National Guard museum foundation loses exemption after rental business becomes primary

Plain-English summary

A foundation was recognized as exempt to operate a National Guard museum, hall of fame, and library, provide scholarships, and help fund another museum. The IRS found that the foundation's main activity had instead become operating four debt-financed rental properties, which generated most of its revenue and absorbed most of its spending. Its museum and library occupied only a small part of one building and were open by appointment, while the organization reported no recent spending on artifacts or preservation and little scholarship activity. The IRS concluded that the rental business, rather than the stated museum and scholarship programs, was the foundation's primary purpose. It revoked the exemption effective on a redacted date. The IRS also determined that, if the exemption were not revoked, the organization would be a private foundation because it failed the section 509(a)(2) public-support tests.

Ruling snapshot

• Question: Did the foundation remain operated primarily for museum and scholarship purposes, and did it still qualify as publicly supported?
• Outcome: Revocation.
• Key authorities: IRC §§ 501(c)(3), 509(a)(2), and 513; Treas. Reg. §§ 1.501(c)(3)-1 and 1.509(a)-3.

Full text (IRS public release)

Internal Revenue Service
Tax Exempt and Government Entities Division
Exempt Organizations: Examinations

Department of the Treasury

Release Number: 201517011
Release Date: 4/24/2015
ORG
UIL code: 501.03-13

Date:
February 27, 2014

Taxpayer Identification Number:

Form:
990

Tax Year(s) Ended:
March 31, 20XX

Person to Contact/ID Number:

Contact Numbers:
Telephone:
Fax:

Manager’s name/ID number:

Manager’s contact number:

Response due date:
March 28, 20XX

Certified Mail – Return Receipt Requested
Dear

Why you are receiving this letter

We propose to revoke your status as an organization described in section 501(c)(3) of the
Internal Revenue Code (Code). Enclosed is our report of examination explaining the proposed
action.

What you need to do if you agree

If you agree with our proposal, please sign the enclosed Form 6018, Consent to Proposed
Action — Section 7428, and return it to the contact person at the address listed above (unless
you have already provided us a signed Form 6018). We'll issue a final revocation letter
determining that you aren't an organization described in section 501(c)(3).

After we issue the final revocation letter, we'll announce that your organization is no longer
eligible for contributions deductible under section 170 of the Code.

If we don't hear from you
If you don’t respond to this proposal within 30 calendar days from the date of this letter, we'll
issue a final revocation letter. Failing to respond to this proposal will adversely impact your legal

Letter 3618 (Rev. 6-2012)
Catalog Number 34809F

standing to seek a declaratory judgment because you failed to exhaust your administrative
remedies.

Effect of revocation status
If you receive a final revocation letter, you'll be required to file federal income tax returns for the
tax year(s) shown above as well as for subsequent tax years.

What you need to do if you disagree with the proposed revocation

If you disagree with our proposed revocation, you may request a meeting or telephone
conference with the supervisor of the IRS contact identified in the heading of this letter. You also
may file a protest with the IRS Appeals office by submitting a written request to the contact
person at the address listed above within 30 calendar days from the date of this letter.

The Appeals office is independent of the Exempt Organizations division and resolves most
disputes informally.

For your protest to be valid, it must contain certain specific information including a statement of
the facts, the applicable law, and arguments in support of your position. For specific information
needed for a valid protest, please refer to page one of the enclosed Publication 892, How to
Appeal an IRS Decision on Tax-Exempt Status, and page six of the enclosed Publication 3498,
The Examination Process. Publication 3498 also includes information on your rights as a
taxpayer and the IRS collection process. Please note that Fast Track Mediation referred to in
Publication 3498 generally doesn’t apply after we issue this letter.

You also may request that we refer this matter for technical advice as explained in Publication

892. Please contact the individual identified on the first page of this letter if you are considering
     requesting technical advice. If we issue a determination letter to you based on a technical
     advice memorandum issued by the Exempt Organizations Rulings and Agreements office, no
     further IRS administrative appeal will be available to you.

Contacting the Taxpayer Advocate Office is a taxpayer right

You have the right to contact the office of the Taxpayer Advocate. Their assistance isn’t a
substitute for established IRS procedures, such as the formal appeals process. The Taxpayer
Advocate can't reverse a legally correct tax determination or extend the time you have (fixed by
law) to file a petition in a United States court. They can, however, see that a tax matter that
hasn't 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:

Internal Revenue Service
Office of the Taxpayer Advocate

For additional information

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 3618 (Rev. 6-2012)
Catalog Number 34809F

Thank you for your cooperation.

Enclosures:

Report of Examination
Form 6018
Publication 892
Publication 3498

Sincerely,

Nanette M. Downing
Director, EO Examinations

Letter 3618 (Rev. 6-2012)
Catalog Number 34809F

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 3/31/20XX
LEGEND
ORG ~ Organization name XX — Date address - Address city - City
state - State
Issues

Issue 1: Whether ORG is operated exclusively for a tax-exempt purpose and should be
considered tax-exempt under Internal Revenue Code section 501(c)(3).

Issue 2: Whether ORG is properly classified as not being a private foundation because it is
described in Internal Revenue Code Section 509(a)(1), (2), (3) or (4).

Facts

ORG (Taxpayer or Organization) was incorporated under the laws of the State of State
on October 5, 19XX, as a non-profit domestic corporation.

Form 1023 was received by the Service on May 3, 19XX. In answer to the question in
Part II, Number 1, Taxpayer stated that it would participate in three activities: (1) operate a
museum, hall of fame and library which will be a “central collection point and depository for any
materials dealing with the State National Guard and its forerunner, the State Militia’, (2) provide
scholarships to “qualified candidates” who are children of members or deceased members of
the State National Guard and (3) attempt to raise $0 to help build a National Guard museum in
City, State.

Taxpayer was granted advance ruling tax-exempt status under Internal Revenue Code §
501(a) as an organization described in section 501(c)(3) on August 9, 19XX. Additionally, it
was determined not to be a private foundation because it was determined to meet the
requirements of IRC § 509(a)(2) on January 12, 19XX.

In the revised bylaws of Taxpayer, dated April 1, 19XX, Taxpayer states its purpose as
establishing in City, State “A permanent display to be known as the State National Guard
Memorial Hall and Hall of Fame, open to the public without charge, to contain the art, artifacts
and memorabilia of peculiar significance to the State militia and National Guard, and visual
representation of dramatic moments in its military history. There will also be displayed the
colors of all major commands of the State Army and Air National Guard. A library, open to the
public without charge, of books, periodicals and other publications of special interest to
historians of the State Militia and the State National Guard.”

Article V of the revised bylaws states that “Members of the Foundation shall be all
individuals who contribute zero dollars ($0) or more in support per year.” There is no entry for
membership dues on any of the Form 990s which were inspected during the examination.

During the examination of Taxpayer, Revenue Agent discovered that the organization
was actively engaged in the rental of various real properties from which it earns the major
portion of its gross earnings. In addition, the majority of the expenditures of the organization
are for the purpose of maintaining these rental properties. Taxpayer files Form 990-T Exempt
Organization Business Income Tax Return to report its rental activities.

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

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 3/31/20XX

The addresses and square footage of each of the organization's properties is shown in
Table 1, below.

Table 1
Address Square Footage
Address, City, State Zip code 0 sq. ft.
Address, City, State Zip code 0 sq. ft.
Address, City, State Zip code 0 sq. ft.
Address, City, State Zip code 0 sq. ft.
Total Square Footage Owned 0 sq. ft.

The properties are situated on a parcel of land that consists of four separate
buildings located on Address in City, State. This property was conveyed to the organization by
The National Guard Association of State, Inc. on January 30, 19XX as a donation.

The buildings consist of Address which is a newer two-story commercial building which
currently has two tenants, the Veterans Affairs and Military Affairs branches of the
Commonwealth of State. Per a lease agreement between Taxpayer and the State of State a
total of 0 sq. ft. of space is leased to the state. The remaining 0 sq.ft. is used in the building
located at Address for the organization's historical archive and display.

The museum and library which the organization operates consists of a conference room
with wall displays and several bookshelves for books and other papers. During an unscheduled
visit to the museum, the Revenue Agent was told that the museum and library were currently
locked and would have to be opened by a staff person who works at Address. The Revenue
Agent observed no notices or any signage that would indicate that the museum was open to the
public at any time without request. In a letter, dated July 10, 20XX and received by the
Revenue Agent from the Power of Attorney for the organization, Accountant, CPA, stated that
the museum and library were open to the public by appointment.

The buildings at Address and Address are older construction and consist of single story
residential tenants and a barber shop. The building at Address appears to be a renovated
small house which is leased to The National Guard Association of State. The

., also has its mailing address at Address.

The properties at Address and Address are leased to various residential tenants and
one retail tenant.

The property at Address is leased to the National Guard Association of State.

Taxpayer reported the following gross revenues on its Form 990 for the years ending
March 31, 20XX, March 31, 20XX, March 31, 20XX and March 31, 20XX (Table 2):

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

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 3/31/20XX
Table 2

3/31/XX 3/31/XX 3/31/XX 3/31/XX
Contributions $0 $0 $0 $0
Investment Income 0 0 0 0
Gross Rents 0 0 0 0
Misc. Income 0 0 0 0
Total Revenues $0 $0 $0 $0

Contributions as a

percent of Total

Revenues 0.0% 0.0% 0.0% 0.0%
Gross Rents as

percent of Total

Revenues 0.0% 0.0% 0.0% 0.0%

On August 3, 20XX the organization recorded a donation in the amount of $0 from
Donor (Donor). Two donations from Donor were made to the organization during 20XX in the
amounts of $0 and $0.

Taxpayer has reported no expenses ($0) for the acquisition or preservation of
any art, artifacts, or memorabilia concerning the National Guard of State during the fiscal years
ending March 31, 20XX, March 31, 20XX, March 31, 20XX and March 31, 20XX.

Scholarships awarded by Taxpayer totaled $0 in 20XX, $0 in 20XX, $0 in 20XX and $0
in 20XX. Other donations made by the organization totaled $0 during the 20XX tax year. No
other donations were reported on the Form 990 for the years ending March 31, 20XX, 20XX
and 20XX.

There was no mention of an attempt to raise $0 for the construction of a National Guard
museum in City, State in any of the four Form 990s. In a written answer to a Form 4564
Information Document Request, dated January 29, 20XX, Taxpayer indicated that it had no
records of whether it had ever raised this money or donated it to help with the construction of a
National Guard Museum in City, State.

The minutes of Taxpayer’s board of directors were requested and provided by
Taxpayer for the period May, 20XX to the present. Minutes were requested and not provided
for the period April, 20XX through April, 20XX. There was no mention in the minutes that were
provided of any activity pertaining to the museum, artifacts obtained or visitor information.
Items noted in the minutes chiefly concerned the rental properties owned by Taxpayer and
rented to the general public. (See Appendix 1.)

As a 509(a)(2) type organization, Taxpayer is required to file Form 990 (Schedule A).
Taxpayer has consistently filed this form as if the organization is tax-exempt under IRC
§170(b)(1)(A)(vi). During the course of the examination it was discovered that the Form 990

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

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 3/31/20XX

(Schedule A) submitted by the taxpayer was not correctly prepared. Revenue Agent used
information provided by the organization to prepare corrected Schedule A’s for Taxpayer's tax
periods ending March 31, 20XX, March 31, 20XX, and March 31, 20XX. (See Appendix 2.) The
data used to compute the Public Support Percentage was obtained from the previously filed
Form 990s of the Taxpayer. These corrected forms were mailed to the Taxpayer on April 16,
20XX with a request for comment. Taxpayer replied that it did not agree with the corrections
but did not offer any explanation as to why it did not agree.

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.

Treas. Reg. § 1.501(c)(3)-1(a) states that “In order to be exempt as an organization
described in section 501(c)(3), an organization must be both organized and operated
exclusively for one or more of the purposes specified in such section. If an organization fails to
meet either the organizational test or the operational test, it is not exempt.

The organizational test states in that “An organization is organized exclusively for one or
more exempt purposes only if its articles of organization (referred to in this section as its
articles) as defined in subparagraph (2) of this paragraph:

(a) Limit the purposes of such organization to one or more
exempt purposes; and

(b) Do not expressly empower the organization to engage,
otherwise than as an insubstantial part of its activities, in
activities which in themselves are not in furtherance of one or
more exempt purposes.” (Treas. Reg. § 1.501(c)(3)-1(b))

The operational test states that “An organization will be regarded as operated
exclusively for one or more exempt purposes only if it engages primarily in activities which
accomplish one or more of such exempt purposes specified in section 501(c)(3). An
organization will not be so regarded if more than an insubstantial part of its activities is not in
furtherance of an exempt purpose.” (Treas. Reg. § 1.501(c)(3)-1(c))

Treas. Reg. § 1.501(c)(3)-1(d)(i) states that “An organization may be exempt as an
organization described in section 501(c)(3) if it is organized and operated exclusively for one or
more of the following purposes: (a) Religious, (b) Charitable, (c) Scientific, (d) Testing for public

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

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 3/31/20XX

safety, (e) Literary, (f) Educational, or (g) Prevention of cruelty to children or animals.”

Section 1.501(c)(3)-1(d)(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 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(e)(1) states that “An organization may meet the
requirements of section 501(c)(3) although it operates a trade or business as a substantial part
of its activities, if the operation of such trade or business is in furtherance of the organization's
exempt purpose or purposes and if the organization is not organized or operated for the primary
purpose of carrying on an unrelated trade or business, as defined in section 513. In
determining the existence or nonexistence of such primary purpose, all the circumstances must
be considered, including the size and extent of the trade or business and extent of the activities
which are in furtherance of one or more exempt purposes. An organization which is organized
and operated for the primary purpose of carrying on an unrelated trade or business is not
exempt under section 501(c)(3).”

IRC § 513(a) states that an unrelated trade or business is one which is “any trade or
business the conduct of which is not substantially related (aside from the need of such
organization for income or funds or the use it makes of the profits derived) to the exercise or
performance by such organization of its charitable, educational, or other purpose or function
constituting the basis for its exemption under section 501.”

Treas. Reg. § 1.509(a)-3(a) states that “Section 509(a)(2) excludes certain types of
broadly, publicly supported organizations from private foundation status. An organization will be
excluded under section 509(a)(2) if it meets the one-third support test under section
509(a)(2)(A) and the not-more-than-one-third support test under section 509(a)(2)(B).”

Treas. Reg. § 1.509(a)-3(a)(2) states that “An organization will meet the one-third
support test if it normally receives from permitted sources more than one-third of its support in
each taxable year from any combination of--

(i) Gifts, grants, contributions, or membership fees; and
(ii) Gross receipts from admissions, sales of merchandise, performance of services, or

furnishing of facilities, in an activity that is not an unrelated trade or business (within the
meaning of section 513), subject to certain limitations.”

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

Page: -5-

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 3/31/20XX
Issue 1

Taxpayer’s Position
Unknown
Government's Position

The organization described three tax-exempt purposes in its Form 1023: (1) operating a
museum, hall of fame and library, (2) providing scholarships, and (3) raising money for a
National Guard museum in City, State. All of these purposes can be considered to be tax-
exempt purposes under the organizational test in Treas. Reg. § 1.503(c)(3)-1(b) and Treas.
Reg. § 1.501(c)(3)-1(d)(i). Organization, therefore, passes the organizational test.

Taxpayer is not actively pursuing the stated activity of operating a museum, hall of fame
and library. There have been no expenditures made in the previous four years that indicate any
activity in the area of operating a museum, hall of fame or library. No money has been spent
on the acquisition or preservation of any art, artifacts, or memorabilia. Minutes from the board
of directors meetings do not mention any activity concerning the museum, hall of fame or library
directly. The minutes indicate that the meetings of the board of directors were concerned with
the rental properties only.

Additionally, Taxpayer has stated that it doesn’t have any records to show whether there
was ever a $0 contribution made to help in the construction of a National Guard museum in
City, State.

In the area of scholarships, Organization has granted only very small amounts of money
to its scholarship program in relation to the amount of gross revenue that is being produced by
the rental properties.

The lack of any financial support and the fact that there was no discussion of the
museum at board of directors meetings show that there is little or no activity in conducting the
main purpose for which Organization applied for tax-exemption. Also, there appears to have
been such little activity in the contribution to the National Guard museum that the organization
does not even have any records of whether the contribution, which also was part of its
determination application, was ever made. Finally, the dollar amount of the scholarships which
was the third tax-exempt activity mentioned in the determination application is very low when
compared with the gross rental revenue that Taxpayer receives yearly.

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

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 3/31/20XX

Taxpayer has shown little or no activity in the areas in which it applied for tax-exempt
status.

In order to pass the operational test, Organization must be operated exclusively for tax-
exempt purposes and any activities that are not in furtherance of an exempt purpose must be
insubstantial as per Treas. Reg. § 1.501(c)(3)-1(c).

The purposes for which an organization may be tax-exempt are laid out in Treas. Reg.
§ 1.501(c)(3)-1(e)(1). While Organization meets the criteria of a charitable organization with
regards to its organizational documents and it does have a number of display cases in the State
National Guard offices, the organization’s primary activity is operation of a rental business.

Table 1, in the Facts section of this document, shows that the organization owns four
separate properties. The total square footage of these properties is 0 square feet. Taxpayer
has identified 0 square feet of space as being utilized by its historical archive and display.
Thus, only 0% of the total square feet that the organization owns is used for its tax-exempt
activities.

As can be seen in Table 2, contributions form a very small part of the gross revenue of
the organization. During the examination year, contributions amounted to 0% of gross revenue.
Previous years’ contribution rate was even smaller.

Organization has consistently filed Form 990-T to report its rental activities as the
properties being rented are debt financed.

The facts have shown that the primary purpose of this organization is to operate a real
estate rental service. Due to the extent of the rental activities, the lack of any activity or
discussion of the museum, the lack of any records concerning the donation to the National
Guard museum in , and the small amount of money that has been committed
to scholarships it has been determined that Taxpayer has failed to meet the test described in
Treas. Reg. § 1.501(c)(3)-1(e)(1) because the organization is “organized and operated for the
primary purpose of carrying on an unrelated trade or business”. Taxpayer cannot be
considered to be exempt under section 501(c)(3) because its primary purpose is carrying on an
unrelated trade or business, the rental of real estate properties.

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

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 3/31/20XX

Conclusion

ORG, based on the analysis above, is not an exempt organization under IRC §
501(c)(3). The tax exemption for this organization should be revoked as of April 1, 20XX.

Issue 2
Taxpayer’s Position
Unknown
Government’s Position

An IRC section 509(a)(2) type organizations is required to be considered a private
foundations unless it is able to meet the one-third support test under section 509(a)(2) and the
not-more-than-one-third support test under section 509(a)(2)(b).

A taxpayer will meet the one-third support test if it normally receives more than one-third
of its support from a combination of gifts, grants, contributions or membership fees and gross
receipts from admissions, sales of merchandise, performance of services, or furnishing of
facilities, in an activity that is not an unrelated trade or business, subject to certain limitations.

Taxpayer claims to be tax-exempt by virtue of being classified under IRC section
501(c)(3) and claims to receive a substantial portion of its support from a governmental unit or
from the general public as described in IRC section 170(b)(1)(A)(vi). It is therefore required to
file Form 990 Schedule A each year which it has consistently done.

As part of the examination of Taxpayer, the Revenue Agent recalculated the Form 990
Schedule A for the tax years ending March 31, 20XX, March 31, 20XX, and March 31, 20XX.
(See Appendix 2)

In each of the four years in which the Public Support Percentages were calculated for
Part II of Form 990 Schedule A Taxpayer failed to pass the one-third support test. Additionally,
Taxpayer was unable to pass the one-third support test in Part III of Form 990 Schedule A for
any of the four years.

Although Taxpayer was requested to provide an explanation as to whether it agreed with
the corrected Form 990 Schedule As, it did not provide any documentation or explanation to
refute the corrected Form 990 Schedule As.

Accordingly, Taxpayer should be considered to be a private foundation.

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service
Page: -8-

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 3/31/20XX
Conclusion

If the organization’s tax-exempt status is not revoked, ORG should henceforth be

considered to be a private foundation within the meaning of the law.

Form 886-A (Rev. 4-68)

Department of the Treasury - Internal Revenue Service

Page: -9-