. In the case of a trust, the term “substantial
contributor’ also means the creator of the trust. Such term does not include a
governmental unit described in section 170(c)(1).

Regulations section 1.509(a)-4(c), regarding the organizational test of a 509(a)(3)
organization, states that:

(1) In general. —An organization is organized exclusively for one or more of the
purposes specified in section 509(a)(3)(A) only if its articles of organization (as
defined in §1.501(c)(3)-1(b)(2)):

(i) Limit the purposes of such organization to one or more of the purposes
set forth in section 509(a)(3)(A);

(ii) Do not expressly empower the organization to engage in activities
which are not in furtherance of the purposes referred to in subdivision (i)
of this subparagraph;

(iii) State the specified publicly supported organizations on whose behalf
such organization is to be operated (within the meaning of paragraph (d)
of this section); and

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

Page: -10-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or

Explanation of Items Exhibit

Vear/Period Ended
20XX/20XX

Name of Taxpayet

(iv) Do not expressly empower the organization to operate to support or
benefit any organization other than the specified publicly supported
organizations referred to in subdivision (iii) of this subparagraph.

(2) Purposes. —in meeting the organizational test, the organization's purposes, as
stated in its articles, may be as broad as, or more specific than, the purposes set
forth in section 509(a)(3)(A). Therefore, an organization which, by the terms of its
articles, is formed “for the benefit of” one or more specified publicly supported
organizations shall, if it otherwise meets the other requirements of this paragraph, be
considered to have met the organizational test. Similarly, articles which state that an
organization is formed “to perform the publishing functions” of a specified university
are sufficient to comply with the organizational test. An organization which is
“operated, supervised, or controlled by” (within the meaning of paragraph (g) of this
section) or “supervised or controlled in connection with” (within the meaning of
paragraph (h) of this section) one or more section 509(a)(1 ) or (2) organizations to
carry out the purposes of such organizations, will be considered as meeting the
requirements of this paragraph if the purposes set forth in its articles are similar to,
but no broader than, the purposes set forth in the articles of its controlling section

509(a)(1) or (2) organizations.

(3) Limitations. —An organization is not organized exclusively for the purposes set
forth in section 509(a)(3)(A) if its articles expressly permit it to operate to support or
benefit any organization other than those specified publicly supported organizations
referred to in subparagraph (1)(iii) of this paragraph. Thus, for example, an organization
will not meet the organizational test under section 509(a)(3)(A) if its articles expressly
empower it to pay over any part of its income to, or perform any service for, any
organization other than those publicly supported organizations specified in its articles
(within the meaning of paragraph (d) of this section). The fact that the actual operations
of such organization have been exclusively for the benefit of the specified publicly
supported organizations shall not be sufficient to permit it to meet the organizational

test.

Regulations section 1.509(a)-4(d) pertains to the organizational test and provides a
definition of the term “specified organizations” used in Code section 509(a)(3)(A).

(1) In general. —In order to meet the requirements of section 509(a)(3)(A), an
organization must be organized and operated exclusively to support or benefit one
or more “specified” publicly supported organizations. The manner in which the
publicly supported organizations must be “specified? in the articles for purposes of
section 509(a)(3)(A) will depend upon whether the supporting organization is .
“operated, supervised, or controlled by” or “supervised or controlled in connection
with” (within the meaning of paragraph (g) and (h) of this section) such

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
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Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or

Explanation of Items Hxhibit
Year/Period Ended

20XX/20XX

Name of Taxpayer

organizations or whether it is “operated in connection with” (within the meaning of
paragraph (i) of this section) such organizations.

(2) Nondesignated publicly supported organizations; requirements

(i) Except as provided in subdivision (iv) of this subparagraph, in order to meet
the requirements of subparagraph (1) of this paragraph, the articles of the
supporting organization must designate each of the “specified” organizations by
name unless:

(a) The supporting organization is operated, supervised, or controlled by
(within the meaning of paragraph (g) of this section), or is supervised or
controlled in connection with (within the meaning of paragraph (h) of this
section) one or more publicly supported organizations; and

(b) The articles of organization of the supporting organization require that it
be operated to support or benefit one or more beneficiary organizations which
are designated by class or purpose and which include:

(1) The publicly supported organizations referred to in subdivision (i)(a) of
this subparagraph (without designating such organization by name), or

(2) Publicly supported organizations which are closely related in purpose
or function to those publicly supported organizations referred to in
subdivision (i)(a) or this subparagraph (without designating such
organization by name).

(ii) If a supporting organization is described in subdivision (i)(a) of this
subparagraph, it will not be considered as failing to meet the requirements of
subparagraph (1) of this paragraph that the publicly supported organizations be
specified merely because its articles of organization permit the conditions
described in subparagraphs (3)(i), (ii), and (iii) and (4)(i)(a) and (b) of this
paragraph.

(3) Nondesignated publicly supported organizations; scope of rule. —If the
requirements of subparagraph (2)(i)(a) of this paragraph are met, a supporting
organization will not be considered as failing the test of being organized for the
benefit of “specified” organizations solely because its articles:

(i) Permit the substitution of one publicly supported organization within a
designated class for another publicly supported organization either in the same
or a different class designated in the articles;

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
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Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
20XX/20XX

(ii) Permit the supporting organization to operate for the benefit of new or
additional publicly supported organizations of the same or a different class
designated in the articles; or

(iii) Permit the supporting organization to vary the amount of its support among
different publicly supported organizations within the class or classes of
organizations designated by the articles.

(4) Designated publicly supported organizations

(i) If an organization is organized and operated to support one or more publicly
supported organizations and it is “operated in connection with” such organization
or organizations, then, except as provided in subparagraph (2)(iv) of this
paragraph, its articles of organization must, for purposes of satisfying the
organizational test under section 509(a)(3)(A), designate the “specified”
organizations by name. Under the circumstances described in this
subparagraph, a supporting organization which has one or more “specified”
organizations designated by name in its articles, will not be considered as failing
the test of being organized for the benefit of “specified” organizations solely
because its articles:

(a) Permit a publicly supported organization which is designated by class or
purpose, rather than by name, to be substituted for the publicly supported
organization or organizations designated by name in the articles, but only if
such substitution is conditioned upon the occurrence of an event which is
beyond the control of the supporting organization, such as loss of exemption,
substantial failure or abandonment of operations, or dissolution of the publicly
supported organization or organizations designated in the articles;

(b) Permit the supporting organization to operate for the benefit of a
beneficiary organization which is not a publicly supported organization, but
only if such supporting organization is currently operating for the benefit of a
publicly supported organization and the possibility of its operating for the
benefit of other than a publicly supported organization is a remote
contingency; or

(c) Permit the supporting organization to vary the amount of its support
between different designated organizations, so long as it meets the
requirements of the integral part test set forth in paragraph (i)(3) of this section
with respect to at least one beneficiary organization.

(ii) If the beneficiary organization referred to in subdivision (i)(b) of this
subparagraph is not a publicly supported organization, the supporting

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

organization will not then meet the operational test of paragraph (e)(1) of this
section. Therefore, if a supporting organization substituted in accordance with
such subdivision (i)(b) a beneficiary other than a publicly supported organization
and operated in support of such beneficiary organization, the supporting
organization would not be described in section 509(a)(3).

in Revenue Ruling 79-197, 1979-1 CB 204 it was held that a newly created nonprofit
organization is to pay its future income until a specific amount has been paid to
specified organizations described in section 509(a)(1) or (a)(2) of the Code that appoint
a majority of its governing body. The organization will dissolve after the specific amount
has been paid and will distribute its assets to such specified organizations that a
contributor, named in its articles of organization, selects. The organization is a private
foundation and not a supporting organization.

Regulations section 1.509(a)-4(e) references the operational test a 509(a)(3)
organization must comply with.

(1) Permissible beneficiaries. —A supporting organization will be regarded as
“operated exclusively” to support one or more specified publicly supported
organizations (hereinafter referred to as the “operational test’) only if it engages
solely in activities which support or benefit the specified publicly supported
organizations. Such activities may include making payments to or for the use of, or
providing services or facilities for, individual members of the charitable class
benefited by the specified publicly supported organization. A supporting
organization may also, for example, make a payment indirectly through another
unrelated organization to a member of a charitable class benefited by a specified
publicly supported organization, but only if such a payment constitutes a grant to
an individual rather than a grant to an organization. In determining whether a grant
is indirectly to an individual rather than to an organization the same standard shall
be applied as in §53.4945-4(a)(4) of this chapter. Similarly, an organization will be
regarded as “operated exclusively” to support or benefit one or more specified
publicly supported organizations even if it supports or benefits an organization,
other than a private foundation, which is described in section 501(c)(3) and is
operated, supervised, or controlled directly by or in connection with such publicly
supported organizations, or which is described in section 511(a)(2)(B). However,
an organization will not be regarded as operated exclusively if any part of its
activities is in furtherance of a purpose other than supporting or benefiting one or
more specified publicly supported organizations.

(2) Permissible activities. —A supporting organization is not required to pay over
its income to the publicly supported organizations in order to meet the operational
test. It may satisfy the test by using its income to carry on an independent activity
or program which supports or benefits the specified publicly supported

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
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Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
20XX/20XX

organizations. All such support must, however, be limited to permissible
beneficiaries in accordance with subparagraph (1) of this paragraph. The
supporting organization may also engage in fund raising activities, such as
solicitations, fund raising dinners, and unrelated trade or business to raise funds for
the publicly supported organizations, or for the permissible beneficiaries.

Regulations section 1.509(a)-4(f) regarding the nature of relationships required for
section 509(a)(3) organizations provides:

(1) In general. —Section 509(a)(3)(B) describes the nature of the relationship
required between a section 501 (c)(3) organization and one or more publicly
supported organizations in order for such section 501(c)(3) organization to
qualify under the provisions of section 509(a)(3). To meet the requirements of
section 509(a)(3), an organization must be operated, supervised, or controlled by
or in connection with one or more publicly supported organizations. If an
organization does not stand in one of such relationships (as provided in this
paragraph) to one or more publicly supported organizations, it is not an
organization described in section 509(a)(3).

(2) Types of relationships. —Section 509(a)(3)(B) sets forth three different
types of relationships, one of which must be met In order to meet the
requirements of subparagraph (1) of this paragraph. Thus, a supporting
organization may be:

(i) Operated, supervised, or controlled by,
(ii) Supervised or controlled in connection with, or
(iii) Operated in connection with, one or more publicly supported

organizations.

(3) Requirements of relationships. —Although more than one type of
relationship may exist in any one case, any relationship described in section
509(a)(3)(B) must insure that:

(i) The supporting organization will be responsive to the needs or demands of
one or more publicly supported organizations; and

(ii) The supporting organization will constitute an integral part of, or maintain a
significant involvement in, the operations of one or more publicly supported
organizations.

(4) General description of relationships. —In the case of supporting
organizations which are “operated, supervised, or controlled by” one or more
publicly supported organizations, the distinguishing feature of this type of

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
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Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
20XX/20XX

relationship is the presence of a substantial degree of direction by the publicly
supported organizations over the conduct of the supporting organization, as
described in paragraph (g) of this section. In the case of supporting organizations
which are “supervised or controlled in connection with” one or more publicly
supported organizations, the distinguishing feature is the presence of common
supervision or control among the governing bodies of all organizations involved,
such as the presence of common directors, as described in paragraph (h) of this
section. In the case of a supporting organization which is “operated in connection
with” one or more publicly supported organizations, the distinguishing feature is
that the supporting organization is responsive to, and significantly involved in the
operations of, the publicly supported organization, as described in paragraph (i)
of this section.

Regulation section 1.509(a)-4(g) defines the meaning of “operated, supervised, or
controlled by”.

(1) (i) Each of the items “operated by’, “supervised by”, and “controlled by’, as
used in section 509(a)(3)(B), presupposes a substantial degree of direction over
the policies, programs, and activities of a supporting organization by one or more
publicly supported organizations. The relationship required under any one of these
terms is comparable to that of a parent and subsidiary, where the subsidiary is
under the direction of, and accountable or responsible to, the parent organization.
This relationship is established by the fact that a majority of the officers, directors,
or trustees of the supporting organization are appointed or elected by the
governing body, members of the governing body, officers acting in their official
capacity, or the membership of one or more publicly supported organizations.

(ii) A supporting organization may be “operated, supervised or controlled by” one or
more publicly supported organizations within the meaning of section 509(a)(3)(B) even
though its governing body is not comprised of representatives of the specified publicly
supported organizations for whose benefit it is operated within the meaning of section
509(a)(3)(A). A supporting organization may be “operated, supervised, or controlled by”
one or more publicly supported organizations (within the meaning of section
509(a)(3)(B)) and be operated “for the benefit of? one or more different publicly
supported organizations (within the meaning of section 509(a)(3)(A)) only if it can be
demonstrated that the purposes of the former organizations are carried out by
benefiting the latter organizations.

Regulations section 1.509(a)-4(j) regarding control by disqualified persons states that:
(1) In general. —Under the provisions of section 509(a)(3)(C) a supporting

organization may not be controlled directly or indirectly by one or more
disqualified persons (as defined in section 4946) other than foundation

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
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Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or

Explanation of Items Exhibit

Year/Period Ended
20XX/20XX

Name of Taxpayer

managers and other than one or more publicly supported organizations.
If a person who is a disqualified person with respect to a supporting
organization, such as a substantial contributor to the supporting
organization, is appointed or designated as a foundation manager of the
supporting organization by a publicly supported beneficiary organization
to serve as the representative of such publicly supported organization,
then for purposes of this paragraph such person will be regarded as a
disqualified person, rather than as a representative of the publicly
supported organization. An organization will be considered “controlled”,
for purposes of section 509(a)(3)(C), if the disqualified persons, by
aggregating their votes or positions of authority, may require such
organization to perform any act which significantly affects its operations
or may prevent such organization from performing such act. This
includes, but is not limited to, the right of any substantial contributor or
his spouse to designate annually the recipients, from among the publicly
supported organizations of the income attributable to his contribution to
the supporting organization. Except as provided in subparagraph (2) of
this paragraph, a supporting organization will be considered to be
controlled directly or indirectly by one or more disqualified persons if the
voting power of such persons is 50 percent or more of the total voting
power of the organization's governing body or if one or more of the total
voting power of the organization's governing body or if one or more of
such persons have the right to exercise veto power over the actions of
the organization. Thus, if the governing body of a foundation is
composed of five trustees, none of whom has a veto power over the
actions of the foundation, and no more than two trustees are at any time
disqualified persons, such foundation will not be considered to be
controlled directly or indirectly by one or more disqualified persons by
reason of this fact alone. However, ail pertinent facts and circumstances
including the nature, diversity, and income yield of an organization's
holdings, the length of time particular stocks, securities, or other assets
are retained, and its manner of exercising its voting rights with respect to
stocks in which members of its governing body also have some interest,
will be taken into consideration in determining whether a disqualified
person does in fact indirectly control an organization.

GOVERNMENT’S POSITION:

As set forth above, it is the government's primary position that the tax exempt status of
the Foundation should be revoked. Alternatively, the Foundation
should be reclassified as a private foundation.

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

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

Due to Congressional concerns about wide-spread abuses of their tax-exempt status by
private foundations, private foundations were defined and subjected to significant
regulations and controls by the Tax Reform Act of 1969. The definition of a private
foundation is intentionally inclusive so that all organizations exempted from tax by IRC
§ 501(c)(3) are private foundations except for those specified in IRC § 509(a)(1)
through(4). Roe Foundation Charitable Trust v. Commissioner, See Quarrie, supra.
currently is excepted from private foundation status because it is currently
classified as an organization described in section 509(a)(3) which defines supporting

organizations.

Public charities (organizations described in section 501(c)(3) that meet the requirement
of sections 509(a)(1) or (2)) are excepted from private foundation status on the theory
that their exposure to public scrutiny and their dependence on public support keep them
from the abuses to which private foundations are subject. Supporting organizations are
similarly excepted from private foundation status. Supporting organizations are
excepted if they are subject to the scrutiny of public charities that provide sufficient
oversight to keep supporting organizations from the types of abuses to which private
foundations are prone. Quarrie, 603 F.2d at 1277-78.

Section 509(a)(3) organizations must meet all three of the following tests:

1) Organizational and Operational Tests under section 509(a)(3)(A)
2) Relationship Test under section 509(a)(3)(B)
3) Lack of Disqualified Person Control Test

Overall, these tests are meant to ensure that a supporting organization is responsive to
the needs of a public charity and intimately involved in its operations and that the public
charity (or publicly supported organization) is motivated to be attentive to the operations
of the Supporting organization and that it is not controlled, directly or indirectly, by
disqualified persons. The first and third tests are not satisfied in this case.

1) Operational Test

fails the Operational test set forth in Treas. Reg. § 1.509(a)-4(e)(1). A
supporting organization will be regarded as “operated exclusively’ to support a specified
publicly supported organization(s) only if it engages in activities which support or benefit
the specified publicly supported organizations(s). As was discussed under the Primary
Issue above, has served private interests and has operated for the benefit of
Attorney and/or an organization which he owns and controls. Therefore, it has
not established that it operated exclusively for the benefit of the publicly supported

organizations.

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

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

2) Relationship Test
As set forth in Treas. Reg. § 1.509(a)-4(f)(2), there are three permissible relationships:

(a) operated, supervised, or controlled by; (b) supervised or controlled in connection
with; and
(c) operated in connection with one or more publicly supported organizations.

The relationships “operated, supervised or controlled by’ and “supervised or controlled
in connection with” presuppose a substantial degree of direction over the policies,
programs and activities of the supporting organization by a publicly supported
organization. The “operated, supervised or controlled by” relationship is established by
the fact that a majority of the officers, directors, or trustees of the supporting
organization are appointed or elected by the governing body, members of the governing
body, officers acting in their official capacity or the membership of the publicly
‘supported organization. The “supervised or controlled in connection with” relationship
is established by the fact that there is common supervision or control by the persons
supervising or controlling both the supporting and the publicly supported organizations
(i.e.; that control or management of the supporting organization is vested in the same
persons that control or manage the publicly supported organization.

In the present case, there are two trustees. On paper, the publicly supported
organization is supposed to have 60% of the voting control while , a
disqualified person, has 40% of the voting control. Therefore, has technically
satisfied the requirements of being in a relationship “operated, supervised or controlled
by” the primary charity. As set forth below, in actuality this requirement was not
satisfied.

3) Control by a Disqualified Person

is under the control of a disqualified person. is not a supporting
organization under Code section 509(a)(3) because it is controlled directly or indirectly
by one or more disqualified persons.

is a disqualified person because he is a substantial contributor as
defined in Code section 4946(a)(1)(A). He is the only contributor to . While the
Trust Agreement provides for two trustees with the publicly supported charity having
60% of the vote, there were no board meetings or other indication that any publicly
supported organization had any involvement in the operations of

The first listed supported organization, . never
received tax exempt status. The second listed supported organization,
lost its tax exempt status in 20XX. The third listed

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

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Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
20XX/20XX
supported organization, is a qualified section 501(c)(3)
organization but thought it withdrew as trustee in early 20XX and as
described below never had any input into operations.

. was the designated supported organization per the
Trust Agreement from December 2(%x until sometime after the end of the December
31, 20XX tax year. . never asked for and was not

provided with any monetary grants: During the examination it was determined that
had no contact with the beneficiary organization. There were no meetings, no
elections and no support provided. in addition, the beneficiary had no influence over

any decisions made.

remained listed as a trustee despite its request that the
relationship be terminated. It acknowledged that it had no control over

operations. The only activity of was the distribution of ail of its funds to
Attorney . This was accomplished by a telephone call between Attorney
and . There is no evidence the board considered this action or
approved it.

Treas. Reg. § 1.509(a)-4(j)(1) provides that for purposes of section 509(a)(3)(C), an
organization will be considered “controlled” if the person, by reason of his position or
authority, may require the organization to perform any act which significantly affects its
operations or prevents such organization from performing such act. All facts and
circumstances are taken into consideration in determining whether a disqualified person
controls an organization. Id. There is no indication that any representatives of the
specified public charities had any input into the operations of . Thus,

, a disqualified person, directly controlled

Accordingly, if its exempt status is not revoked, should be reclassified as a
private foundation because it does not qualify as a supporting organization under the
requirements set forth in Treas. Reg. § 1.509(a)-4(j). This reclassification is effective
November 5, 19XX. Retroactive reclassification is appropriate because did not
disclose in its application that it would not operate to benefit the specified public charity
and that it would be controlled by a disqualified person.

TAXPAYER’S POSITION:

The taxpayer has agreed to revocation of exempt status.

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

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Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
20XX/20XX
CONCLUSION:
The Foundation does not qualify for tax exempt status under IRC section

501(a) as an organization described in section 501(c)(3) of the Code. The existence of
substantial private benefit combined with the lack of proper controls and the lack of any
qualified activity indicates that should not be allowed to continue as a tax
exempt organization. Revocation of the tax exempt status of Foundation is

proposed,

Alternately, The Foundation should be reclassified as an organization that is a
private foundation as defined in section 509(a) of the Code.

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

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