IRS revokes a veterans organization dominated by public bar activity

View official IRS release (PDF)

Plain-English summary

The IRS revoked a veterans organization's § 501(c)(19) exemption because its public bar operations overshadowed its limited exempt activities. The examination report estimated that the bar operated 4,970 hours per year and that more than 78% of its sales came from nonmembers, while records for member and nonmember sales were unavailable. The organization also did not establish a bona fide membership that satisfied the statutory veterans-membership test. The IRS found inurement because the organization paid the president's personal residence mortgage and other personal expenses in lieu of rent. It also concluded that the organization failed the recordkeeping and reporting requirements of §§ 6001 and 6033. The revocation was effective on a redacted January 1 date, and all bar income was treated as unrelated business income absent records supporting a different allocation.

Ruling snapshot

• Question: Did the veterans organization satisfy § 501(c)(19)'s operational and membership tests when most activity and revenue came from a public bar and the organization paid personal expenses for its president?
• Outcome: Revocation
• Key authorities: IRC §§ 501(c)(19), 511, 512, 513, 6001, and 6033; Treas. Reg. §§ 1.501(c)(19)-1, 1.6001-1, and 1.6033-2

Full text (IRS public release)

UIL 501.19-00

DEPARTMENT OF THE TREASURY
Internal Revenue Service

TEGE EO Examinations
1122 Town & Country Commons, Room 128
TAX EXEMPT AND Chesterfield, MO 63017-8293

GOVERNMENT ENTITIES
DIVISION

January 12, 2010

Release Number: 201451041
Release Date: 12/19/2014 Taxpayer Identification Number:

Form:

Tax Year(s) Ended:
12/31/20XX & 12/31/20XX

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 an
adjustment of your organization's exempt status is necessary.

If you do not agree with our position you may appeal your case. The enclosed
Publication 3498, The Examination Process, explains 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.

If you request a conference, we will forward your written statement of protest to the
Appeals Office and they will contact you. For your convenience, an envelope is
enclosed.

If you and Appeals do not agree on some or all of the issues after your Appeals
conference, or if you do not request an Appeals conference, you may file suit in United
States Tax Court, the United States Court of Federal Claims, or United States District
Court, after satisfying procedural and jurisdictional requirements as described in
Publication 3498.

Letter 3610 (04-2002)
Catalog Number 34801V

UIL 501.19-00

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

If you accept our findings, please sign and return the enclosed Form 6018, Consent to
Proposed Adverse Action. We will then send you a final letter modifying or revoking
exempt status. If we do not hear from you within 30 days from the date of this letter, we
will process your case on the basis of the recommendations shown in the report of
examination and this letter will become final. In that event, you will be required to file
Federal income tax returns for the tax period(s) shown above. File these returns with
the Ogden Service Center within 60 days from the date of this letter, unless a request
for an extension of time is granted. File returns for later tax years with the appropriate
service center indicated in the instructions for those returns.

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.

Letter 3610 (04-2002)
Catalog Number 34801 V

UIL 501.19-00

Thank you for your cooperation.

Sincerely,

for Nanette M. Downing
Acting Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Form 6018
Report of Examination
Envelope

Letter 3610 (04-2002)
Catalog Number 34801V

Form 886A Department of the Treasury - Internal Revenue Service
Explanation of Items Form 6018-A
Name of Taxpayer Year/Period Ended
12/31/20XX
12/31/20XX

Issues:

1. Whether , doing business as “ ”, ( ) operated exclusively for
   purposes listed in Treas. Reg. § 1.501(c)(19)-1(c).

2. Whether the net earnings of inured to the benefit of its President.

3. Whether has satisfied the recordkeeping and reporting requirements set
   forth in I.R.C. §§ 6001 and 6033.

4. Whether exemption under I.R.C. § 501(a), as an organization described
   in I.R.C. § 501(c)(19), should be revoked effective date January 1, 20XX.

5. Alternatively, if exemption under I.R.C. § 501(a), as an organization
   described in I.R.C. § 501(c)(19), is not revoked, whether the income that
   received from its drink operations, vending machines, Keno and gaming activities should
   be treated as unrelated business income under I.R.C. § 512, and whether such income is
   subject to tax pursuant to I.R.C. § 511.

Facts: Background Information

             (hereinafter referred to as                 ) is a veterans organization that holds a

group exemption for veterans organizations described in I.R.C. § 501(c)(19). web
page states that its mission is to “ .”

             website lists several advantages to be included in its group exemption as a

subordinate organization. These advantages include.

Formation and Purpose

             (hereinafter referred to as                 ) was founded by
             . According to the                 Secretary of State Certificate of Incorporation,
             was incorporated on December 8, 20XX. The organization was formed to support all

veterans and their families. also uses other governing instruments provided to
it by , “Constitution of ” and “By-Laws to Corporations.”

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

Page: -1-

Form 886A Department of the Treasury - Internal Revenue Service
Explanation of Items Form 6018-A
Name of Taxpayer Year/Period Ended
12/31/20XX
12/31/20XX

According to the bylaws, stated purpose is “ ”. The bylaws further
state that these purposes include, but are not limited, to the following:

A.
B.
C.
D.
E.
F.
G.
H.
I.
J.

             also serves as the President of                 .

             is included in                 group exemption was and incorporated in the State of
             on December 8, 20XX.

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 Exhibit:
Explanation of Items Form 6018-A
Name of Taxpayer Year/Period Ended
12/31/20XX
12/31/20XX

Business Operations, Business Activities, and Members

primary activity is operation of a cash business at . The
building’s facade exhibits signs stating “ ” and “ ”. In order to sell alcohol in
the area, a bar has to be recognized as an exempt organization, like , or a regular

restaurant with more than $50,000 in sales from food. The facility has a full service bar (beer,

wine, and liquor), several dining tables and chairs, pool tables, television set, juke box, gaming

machines, and a dining hall.

is open to both members and nonmembers (general public). There are no signs
of private club or members only posted any where at the facility. The does
not have a sign-in book for members or nonmembers. Everyone is welcome to the facility as
long as the customer has met the drinking age requirement. Per initial meeting with the

President, , has about 0 members. No membership fee was charged to individual
members. The ; pays for the annual membership fee to which
included 0 individual membership fee. Also, the pays the sales tax on all

sales (members and nonmembers). The does not have adequate records to
substantiate membership and non-membership sales. The reported sales after cash expenses
as gross sales of inventory on Form 990 for the examination years.

facilities are open 7 days a week, including holidays. is open to
members and nonmembers (i.e., the general public). Although serves approximately 40
customers per day, the organization was only able to verify that it had -0 member-veterans. .
provided proof of the veteran status of its members to . The annual dues for
the members of are $0. was unable to verify the membership status
of any of its other customers during the examination.

In addition to managing the day-to-day bar operations, , President, was solely
responsible for managing the organization’s financial affairs and he was responsible for
maintaining its books and records. was responsible for filing the organization’s Forms
990 for 20XX and 20XX.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -3-

Form 886A

Department of the Treasury - Internal Revenue Service

Explanation of Items

Schedule No. or Exhibit:
Form 6018-A

Name of Taxpayer

Year/Period Ended
12/31/20XX
12/31/20XX

The following is a list of the personal expenses paid in lieu of rental payments for tax year 20XX
and 20XX.

(TY-20XX) Personal Residence Mortgage Paid by

Date Description Check Amount
01/04/XX 00 00.00
02/01/XX 0 0.00
02/16/XX Bank ) 0
03/02/XX 0 0.00
03/14/XX Bank 0 0
03/20/XX 0 0.00
06/30/XX 0 0.00
08/30/XX 0 0.00
08/01/XX 0 0.00
08/04/XX Bank 0 0
08/04/XX Bank 0 0
08/21/XX Bank 0 0
08/21/XX Bank 0 0)
09/05/XX 0 0.00
11/03/XX 0 0.00
12/03/XX Bank 0 0.00
Personal expenses paid $0.00

Comment

Loan repayment to formal owner
Loan repayment to formal owner
Personal mortgage and loan
Loan repayment to formal owner
Personal mortgage and loan
Loan repayment to formal owner
Loan repayment to formal owner
Loan repayment to formal owner
Loan repayment to formal owner
Residence Equity Loan Pymt
Personal mortgage and loan
Personal mortgage and loan
Residence Equity Loan Pymt
Loan repayment to formal owner
Loan repayment to formal owner
Personal mortgage and loan

in lieu of rental payment

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 Exhibit:

Explanation of Items Form 6018-A

Name of Taxpayer Year/Period Ended
12/31/20XX

12/31/20XX

(TY-20XX) Personal Residence Mortgage Paid by
Date Description Check Amount Comment

12/28/XX Bank 0 0.00 Mortgage Payment

11/23/XX Bank 0 0.00 Mortgage Payment

11/23/XX Bank 0 0 Mortgage Payment

10/11/XX Bank 0 0 Mortgage Payment

08/13/XX Bank 0 0 Mortgage Payment

07/30/XX Bank 0 0 Mortgage Payment

06/19/XX Bank 0 0 Mortgage Payment

06/19/XX Bank 0 0 Mortgage Payment

06/19/XX Bank 0 0 Mortgage Payment

05/15/XX Bank 0 0 Mortgage Payment

05/25/XX Bank 0 0.00 Mortgage Payment

04/05/XX Bank 0 0 Mortgage Payment

04/17/XX Bank 0 0.00 Mortgage Payment

03/08/XX Bank 0 0.00 Mortgage Payment

03/20/XX Bank 0 0 Mortgage Payment

02/21/XX Bank 0 0.00 Mortgage Payment

02/20/XX Bank 0 0.00 Mortgage Payment

02/28/XX Bank 0 0 Mortgage Payment

01/23/XX Bank 0 0.00 Mortgage Payment

01/23/XX Bank 0 0 Mortgage Payment

01/29/XX Bank 0 0 Mortgage Payment

12/04/XX Bank 0.00 ML Payment

09/27/XX Bank 0 ML Payment

Personal expenses paid $0.00 in lieu of rental payment

Per initial meeting with the President,

A. The has about 0 members. No membership fees were charged
to individual members. The paid for the annual membership fee
to the which also included 0 individual membership fees;

B. The paid sales tax on all sales (members and nonmembers).
However, the does not have any records to substantiate

membership and non-membership sales;

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 Exhibit:
Explanation of Items Form 6018-A
Name of Taxpayer Year/Period Ended
12/31/20XX
12/31/20XX

C. More than 50% of sales were from nonmembers;

D. The facility is open to the general public. No membership is required to purchase

alcohol and food, or to attend any events held by the

E. The facility is available to both members and nonmembers.
All events were available to general public;

F. General membership usually do not attend any of the monthly meetings;

During examination process, provided ten copies of DD-214 and ID-Cards. The
minimum of ten active members that was required by

Per review of the records and interview with the
President, , it is determined that :

A. The facility is open to general public, no membership is required to purchase food

and drink from the ;
B. No sign-in book for members or nonmembers;
C. The charged sales tax on all sales (per note, sales tax
does not apply to bona fide members);
D. The does not have adequate records for member and

nonmember sources of income;

E. Over 50% of income is from the general public;

F. The provided copy of DD-214, copy of military ID card, and
other alternative forms to verify veteran status. The membership is free of charge to
chapter members.

Financial Information

Per review of bank statements, for tax years 20XX and 20XX, the President’s

personal home mortgage was paid by the organization. Per rental contract between

, President/owner, and , the organization was required to pay $0.00
per month rent. In lieu of rental payments, , paid personal mortgage
payments. The amounts paid to in lieu of rent for his personal residence mortgage
payments in 20XX tax year was $0., and 20XX tax year was $0.

The 20XX Form 990, the gross sales' of the organization totaled $0. The
organization’s gross receipts per the audit were $0.

---

¹ For purposes of this discussion, the term “gross sales” means “gross receipts” as reported on the
organization’s Form 990.

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

Form 886A Department of the Treasury - Internal Revenue Service
Explanation of Items Form 6018-A
Name of Taxpayer Year/Period Ended
12/31/20XX
12/31/20XX

Total Bank Deposits in the amount of $0 less Nontaxable receipts deposited $0 plus Business
expenses paid by cash $0 equaled a total Gross receipts of $0 less the gross sales of the
organization total $0 as reported on Form 990 for 20XX understated Gross Income in the amount
of $0.

Per our sample test workpaper and our analysis of COGS to Sales ratio, it was determined that
the reported the correct amount of COGS on the return.

Activities, Revenues, and Expenses

             was unable to provide a complete breakdown of the hours it spent, the amount of

revenue that it generated, and/or the expenses that it incurred, in connection with its activities
during the years under examination. The charts that appear below summarize information that
was produced during the examination and they provide an overview of the organization’s exempt
and nonexempt activities during 20XX and 20XX, respectively.

In addition to characterizing the organization’s activities as exempt and non-exempt, the
following charts identify the amount of time that the organization reportedly spent, and they
specify the amount of revenue that the organization reportedly received, and list the expenses
that the organization reportedly incurred in connection with each activity during the years under
examination.

Breakdown of Exempt vs. Non Exempt Activities – 20XX

Activity Exempt Non Exempt Hours Revenue Expenses
Fall cook out (available to anyone)
free to members X Not Provided When Requested N/A N/A
Annual USMC Toys for Tots Drive X X No Records N/A N/A
Funeral Flowers X No Records N/A Not Provided When Requested
Provide Free Food to Members daily. X Not Provided When Requested N/A Expenses Not Separately Tracked.

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

Page: -7-

Form 886A Department of the Treasury - Internal Revenue Service
Explanation of Items Form 6018-A
Name of Taxpayer Year/Period Ended
12/31/20XX
12/31/20XX

Activity Exempt Non Exempt Hours Revenue Expenses
Helped disable member X Not Provided When Requested Not Provided When Requested Not Provided When Requested
Poker Run & Auctions for fund raise X N/A N/A N/A

Non-Exempt Activity Hours

Activity
Operating a bar (sale food and drinks and other bar activities
(pool table, music box, shuffle board, dart, Keno))

Hours Per Activity
14 Hr * 355 D = 4,970 Hrs (Estimated)

Who Preformed Such Activities
Pay employees and volunteers work for tips

Number of Customers In Bar On Given Day

                     SUN    MON    TUES   WED    THUR   FRI    SAT

Veteran Club Members 5 5 5 5 5 5 5
Other Club Members 0 0 0 0 0 0 0
Non Veteran Members 10 35 15 15 35 35 35
Estimated Member
Percentage 50% 12.5% 25% 25% 12.5% 12.5% 12.5%

Compared exempt activity hours to non-exempt activity hours and determined the organization is
not operating primarily for exempt purpose(s). Based on information provided by
president and the review of available records, the is operating primarily as a bar (sell

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 Exhibit:
Explanation of Items Form 6018-A
Name of Taxpayer Year/Period Ended
12/31/20XX
12/31/20XX
food and drinks, and other bar activities). The bar is open to anyone who enters the
establishment. does not have records for members and nonmembers’ sales.
Base on information provided by president and review of available records, less than

22% (estimated) of sales is from members vs over 78% of sales from nonmembers.
had no records or books on members’ and nonmember’s sales and bar exempt activities.

LAW AND ANALYSIS

Tax Exemption - Veterans Organizations

Prior to the enactment of I.R.C. § 501(c)(19) by Public Law 92-418, 1972-2 C.B. 675, many
veterans organizations qualified for exemption from federal income tax under I.R.C. § 501(c)(4)
because most of the traditional activities of these organizations were recognized by the IRS as
primarily promoting social welfare. Staff of Joint Comm. on Taxation, 109th Cong., Historical
Development and Present Law of the Federal Tax Exemption for Charities and Other Tax-
Exempt Organizations, JCX-29-05 NO 8, (Comm. Print 2005). The traditional activities of
veterans organizations that were social welfare organizations included promoting patriotism,
preserving the memory of those who died in war, and assisting veterans in need. Id. A veterans
organization whose primary activity consisted of operating social facilities for its members was
not able to qualify for exemption as a § 501(c)(4) social welfare organization, but it could
qualify as a social club under § 501(c)(7). Rev. Rul. 66-150, 1966-1 C.B. 147; S. Rep. No. 1082,
92d Cong., 2d Sess. 2 (1972) reprinted in 1972-2 C.B. 713; H.R. Rep. No. 851, 92d Cong., 2d
Sess. 1 (1972).

In 1972, Congress enacted I.R.C. § 501(c)(19) and I.R.C. § 512(a)(4) to address the concern that
a veterans organization exempt under I.R.C. § 501(c)(4) or (7) may be subject to unrelated
business income tax on the provision of insurance to its members. S. Rep. No. 1082, 92d Cong.,
2d Sess. 2 (1972) reprinted in 1972-2 C.B. 713.” Section 512(a)(4) excludes amounts attributable
to, or set aside by a §501(c)(19) veterans organization for the payment of life, sick, accident, or
health insurance benefits for their members and their members’ dependents. Public Law 92-418,
1972-2 C.B. 675.

The Section 501(c)(19) Exemption Requirements

In General

---

² “Before the enactment of the Tax Reform Act of 1969, there was no tax on the insurance activities of
the veterans’ organizations since the unrelated business income did not apply to social welfare
organizations and social clubs. However, the 1969 Act extended the application of the unrelated
business income tax to virtually all exempt organizations including social welfare organizations and social
clubs.” S. Rep. No.1082, 92d Cong., 2d Sess. 2 (1972) reprinted in 1972-2 C.B. 713.

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 Exhibit:
Explanation of Items Form 6018-A
Name of Taxpayer Year/Period Ended
12/31/20XX
12/31/20XX

Section 501(c)(19) of the Internal Revenue Code provides for the exemption from federal
income tax of a post or organization of past or present members of the United States Armed
Forces if it is:

(a) organized in the United States or any of its possessions,

(b) at least 75 percent of its members are past or present members of the Armed Forces
of the United States,

(c) substantially all of its other members are individuals who are cadets or are
spouses, widows, widowers, ancestors or lineal descendants of past or present
members of the Armed Forces of the Unites States or of cadets, and

(d) no part of the net earnings of which inures to the benefit of any private shareholder or
individual.

Membership Requirements

Under I.R.C. § 501(c)(19), at least 75 percent of an organization’s members must be past or
present members of the Armed Forces of the United States (“veterans”). Section 501(c)(19) does
not define the term “Armed Forces of the United States.” The regulations under I.R.C. §
501(c)(19), likewise, do not define the term. Section 7701(a)(15) of the Code, however, defines
“Armed Forces” to include all regular and reserve components of the uniformed services which
are subject to the jurisdiction of the Secretary of Defense, the Secretary of the Army, the
Secretary of the Navy, or the Secretary of the Air Force, and the Coast Guard.

In addition, I.R.C. § 501(c)(19)(B) requires that substantially all other members of an
organization be cadets or spouses, widows, widowers, ancestors, or lineal descendants of
veterans or cadets. According to the Senate Report accompanying the legislation, “substantially
all” means 90 percent. See S. Rep. No. 1082, 92nd Cong. 2d Sess. 5 (1972), reprinted in 1972-2
C.B. 713, 715. Therefore, of the 25 percent of the members that do not have to be veterans, 90
percent must be cadets, or spouses, etc. Consequently, no more than 2.5 percent (10% x 25%) of
an I.R.C. § 501(c)(19) organization’s total membership may consist of individuals not mentioned
in the statute.

---

³ Prior to 2003, ancestors and lineal descendent were not included in the statutory list of persons
permitted to be members. In 2003, Congress amended I.R.C. § 501(c)(19) to include ancestors or lineal
descendents of present or former members of the United States Armed Forces or cadets in the statutory
list of individuals who may be members of an organization. The regulations have not been updated to
reflect this change nor do they reflect the 1982 statutory change eliminating a requirement that veterans
be veterans of war.

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 Exhibit:
Explanation of Items Form 6018-A
Name of Taxpayer Year/Period Ended
12/31/20XX
12/31/20XX

Neither, I.R.C. § 501(c)(19), its legislative history, nor the regulations under I.R.C. § 501(c)(19)
define what it means to be a member of a veterans organization. However, whatever the
organization requires for one to become a member, the organization must maintain records
tracking who its members are and the proportions in the various categories of membership
permitted under I.R.C. § 501(c)(19)(B) (member of armed forces, cadet, relative, etc.) to
substantiate that its members are veterans or other permitted members. See I.R.C. § 6001 and
Treas. Reg. §1.6001-1(c).⁴

Operational Test

Section 1.501(c)(19)-1(c) of the regulations provides that an organization exempt under I.R.C. §
501(c)(19) must be operated exclusively for one or more of the following purposes:

1) To promote the social welfare of the community as defined in section 1.501(c)(4)-1(a)(2)
of the regulations,

2) To assist disabled and needy war veterans and members of the United States Armed
Forces and their dependents and widows and orphans of deceased veterans,

3) To provide entertainment, care, and assistance to hospitalized veterans or members of the
Armed Forces of the United States,

4) To carry on programs to perpetuate the memory of deceased veterans and members of the
Armed Forces and to comfort their survivors,

5) To conduct programs for religious, charitable, scientific, literary, or educational
purposes,

6) To sponsor or participate in activities of a patriotic nature,

• Section 6001 of the Code provides that every person liable for any tax imposed by the Code, or for the
  collection thereof, shall keep adequate records as the Secretary of the Treasury of his delegate may from
  time to time proscribe. Every organization exempt from tax under § 501(a) and subject to the unrelated
  business income tax, including veterans organizations, must keep such records. Treas. Reg. § 1.6001-
  1(a). These books and records are required to be available for inspection by the Service. Treas. Reg. §
  1.6001-1(a). In addition, veterans organizations are required to keep books and records to substantiate
  information reported on their information return. See I.R.C. § 6033 and Treas. Reg. § 1.6001-1(c). They
  are also required to submit additional information to the Service for the purpose of enabling the Service to
  inquire further into its exempt status.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -11-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or Exhibit:
Explanation of Items Form 6018-A
Name of Taxpayer Year/Period Ended
12/31/20XX
12/31/20XX

7) To provide insurance benefits for their members or the dependents of their members or
both, or

8) To provide social and recreational activities for their members.
Treas. Reg. § 1.501(c)(19).
Social and Recreational Activities for Members

While Treas. Reg. §1.501(c)(19)-1(c)(8) does not address what it means to “exclusively” provide
social and recreational activities for members it is similar to the exempt purpose contained in
I.R.C. § 501(c)(7), as both provisions permit an exempt organization to operate social and
recreational facilities for its members. In fact, prior to the enactment of I.R.C. § 501(c)(19), a
veterans organization whose primary activity consisted of operating a bar or restaurant for the
benefit of its members would have to qualify as §501(c)(7) social club to be tax-exempt. See
Rev. Rul. 60-324 and Rev. Rul. 69-219.⁵ These organizations, prior to 1976, were required to
operate “exclusively” for the pleasure and recreation of its members. See I.R.C. § 501(c)(7)
(1975). Thus, the rulings and case law under I.R.C. § 501(c)(7) are useful for purposes of
determining whether an I.R.C. § 501(c)(19) veterans organization is providing social and
recreational activities exclusively for its members.

Treas. Reg. § 1.501(c)(7)-1(b) provides that a club that engages in business, such as making its
social and recreational facilities available to the general public is not organized and operated
exclusively for pleasure, recreation, and other nonprofit purposes, and is not exempt under I.R.C.
§ 501(a). Solicitation by advertisement or otherwise for public patronage of its facilities is prima
facie evidence that the club is engaging in business and is not being operated exclusively for
pleasure, recreation, or social purposes.

In West Side Tennis Club v. Commissioner,111 F.2d 6 (2nd Cir. 1940), cert. denied, 311 U.S.
674 (1940), the Second Circuit upheld the board of tax appeals determination that a social club
was not exempt because a substantial amount of its income was received from the general public.
West Side Tennis Club was organized to provide tennis facilities for the use and enjoyment of its
members. The facilities were only available to members for most of the year; the club hosted
annual national championship tennis matches, however, that were open to the general public.
The club shared in the ticket proceeds from these matches. The Second Circuit upheld the board

---

⁵ In 1976, Congress amended § 501(c)(7) replacing “exclusively” with “substantially all.” This change
was effected to establish that social clubs will not jeopardize their exempt status if they receive 35% of
their gross receipts from non-membership sources. Only 15% of their gross receipts, however, may be
derived from nonmembers’ use of club facilities or services. Pub. L. No. 92-568, S. Rep. 1318, 94 Cong,
2d Sess. (1976).

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -12-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or Exhibit:
Explanation of Items Form 6018-A
Name of Taxpayer Year/Period Ended
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of tax appeals determination that the national championship matches were a substantial and

profitable business which jeopardized the club’s exemption. West Side Tennis Club, 111 F.2d at
p. 7.⁶

In Rev. Rul. 60-324, 1960-2 C.B. 173 and Rev. Rul. 69-219, 1969-1 C.B. 153, the Service held
that a § 501(c)(7) social club is not operated exclusively for the pleasure or recreation of its
members if it makes its facilities available to the general public to a substantial degree. Id.
However, this does not mean that all dealings with the general public are necessarily inconsistent
with the club’s exempt purposes. For instance, in Rev. Rul. 60-324, 1960-2 C.B. 173, the
Service stated that:

[w]hile [the] regulations indicate that a club may lose its exempt status if it makes

its facilities available to the general public, [it] does not mean that any dealings
with outsiders will automatically cause a club to lose its exemption. A club will
not lose its exemption merely because it receives some income from the general
public, that is, persons other than members and their bona fide guests, or because
the general public may occasionally be permitted to participate in its affairs,
provided such participation is incidental to and in furtherance of its general club
purposes and the income therefrom does not inure to members.

In 1971, the Service issued Revenue Procedure 71-17, 1971-1 C.B. 683, which contains
guidelines for determining the impact of an organization’s nonmember gross receipts on its
exempt status under I.R.C. § 501(c)(7). The revenue procedure provides that “[a] significant
factor reflecting the existence of a nonexempt purpose is the amount of gross receipts derived
from use of a club’s facilities by the general public.” The revenue procedure went on to provide
a safe harbor for organizations serving the general public:

As an audit standard, [the gross receipts derived from the general public]

alone will not be relied upon by the Service if annual gross receipts from the
general public for [use of the club’s facility] is $2,500 or less or, if more

than $2,500, where gross receipts from the general public for use is five percent
or less of total gross receipts of the organization.

Rev. Proc. 71-17, 1971-1 C.B. 683 at § 3.01.

---

⁵ In 1976, Congress amended § 501(c)(7) replacing “exclusively” with “substantially all.” This change
was effected to establish that social clubs will not jeopardize their exempt status if they receive 35% of
their gross receipts from non-membership sources. Only 15% of their gross receipts, however, may be
derived from nonmembers’ use of club facilities or services. Pub. L. No. 92-568, S. Rep. 1318, 94 Cong.,
2d Sess. (1976).

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The term “general public” is defined as persons other than members or their dependents or
guests. Id. at § 2.01. Section 3.03 of Rev. Proc. 71-17 provides four instances in which
nonmembers are assumed to be the guests of the members. The assumptions include:

Where a group of eight or fewer individuals, at least one of whom is a member,
uses club facilities, it will be assumed for audit purposes that the nonmembers are
the guests of the member, provided payment for such use is received by the club
directly from the member or the member’s employer.

Where 75 percent or more of a group using club facilities are members, it will
likewise be assumed for audit purposes that the nonmembers in the group are
guests of members, provided payment for such use is received by the club directly
from one or more of the members or the member’s employer.

Rev. Proc. 71-17, Section 3.03.

In Pittsburgh Press Club v. United States, 615 F.2d 600 (3rd Cir. 1980), the Third Circuit

upheld the Commissioner’s determination that a social club failed to qualify for

exemption from income tax as a §501(c)(7) organization because it was operated for business
and not for the pleasure and recreation of its members. The Pittsburgh Press Club was organized
for the purpose of providing a professional and social meeting place for its members. During the
years under exam, however, the Pittsburgh Press Club hosted several functions for nonmember
outside groups, although each such group had been member sponsored. Based on the amount of
nonmember revenues ($281,000 of nonmember receipts), as well as the percentage of those
revenues (11 to 17 percent of gross receipts), the Third Circuit upheld the revocation stating that
the exemption from Federal income tax for §501(c)(7) organizations “is to be strictly construed.”
Pittsburgh Press Club, 615 F.2d at 606. The Court stated that such strict construction cannot be
reconciled with the fact that a substantial amount of the Club’s activities and income consisted of
nonmember functions and nonmember income. Therefore, the Court held “revocation of its
exemption was proper.” Id.

Inurement

An organization fails to qualify for exemption under I.R.C. § 501(c)(19) if there is inurement.
Section 501(c)(19) of the Code prohibits inurement “to the benefit of any private shareholder or
individual.” The regulations contain corresponding language. See Treas. Reg. §1.501(c)(19)-

1(a)(1).

There are no cases or rulings interpreting this statutory or regulatory language under I.R.C. §
501(c)(19). The inurement prohibition set forth in I.R.C. § 501(c)(19), however, parallels
exactly the language found in I.R.C. § 501(c)(3). Thus, it is the government’s position that the
case law, as well as the regulatory and other guidance, on inurement under I.R.C. § 501(c)(3)

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may be used by analogy in interpreting prohibited inurement under I.R.C. § 501(c)(19).

An organization will not qualify for exempt status under I.R.C. § 501(c)(3) if it is organized or
operated for the benefit of private interests such as designated individuals, the creator or his
family, shareholders of the organization, or persons controlled directly or indirectly by such
private interests. Treas. Reg. § 1.501(c)(3)-1(d)(1)(ii). Inurement refers to the non-incidental
diversion of assets, which are supposed to be dedicated to charitable purposes, to an insider of
the organization. See Treas. Reg. § 1.501(a)-1(c); Ginsburg v. Commissioner, 46 T.C. 47
(1966).

Inurement may take many forms and an organization’s earnings may inure to the benefit of
private individuals in ways other than by the actual distribution of dividends or payment of
excessive salaries. See Founding Church of Scientology v. United States, 412 F.2d 1197, 1200
(1969), cert. denied, 397 U.S. 1009 (1970) (excessive compensation paid to insiders); Founding
Church of Scientology, 412 F.2d 1197, 1200 (1969), cert. denied, 397 U.S. 1009 (1970)
(excessive rents paid to insiders as landlords); Easter House v. U.S., 12 Cl. Ct. 476 (1987) (loans
to insiders on advantageous terms); Rev. Rul. 56-138, 1956-1 C.B. 202 (excessive employee
benefits provided to insiders); Anclote Psychiatric Center, Inc. v. Commissioner, T.C. Memo
1998-273 (purchase of assets from insiders for more than fair market value or sale of assets to
insiders for less than fair market value). Moreover, the unaccounted for diversions of a
charitable organization’s resources by one who has complete and unfettered control can
constitute inurement. Founding Church of Scientology of California v. United States, 823 F.2d
1310, 1316. See also, Parker v. Commissioner, 365 F.2d 792, 799 (8th Cir. 1966), cert. denied,
385 U.S. 1026 (1967); Kenner v. Commissioner, 318 F.2d 632 (7th Cir. 1963).

In People of God Community v. Commissioner, 75 T.C. 127 (1980), a newly formed Christian
religious organization, which was founded by one of its ministers, paid its founder and its other
ministers a predetermined percentage of the gross tithes and offerings that were received by the
organization. After determining that part of the organization’s net earnings inured to the benefit
of private shareholders or individuals (i.e., the ministers), the Tax Court held that the
organization was not exempt as an organization described in I.R.C. § 501(c)(3).

In Spokane Motorcycle Club v. United States, 222 F. Supp. 151 (E.D. Wash. 1963), the plaintiff,
a motorcycle club, claimed it was a non-profit, charitable corporation, and asserted that it was
except from Federal income tax under I.R.C. § 501(c)(7) and entitled to a refund. The District
Court disagreed with the plaintiff's assertions, held that part of the motorcycle club’s net
earnings inured to its members, even though the amount involved was de minimus, and
concluded that the plaintiff was not exempt from Federal income tax.

In Mabee Petroleum Corp. v. United States, 203 F. 2d 872, 875 (5th Cir. 1953), a corporation
filed suit to recover overpayments of income taxes on grounds that it was entitled to charitable
exemption. The United States District Court for the Northern District of Texas entered judgment

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against the plaintiff and the plaintiff appealed. The Court of Appeals affirmed the District
Court’s judgment and concluded that the District Court’s finding that the salary that was paid to
the founder of the charitable foundation, to which all of the founder’s stock in the corporation
was transferred, was excessive and constituted inurement of net earnings to the benefit of a
private individual, was not clearly erroneous.

In The Founding Church of Scientology v. United States, 412 F.2d 1197, 1201 (Ct. Cl. 1969),
cert. denied, 397 U.S. 1009 (1970), in addition to receiving salary, commission, and royalty

payments, the founder of the church, and several members of his family, received unexplained
payments in the nature of loans and reimbursements for expenditures made in plaintiff's behalf,
for expenses and other purposes. The Court of Claims held that the plaintiff was not entitled to
exemption from Federal income tax because it failed to prove that no part of the corporate net
earnings benefited private individuals. Thus, the plaintiff's claim was denied and the petition
was dismissed.

In Parker v. Commissioner, 365 F.2d 792 (8th Cir. 1966), after the Court of Appeals concluded
that the Tax Court was justified in ruling that the corporate petitioner was not entitled to tax
exemption as a religious organization under I.R.C. § 501, it turned its attention to the
unaccounted-for and unexplained withdrawals from the corporation’s bank accounts and the
checks, which were made payable to the founder, that were drawn on the organization’s account.
The Commissioner credited the unidentified withdrawals to the founder’s income. The Tax
Court sustained such action, and the Court of Appeals affirmed the Tax Court’s determination,
noting that [d]ue to the extremely close relationship between [the founder] and the day-to-day
financial activities of [organization] and due to [the founder’s] complete and unfettered control
over [the organization], [the founder] has the burden of explaining unidentified withdrawals from
the [organization’s] accounts.” Id. at 799, citing Reinecke v. Spalding, 280 U.S. 227 (1930); Arc
Realty Company v. Commissioner, 295 F.2d 98 (8th Cir. 1961). “If he is unable to do so the
Commissioner may validly assume that the withdrawals were income to the [founder].” Parker
v. Commissioner, 365 F.2d 792, 799 (8th Cir. 1966). No evidence of any kind was produced
explaining the withdrawals or indicating that the founder did not receive the benefit from them.
Thus, the Court of Appeals concluded that the assessments were proper. Id.

In Church of Scientology of California v. Commissioner, 823 F.2d 1310 (9th Cir. 1987), cert.
denied, 486 U.S. 1015 (1988), the Court of Appeals affirmed the Tax Court’s judgment which
upheld the Commissioner’s assessment of tax deficiencies and penalties against the church,
following the revocation of the church’s tax exempt status.

The Court of Appeal reviewed the Tax Court’s factual finding that a portion of the church’s net
earnings inured to the benefit of L. Ron Hubbard, and his family, and OTC, a private for-profit
corporation, for clear error. In finding that a portion of the church’s net earnings inured to the
benefit of L. Ron Hubbard, his family and OTC, the Tax Court isolated two indicia of inurement,
overt and covert inurement. The overt indicia included salaries, living expenses, and royalties,
and the covert indicia included “debt repayments” and L. Ron Hubbard’s unfettered control over

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millions of dollars of church assets. The Tax Court concluded that these indicia, when viewed in
light of the self-dealing associated with them, coupled with the church’s failure to carry its
burden of proof and to disclose the facts candidly, proved conclusively that the church was
operated for the benefit of L. Ron Hubbard and his family. Id. at p. 1317. In addition to
Hubbard’s salary, the church paid for all of the Hubbards’ living and medical expenses aboard
the cruise ship Apollo. The church paid substantial royalties to L. Ron Hubbard for his books,
recordings and E-meters. The record revealed that L. Ron Hubbard had unfettered control over
millions of dollars in church assets, and supported the Tax Court’s conclusion that L. Ron
Hubbard had unfettered control over Church of Scientology Trust Fund assets. Additionally, the
Tax Court found that church income incurred to the benefit of L. Ron Hubbard in a “grand scale”
in the form of “debt repayments.” Id. at p. 1319. In sum, the Tax Court held that “significant
sums of money inured to the benefit of L. Ron Hubbard and his family” during the years at issue.
The Court of Appeals found no clear error and noted that “[a]lthough neither the salaries nor the
living expenses necessarily constituted evidence of inurement, the cumulative effect of
Hubbard’s use of the Church to promote royalty income, Hubbard’s unfettered control over
millions of dollars of church assets, and his receipt of untold thousands of dollars worth of “debt
repayments” strongly demonstrative inurement.” Id.

Recordkeeping and Reporting Requirements

Every person liable for any tax imposed by the Code, or for the collection thereof, shall keep
adequate records as the Secretary of the Treasury or his delegate may from time to time
prescribe. See I.R.C. § 6001. Every organization exempt from tax under I.R.C. § 501(a), and
subject to the tax imposed by I.R.C. § 511 on its unrelated business income, must keep such
permanent books or accounts or records, including inventories, as are sufficient to establish the
amount of gross income, deduction, credits, or other matters required to be shown by such
person in any return of such tax. Such organization shall also keep such books and records as
are required to substantiate the information required by §6033. See Treas. Reg. §§ 1.6001-1(a)
and 1.6001-1(c). The books or records required by section 1.6001-1 shall be kept at all times
available for inspection by authorized internal revenue officers or employees, and shall be
retained so long as the contents thereof may become material in the administration of any
internal revenue law. See Treas. Reg. §1.6001-1(e).

Except as provided, every organization exempt from tax under I.R.C. § 501(a) shall file an
annual return, stating specifically the items of gross income, receipts and disbursements, and
such other information for the purposes of carrying out the internal revenue laws as the Secretary
may by forms or regulations prescribe, and keep such records, render under oath such statements,
make such other returns, and comply with such rules and regulations as the Secretary may from
time to time prescribe.

See I.R.C. § 6033(a)(1).

Every organization which is exempt from tax, whether or not it is required to file an annual
information return, shall submit such additional information as may be required by the Service

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for the purpose of inquiring into its exempt status and administering the provisions of subchapter
F (i.e., I.R.C. § 501 and following), chapter 1 of subtitle A of the Code, I.R.C. § 6033, and
chapter 42 of subtitle D of the Code. See Treas. Reg. §1.6033-2(i)(2). See also, I.R.C. § 6001,
Treas. Reg. §1.6001-1.

An organization’s failure or inability to file required information returns or otherwise to comply
with the provisions of I.R.C. § 6033 and the regulations which implement it, may result in the
termination of the organization’s exempt status based on the grounds that the organization has
not established that it is observing the conditions that are required for the continuation of its
exempt status. See Rev. Rul. 59-95. These conditions require the filing of a complete and
accurate annual information return (and other required federal tax forms) and the retention of
records sufficient to determine whether the organization is operated for the purposes for which it
was granted tax-exempt status and to determine its liability for any unrelated business income
tax. Id.

Rev. Rul. 59-95, 1959-1 C.B. 627, concerns an exempt organization that was requested to
produce a financial statement and statement of its operations for a certain year. Its records were
so incomplete, however, that the organization was unable to furnish such statements. The
Internal Revenue Service held that the organization’s failure or inability to file the required
information return or otherwise to comply with the provision of section 6033 of the Code and the
regulations which implement it, may result in the termination of the exempt status of an
organization previously held exempt, on the grounds that the organization has not established
that it is observing the conditions required for the continuation of its exempt status.

Unrelated Business Income Tax

Section 511(a) of the Code imposes a tax upon the unrelated business taxable income of
organizations exempt from federal income tax.

Section 512(a)(1) defines unrelated business taxable income as the gross income from any
unrelated trade or business regularly carried on by the organization.

Section 513(a) defines the term “unrelated trade or business” as any trade or business the
conduct of which is not substantially related (aside from the need of such organization for
income of funds or the use it makes of the profits derived) to the exercise or performance by
such organization of its exempt functions.

Section 513(c) provides that the term “trade or business” includes any activity which is carried

on for the production of income from the sale of goods. An activity does not lose its identity as
trade or business merely because it is carried on within a larger aggregate of similar activities or
within a larger complex of other endeavors which may not be related to the exempt purposes of

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the organization.

Treas. Reg. § 1.513-1(d)(2) provides that a trade or business is related to exempt purposes only
where the conduct of the business activities has a causal relationship to the achievement of
exempt purposes (other than through the production of income). It is substantially related, for
purposes of section 513 of the Code, only if the causal relationship is a substantial one. For this
relationship to exist, the production or distribution of the goods or the performance of the
services from which the gross income is derived must contribute importantly to the
accomplishment of those purposes. Whether activities productive of gross income contribute
importantly to the accomplishment of any purpose for which an organization is granted
exemption depends on each case upon the facts and circumstances involved.

In Rev. Rul. 68-46, 1968-1 C.B. 260 a war veterans’ organization did not qualify for exemption
from Federal income tax under I.R.C. § 501(c)(4) because it was primarily engaged in renting a
commercial building and operating a public banquet and meeting hall having bar and dining
facilities.

Government’s Position and Conclusions

Taxpayer’s Position 1:

The corporation was dissolved in 20XX.

Issue 1. has not established that it operates exclusively for exempt purposes listed
in Treas. Reg. § 1.501(c)(19)-1(c).

As is discussed more fully above, an organization described in I.R.C. § 501(c)(19) carries out
activities in furtherance of its exempt purposes only when such activities are carried out
exclusively in furtherance of the purposes listed in Treas. Reg. § 1.501(c)(19)-1(c). Among
these purposes is the provision of social and recreational activities for its members.

Accordingly, when a veterans organization described in I.R.C. § 501(c)(19) provides social and
recreational activities for its members, or for guests whose expenses are paid by members, the

organization is engaged in activities in furtherance of its exempt purposes. If such an
organization makes its facilities available to the general public to a substantial degree, and/or a
significant amount of the organization’s income is received from the general public, the
organization may lose its tax exemption.

A veterans’ organization must be operated for one or more of the purposes listed in Treas. Regs.
Section 1.501(c)(19)-1(c). The organization is not required to include all of the listed purposes or

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activities in its organizing instrument. However, the organization cannot have purposes of a
substantial nature that are not listed and retain exempt status under IRC 501(c)(19). The exempt
purposes are:

A. Promoting the social welfare of the community as defined in Treas. Regs. section
1.501(c)(4)-1(a)(2);

B. Assisting disabled and needy war veterans and members of the U.S. Armed Forces and

their dependents and the widows and orphans of deceased veterans;

C. Providing entertainment, care, and assistance to hospitalized veterans or members of

the U.S. Armed Forces;

D. Carrying on programs to perpetuate the memory of deceased veterans and members of

the Armed Forces and to comfort their survivors;

E. Conducting programs for religious, charitable, scientific, literary, or educational

purposes (as set out in IRC 170(c)(4));

F. Sponsoring or participating in activities of a patriotic nature;

G. Providing insurance benefits for their members or dependents of their members (or

both); and

H. Providing social and recreational activities for their members.

The primary activity of is operating a bar and to serve the general public and the
members. Per initial meeting with the President, , he is certain that
more than 50% of sales were from the general public.

Where goods or services are furnished to nonmembers who provide payment for such goods or
services, their furnishing is outside the scope of section 1.501(c)(19)-1(c) of the regulations.
Generally, if an organization has not kept adequate books and records concerning its financial
transactions with nonmembers and more than 50 percent of its gross receipts are derived from
sales transactions (e.g. bar sales), the presumption will be that the organization’s exempt status
should be revoked because it is not primarily engaged in section 501(c)(19) activities. However,
this presumption may be rebutted. All facts and circumstances must be reviewed to determine
whether or not the organization is primarily engaged in section 501(c)(19) activities.

The level of activity with the general public engaged in by the organization overshadows the
organization’s exempt activities, particularly in view of the absence of adequate books and
records pertaining to the year in question, which is required by sections 6001 and 6033 of the
Code, Sections 1.6001-1 and 1.6033-2 of the regulations, and Rev. Rul. 59-95, 1959-1 C.B. 627.

Substantial unrelated activities may adversely effect exempt status. Such activities include:

Renting out facilities to the general public;

Opening bar and dining facilities to the general public;

Selling liquor and/or food to members and/or the public for consumption off the premises;
and

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Gaming activities with nonmembers.

During initial meeting with the , President, , stated that:
o the facility is available for rent to general public,
o the operating a bar and dining facility to the general public;
o the sell liquor and food to members and general public for consumption on
premises and can sell food and liquor to members and general public off premises
o the operate gaming machines and poker games with nonmembers

It is government’s position that providing social and recreational activities to the public is not an
exempt activity under IRC 501(c)(19). Although the carries on veterans’
programs and other benevolent, welfare, patriotic, and civic activities, it has been determined
that the business activities relating to the operation of commercial bar

• for the general public exceeds all other activities.

Government’s Position 2:

current President, , purchased the bar from a previous owner.
is the legal owner of the bar real property and most of the property in the bar.
financed a personal loan with a bank when he bought the business and the property from the
prior owner.

Per review of the expenses records, personal loan repayments
were paid by the . Bar’s real and personal properties are owner by
. In 20XX and 20XX, the paid mortgage interest on behalf of the
President,

The Service does not have to establish that payments for goods or services are unreasonable or
exceed fair market value to substantiate the existence of private benefit. In Hawaii v.
Commissioner, 71 T.C. 1067 (1979), the Tax Court stated: Nor can we agree petitioner that the
critical inquiry is whether the payments made to International were reasonable or excessive.
Regardless of whether the payments made by petitioner to International were excessive,
International and EST, Inc., benefited substantially from the operation of petitioner.

Taxpayer’s Position 3:

The corporation was dissolved in 20XX

Government’s Position 3:

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An organization must satisfy two requirements to be described in Section 501(c)(19) of the
Code. First, the organization must satisfy a membership test, and second, its activities must
further the purposes listed in Section 1.501(c)(19)-1(c) of the regulations. If the membership
requirements are not satisfied, then the organization will not qualify for exemption under section
501(c)(19).

The membership test under section 501(c)(19) of the Code provides that an organization’s
membership must be composed of the following:
o 75% of the membership must consist of past or present members of the Armed Forces;
o Substantially all of its other members need to be individuals who are cadets or are
spouses, widows, or widowers of past or present members of the United States Armed
Forces or cadets. “Substantially all” has been defined to mean 90% of the remaining
25% of the membership. Therefore, 22.5% of the organization’s membership can consist
of cadets, spouses, widows and widowers of cadets or members of the Armed Forces; and
o The remaining 2.5% of the membership can be anyone.

Per initial meeting with the President, , the has
about 0 members. The did not charge membership fee to any members.
The general membership has little to do with the operations and financial
matters. The general membership is not required to attend any membership meetings.

officers were named by rather than voted for. has been the
president of the since he bought the business from prior owner. For the
years under examination, the provided ten copies of DD-214 and other
alternative military forms. The is open to general public. The membership
is not required to purchase food and drink from the for consumption on-site or
off site. The does not have adequate records to represent membership sales. It

is certain that over 50% of sales were from nonmembers.

Section 501(c)(19) of the Code does not define the meaning of member as being an individual
who has the right to control the day-to-day operations of the organization, such as having the
right to vote. Membership in a section 501(c)(19) organization is based upon analyzing the
organization’s organizing document, which defines the rights and obligations of membership.

In determining whether an individual is a member of a veterans’ organization for purposes of
section 501(c)(19) of the Code, such an individual must be involved in the organization in such a
manner as to further the organization’s exempt purposes, rather than joining to receive a personal
benefit, such as the right to receive free food while being a patron at the bar.

Based on the facts available of this case, it appears that Membership are
not bona fide members and should not be part of the membership calculation for purposes of
section 501(c)(19) of the Code. The organization is run like a sole proprietorship bar and

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members do not have a say in its operations. Therefore, since the organization failed to provide
adequate records to substantiate the bona fide members, therefore, failed to meet the
membership test under 501(c)(19) because it has no bona fide members. See National
Association of Life Underwriters, Inc. v. Commissioner, supra and Section 501(c)(19) of the
Code.

Taxpayer’s Position 4:

The corporation was dissolved in 20XX.

Government’s Position 4:

Unless specifically excepted under IRC 6033, every organization exempt from taxation
under section 501(a) must file an annual return, stating specifically the items of gross
income, receipts, and disbursements, and such other information for the purpose of
carrying out the internal revenue laws as the Secretary may by forms or regulations
prescribe, and shall keep such records, render under oath such statements, make such
other returns, and comply with such rules and regulations as the Secretary may from time
to time prescribe.

Regardless of the organization’s requirement to file an information return, it is required to
maintain adequate books and records to substantiate its claims regarding its level of income and
the expenditures and to provide such additional information as may be required by the Internal
Revenue Service for the purpose of inquiring into its exempt status.

Under Section 1.6033-2(i)(2) of the Regulations, every organization exempt from tax,
whether or not it is required to file an annual information return, shall submit additional
information as may be required by the Internal Revenue Service for the purpose of
inquiring into its exempt status. During the examination, several requests for information
were made, but failed to supply the requested information. The
organization has clearly failed to provide the requested information despite adequate
notice as required by Section 1.6033-2(i)(2) of the Regulations.

Revenue Ruling 59-95 states if an exempt organization fails to comply with the
requirements of Section 6033 of the Code and its corresponding Regulations, the
organization will no longer qualify for exempt status. As described in the previous
paragraph, has not complied with Section 1.6033-2(i)(2) of the Regulations
since no reply to information document requests have been received. Per Revenue
Ruling 59-95, you do not qualify for exempt status under Section 501(c)(3) of the Code

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -23-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or Exhibit:
Explanation of Items Form 6018-A
Name of Taxpayer Year/Period Ended
12/31/20XX
12/31/20XX

since your organization has failed to provide the required information as prescribed by
Regulations of Section 6033 of the Code.

Generally, the income an organization receives from nonmembers for the purchase of goods or
services or for the use of its facilities is considered unrelated business taxable income. For
purposes of differentiating unrelated business income and income from exempt activities, an
organization must maintain adequate records to distinguish between members and nonmembers
who participate in its activities and to determine the amount of income received from each.

IRC 6001 and Treas. Regs. Section 1.6001-1(a) and (c) discuss recordkeeping requirements for
exempt organizations. In addition, Publication 3386 provides recordkeeping requirements for
Veterans' Organizations exempt under IRC 501(c)(19) and provides the following guidance in
determining member and non-member participation:

o A guest, for IRC 501(c)(19) purposes, is an individual who is accompanied by a member
who pays for goods or services provided to the guest without being reimbursed by the
guest;

o A nonmember is a person from the general public, who pays the organization for
recreational and social services provided;

o A paying nonmember is a purchaser of the goods or services provided by the
organization and are a direct recipient of those goods or services from the organization.
Such a nonmember is not considered to be entertained by a member even when
accompanied by a member, but is instead considered to be a principal in a business
transaction with the organization; and

o A "social member" is generally considered a member of the general public and a
nonmember for IRC 501(c)(19) purposes unless the membership category is established
in the bylaws and/or articles of incorporation. Such social members must be limited to no
more than 2.5% of a veterans’ organization total membership.

For the years under the examination, there was no permanent mechanism in place to maintain
records to distinguish between income from bona fide members, members’ families, bona fide
guests, auxiliary members, and non-member’s income, with respect to the organization’s
operation.

While the operation of a bar may further an exempt purpose under section 501(c)(19), such
activities are not engaged in for the members’ social and recreational benefit when the facility is
open to the public. No accurate records were maintained indicating use by members and
nonmembers. Based upon the available information, the operation of the bar is a public activity
that primarily serves to non bona fide members and general public.

Based upon an analysis of the whole operation and in view of the unavailability of adequate
records, we believe that the business activities relating to the operation of the bar, all of which
were available to the public, predominate over the inadequately documented exempt activities.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -24-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or Exhibit:
Explanation of Items Form 6018-A
Name of Taxpayer Year/Period Ended
12/31/20XX
12/31/20XX

Based upon the information available, the organization has not met its burden of proof by
furnishing sufficient records to show that it is not operating a business for profit by operating a
bar open to the general public. Operation of an establishment open to the public neither
accomplishes social welfare or any other section 501(c)(19) purposes. See Rev. Rul. 68-46
1968-1 C.B. 260, Rev. Rul. 61-158, 1961-2 C.B. 115, and Section 1.501(c)(19)-1(c) of the
Regulations. These activities establish that the organization is not operated exclusively for
exempt purposes under section 501(c)(19) of the Code.

When Congress enacted IRC 501(c)(19), which provides a specific exemption for veterans’
organizations, social and recreational activities for the members was one of the purposes
permitted. The only way a nonmember may gain admission to the Chapter bar or restaurant is if
he or she is a bona fide guest of a member. Per the interview with the Chapter President,

the bar primarily serves to the general public (more than 80-90% sales were from
nonmembers). The membership is not required to purchase food and drink from the bar. In
addition, the Chapter did not keep the required records to delineate between member and non
member income as required by Section 1.6001-(c) of the Regulations.

Since the Chapter has not complied with the record keeping requirement and the organization is
open to the public, the burden of proof is on the Chapter to prove that a portion of its income
wasn’t from an unrelated trade or business. Unless additional records are submitted to
substantiate the amount of non member income, it is presumed that 100% of the organization’s
income is considered from an unrelated trade or business and is subject to corporate tax under
Section 11 of the Code.

Conclusions

1. During the examination process, the did not provide adequate information to
   show the devoted at least 50% of their time to activities in furtherance of

the organization’s exempt function. Based on the available information, it appears that the
organization primarily operates a bar open to the public. Since operating a bar open to the
public does not further Section 501(c)(19) purposes, it does not qualify for exemption under
Section 501(c)(19) of the Code. Accordingly, the exempt status is
revoked effective January 1, 20XX. Form 1120 returns should be filed for the tax periods
ending on or after December 31, 20XX and beyond. Since the corporation was dissolved in

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -25-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or Exhibit:
Explanation of Items Form 6018-A
Name of Taxpayer Year/Period Ended
12/31/20XX
12/31/20XX

tax year 20XX we will convert the 990 returns for tax years 20XX and 20XX to Form 1120.
You are required to file 20XX Form 1120 for the remaining period from January 1, 20XX to
June 30, 20XX.

2. Since net earnings of , inured to the benefit of the President, ,
   exemption under IRC section 501(a) as an organization described in section
   501(c)(19) should be revoked, effective January 1, 20XX.

3. During the examination process, it was shown that did not have a Bona
   Fide membership. Therefore, it does not meet the membership test and/or qualify for
   exemption under Section 501(c)(19) of the Code. Accordingly, the organization’s exempt
   status is revoked effective January 1, 20XX.

4. Since the has failed to provide the required information that has been requested,
   concerning the organization’s exempt status per Section 6033 of the Code, we have
   determined that the organization has failed to satisfy the conditions required for the
   continuation of its exempt status as required under section 6033 of the Internal Revenue
   Code and Revenue Ruling 59-95, Cumulative Bulletin 1959-1, page 627.

In this case, was actively engaged in the operation of a bar, which was open to
the general public. bar was open 7 days a week, and the bar was operated by
the organization in direct competition with similar non-exempt commercial enterprises. Thus,
bar activities constituted a regularly carried on trade or business.

has failed to demonstrate that its bar activities were conducted in a non-commercial
manner or that the frequency of its operations were irregular compared with similar non-exempt
enterprises. did not maintain any records, which specify the amounts of
income that the bar generated from members and non members, and it failed to provide any basis
for determining how much of its income came from members and non members. Since no
reasonable method exists for determining which part of the organization’s bar income was
derived from the general public as opposed to the organization’s members, it is the government’s
position that all of the income that was generated by the bar including, but not limited, to the bar
operations, vending machines, Keno and gaming activities should be treated as unrelated
business income.

Since the organization’s bar income that was derived from the general public is unrelated to the
organization’s exempt purposes, and the organization failed to maintain records that delineated
between the income that it derived from members and non members, and because it was unable
to establish which part of the income was related to and/or generated by members of the
organization as opposed to nonmembers, such income should be considered to be unrelated trade
or business income and it is therefore subject to income tax. No reasonable basis was provided
to explain how such income was determined.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -26-

Department of the Treasury - Internal Revenue Service Schedule No. or Exhibit:
Form 886A Explanation of Items Form 6018-A
Name of Taxpayer Year/Period Ended
12/31/20XX
12/31/20XX
Because the did not keep proper records related to nonmember income and the
is open to the general public, the burden of proof to prove that the organization
had member income is on the . Therefore, unless additional records are
provided to prove the organizations member income, 100% of the bar income will be considered
non member income subject to tax. 100% of the income is considered from

an unrelated trade or business and is subject to corporate tax under Section 11 of the Code.

If you accept our findings, please sign the enclosed Form 6018-A, Consent to Proposed
Action-Non Declaratory Judgment. Please return it to the following address within 30 days
of the date of this letter:

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -27-