Animal therapy organization loses exemption for private inurement and lack of exempt activity

Plain-English summary

A section 501(c)(3) organization previously operated an animal-assisted therapy facility and sold its horse-therapy property to another exempt organization. The IRS found that mortgage proceeds from the sale were not reported and were used by the executive director to build a barn on personal property. The organization gave inconsistent accounts of whether it conducted any therapy during the examined year and did not provide the requested financial records. The IRS concluded that the organization had not shown any exempt activity or public benefit and that its funds had inured to a private individual. It revoked the organization's exemption effective at the start of the examined year.

Ruling snapshot

• Question: Did the organization continue to qualify under IRC § 501(c)(3) after the sale of its therapy property and during a year with no substantiated exempt activity?
• Outcome: Revocation
• Key authorities: IRC §§ 501(c)(3), 6001, and 6033(a)(1); Treas. Reg. § 1.501(c)(3)-1; Rev. Rul. 59-95

Full text (IRS public release)

DEPARTMENT OF THE TREASURY

Internal Revenue Service
TE/GE EO Examinations
1100 Commerce Street
Dallas, TX 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES Date: February 25, 2015
DIVISION

Person to Contact:

Number: 201522006 Identification Number:

Release Date: 5/29/2015 Contact Telephone Number:
In Reply Refer to: TE/GE Review Staff
EIN:

UIL: 501.03-00
LAST DATE FOR FILING A PETITION
WITH THE TAX COURT:

CERTIFIED MAIL — Return Receipt Requested
Dear

This is a Final Adverse Determination Letter as to your exempt status under section
501(c)(3) of the Internal Revenue Code. Your exemption from Federal income tax under
section 501(c)(3) of the code is hereby revoked effective January 1, 20XX.

Our adverse determination was made for the following reasons:

You have not demonstrated that you are operated exclusively for charitable,
educational, or other exempt purposes within the meaning of I.R.C. section
501(c)(3). You have failed to produce documents or otherwise establish that
you are operated exclusively for exempt purposes and that no part of your net
earnings inures to the benefit of private shareholders or individuals. You
failed to keep adequate books and records as required by I.R.C. § 6001,
6033(a)(1) and Rev. Rul. 59-95, 1959-1 C.B. 627.

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

You are required to file Federal income tax returns on Form 1120. These returns should
be filed with the appropriate Service Center for the year ending December 31, 20XX and
for all years thereafter.

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

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

You also have the right to contact the office of the Taxpayer Advocate. However, you
should first contact the person whose name and telephone number are shown above since
this person can access your tax information and can help you get answers.

You can call 1-877-777-4778 and ask for Taxpayer Advocate assistance. Or you can
contact the Taxpayer Advocate from the site where the tax deficiency was determined by
calling, Tel: or write:

Taxpayer Advocate

Taxpayer Advocate assistance cannot be used as a substitute for established IRS
procedures, formal appeals processes, etc. The Taxpayer Advocate is not able to reverse
legal or technically correct tax determinations, nor extend the time fixed by law that you
have to file a petition in the United States Tax Court. The Taxpayer Advocate can,
however, see that a tax matter that may not have been resolved through normal channels
gets prompt and proper handling.

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

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

Sincerely yours,

Margaret Von Lienen
Director, EO Examinations

Enclosure:
Publication 892

Internal Revenue Service Department of the Treasury
Tax Exempt and Government Entities Division

Exempt Organizations: Examinations

12309 North MOPAC Expressway

Austin, TX 78758

Date:
July 2, 2014
Taxpayer Identification Number:

Form:
Tax Year(s) Ended:

Person to Contact/ID Number:

Contact Numbers:
Telephone:
Fax:

Manager's name/ID number:

Manager’s contact number:

Response due date:

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

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

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.

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

Thank you for your cooperation.

Barbara L. Harris
Acting Director, EO Examinations

Enclosures:

Report of Examination
Form 6018
Publication 892
Publication 3498

3 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 R
Year/Period Ended

Name of Taxpayer

20XX

ISSUES

1. Whether should have their exemption revoked for creating private
   benefit and inurement to the corporate officers of the exempt organization?
2. Whether should be revoked due to no exempt purpose.

FACTS

originally located at is a
corporation granted section 501(c)(3) exemption on April 29, 19XX. is a
Hippo therapy facility. Hippo therapy is a form of physical, occupational and speech
therapy in which a therapist uses the characteristic movements of a horse to provide
carefully graded motor and sensory input. was started by the
family that started the charity.

is a qualified 501(c)(3) that held a mortgage on about 40 acres of land
that housed a horse arena and a large barn. sold the majority of it’s
assets to another exempt organization during the year ending December 31, 20XX. A
Warranty Deed with Vendor's Lien for $ was issued from the new exempt
organization to for the above stated property. sold its interest in
the property and facilities to . The original mortgage was paid. The
inurement amount identified by this agent is $ as per the chart provided below.

An agreement concerning the Intent of Reverter Clause was created between

and . This agreement
states as long as a section 501(c)(3) with a functioning board of directors and a
licensed and/or certified therapist uses the facilities for Animal Assisted Therapy (Hippo
therapy) the property will not revert back to . The agreement also states
the property itself can not be used as collateral for future capital or loans.

filed returns for the following years 20XX, 20XX, 20XX, 20XX, and
20XX. The 20XX return showed a beginning equity balance of $ . The ending
equity balance on the 20XX return shows a balance of zero. The return shows no
expenses to change the equity balance. No returns were filed after the period ending
December 31, 20XX. would Terminate its exemption in February of 20XX.

The return states in Part V line 38a that the organization did not borrow from, or make
any loans to, any officer, director, trustee. Or were any such loans made in prior year
and still outstanding at the end of the year covered by this return.
The return also states in Part V line 40b that as a Section 501(c)(3) organization it did
not engage in any section 4958 excess benefit transaction during the year, or did not
engage in an excess benefit transactions in the prior years that were not reported on

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

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

any prior Form 990 or 990-EZ. Also in line 40c the form states that no amount of tax
was self imposed by the organization for section 4958 transactions.

Schedule O states,” This entity will continue to operate as a tax-exempt entity, involved
with dog therapy only.” Schedule O also states, “This tax-exempt entity sold all of the
assets involved with their horse therapy to , on October 13, 20XX.
is a 501(c)(3) tax exempt organization, operating within the
same exempt purpose as this entity. received a note as part of the price.
This note, in the original amount of $ was scheduled be paid over a 10 year
period. The note referred to on Schedule O was paid in full on October 4, 20XX. The
check # was a payoff of the loan in full that cleared the bank on October 13, 20XX.
The return that these statements are included on was filed on July 01, 20XX. The
return was filed by .

IDR #1 was sent to on March 8, 20XX, it asked for all financial records for
during the year ending December 31, 20XX.

IDR #2 was sent to on April 26, 20XX, it also asked for all financial
records for during the year ending December 31, 20XX.

sent a statement that said, “The year in question 20XX was completely no
activity.” In the next correspondence from The Executive Director the following work
history was provided from the Executive Director: “1/20XX thru 5/20XX Worked with 4
to 5 emotionally disturbed students weekly out of . Horse and dog therapy
were used in these counseling sessions.” In the first correspondence received from
the Executive Director the following statement was received, “Enclosed is the
documents associated with the closing + transfer of my business to . I
could not start a new business nor work in horse therapy for 5 years after 20XX. I did
some animal assisted therapy following XX using the dog for .”

All records provided from Information Document Requests were from the year ending
December 31, 20XX. The Executive Director provided no records from the period
under exam. The Executive Director of in a hand written note to this
agent wrote, “The year in question 20XX was completely no activity.”

In the next correspondence from The Executive Director the following

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 R
Name of Taxpayer Year/Period Ended
20XX

The following chart shows the payments received by between January 1,
20XX & December 31, 20XX.

PAYMENTS RECEIVED FROM MORTGAGE

NAME ON CHECK DATE OF CHECK CHECK # AMOUNT
12/31/20XX 3005
1/31/20XX 3031
2/28/20XX 3053
3/31/20XX 3083
4/30/20XX 3104
5/31/20XX 3149
6/30/20XX 3182
10/4/20XX 3285

TOTAL RECEIVED

These checks were cut by an applicable Section 501(c)(3) to pay for a
note payable to for the facilities purchased from .

LAW

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

Section 1.501(c)(3)-1(a)(1) of the regulations provides that in order to be exempt
as an organization described in section 501(c)(3) of the Code, the organization must be
one that is both organized and operated exclusively for one or more of the purposes
specified in that section.

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

Section 1.501(c)(3)-1(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.

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 R
Name of Taxpayer Year/Period Ended
20XX

Section 1.501(c)(3)-1(d)(1)(ii) of the regulations states that an organization is not
organized or operated exclusively for exempt purposes unless it serves a public rather
than a private interest. The regulation places the burden of proof on the organization to
demonstrate 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.

Section 1.501(c)(3)-1(d)(2) of the regulations provides that the term "charitable"
is used in section 501(c)(3) of the Code in its generally accepted legal sense, and
includes the promotion of education.

The presence of a single substantial nonexempt purpose can destroy the exemption
regardless of the number or importance of exempt purposes. Better Bus. Bureau v.
United States, 326 U.S. 279. 283, 90 L. Ed. 67, 66 S. Ct. 112 (1945); Am. Campaign
Acad. v. Commissioner, 92 T.C. 1053, 1065 (1989); see also Old Dominion Box Co.,
Inc. v. United States, 477 F2d. 340 (4th Cir. 1973), cert. denied, 413 US 910 (1973)
(“operating for the benefit of private parties who are not members of a charitable class
constitutes a substantial nonexempt purpose”). When an organization operates for the
benefit of private interests, such as designated individuals, the creator or his family, or
persons directly or indirectly controlled by such private interests, the organization by
definition does not operate exclusively for exempt purposes. Am. Campaign Acad. v.
Commissioner, supra at 1065-1066.

In B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978), the courts ruled the
organization did not qualify for exemption under IRC section 501(c)(3) because it was
not operated exclusively for charitable, educational, or scientific purposes.

In order to be recognized as exempt under IRC section 501(c)(3), the organization is
prohibited from:

1) permitting its net earnings to inure to the benefit of private individuals or operating in
a way where more than an insubstantial part of its activities further private versus public
purposes

2) engaging substantially in legislative activity

3) participating or intervening in any political activity

Treas. Reg. section 1.501(c)(3)-1(c)(2) states that an organization is not exclusively
operated for one or more exempt purposes if its net earnings inure in whole or in part to
the benefit of private shareholders or individuals.

Treas. Reg. section 1.501(a)-1(c) defines a “private shareholder or individual” as
“persons having a personal and private interest in the activities of an organization.”

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 R
Name of Taxpayer Year/Period Ended
20XX

If the private benefit to an individual or a group of individuals is greater than the public
benefit, the private benefit is considered substantial. A substantial private benefit can
result in revocation of exempt status.

Even a small amount of private inurement is fatal to exemption. In Spokane Motorcycle
Club v. U.S., 222 F. Supp. 151 (E.D. Wash. 1963), net profits were found to inure to
private individuals where refreshments, goods and services amounting to $825
(representing some 8% of gross revenues) were furnished to members

Regs. 1.501(c)(3)-1(d)(1)(ii) states that the burden of proof is upon the organization to
establish that it is not organized or operated for the benefit of private interests. This
requirement applies equally to inurement and private benefit issues. While it is difficult
to prove a negative, the organization is certainly in a better position than the Service to
know the detailed facts surrounding its formation and operation. Therefore, in an
exemption application case the organization is required to furnish the Service with the
documents setting forth its purposes and rules of operation as well as a detailed
explanation of its operations. See Rev. Proc. 84-46, 1984-1 C.B. 541.

In John Marshall Law School and John Marshall University v. United States, 228 Ct. Cl.
902 (1981), 81-2 U.S.T.C. 9514 involve classic channeling of an organization’s net
earnings to those in control. The court sustained the Service’s revocation of the
school’s exempt status based on inurement. The court found inurement existed when
the school provided the following to family members who were its officers:

• Interest free loans
• Unsecured loans
• Payments for non-business travel
• Payments for non-business entertainment
• Personal health spa membership

In United Cancer Council, Inc. v. Commissioner, 165 F.3d 1173 (1999), the appeals
court stated the inurement clause of IRC section 501(c)(3) interprets the phrase “private
individual or shareholder” as an insider of the charity.

The court further said a charity must not improperly pass its earnings to its founder,
board members, their families, or anyone else described as an insider who is the
equivalent of an owner or manager. The insider could be an employee such as an office
manager.

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 R
Year/Period Ended

Name of Taxpayer

20XX

GOVERNMENT’S POSITION

An organization recognized as exempt under IRC section 501(c)(3) is prohibited from
permitting any of its net earnings to inure to the benefit of any private shareholder or
individual.

sent a statement that said, “The year in question 20XX was completely
no activity.” In the second correspondence from The Executive Director the following
work history was provided from the Executive Director: “1/20XX thru 5/20XX Worked
with 4 to 5 emotionally disturbed students weekly out of . Horse and dog
therapy were used in these counseling sessions.” In the first correspondence received
from the Executive Director the following statement was received, “Enclosed is the
documents associated with the closing + transfer of my business to . I
could not start a new business nor work in horse therapy for 5 years after 20XX. I did
some animal assisted therapy following XX using the dog for .” These
written statements completely contradict each other. The first information received by
this agent before the Section 4958 assessment was issued. The second
correspondence from the Executive Director after the Section 4958 assessment was
issued.

Regs. 1.501(c)(3)-1(d)(1)(ii) states that the burden of proof is upon the organization to
establish that it is not organized or operated for the benefit of private interests. This
requirement applies equally to inurement and private benefit issues. While it is difficult
to prove a negative, the organization is certainly in a better position than the Service to
know the detailed facts surrounding its formation and operation. Therefore, in an
exemption application case the organization is required to furnish the Service with the
documents setting forth its purposes and rules of operation as well as a detailed
explanation of its operations. See Rev. Proc. 84-46, 1984-1 C.B. 541.

Just like John Marshall Law School and John Marshall University the officers of
channeled the funds created from the sale of the facilities owned by
. The proceeds from the sale were diverted for personal use just as in United
Cancer Council, Inc. v. Commissioner, 165 F.3d 1173 (1999). The funds were
received by , the funds were used by the Executive Director to build an new
barn on the Executive directors personal property. The dates provided for this activity
were October 20XX to February of 20XX.

stated that they had not received any revenues on their return during the
year ending December 31, 20XX. stated on their 20XX return received on
July 4, 20XX that the loan was to be paid off over a 10 year period, but the loan had
already been paid during the 20XX year. No revenues were disclosed to the
Government by on the Form 990. No revenues were disclosed to the
Government during the exam process. Two IDRs were sent requesting all financial

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 R
Name of Taxpayer Year/Period Ended
20XX

information for the year 20XX. The Executive Director sent a note stating that
absolutely no revenues were received in the year 20XX. The Executive Director
indicated that there was no existing bank account for .

In the case of it is the service’s position that the private individual’s
benefit is substantial and with no exempt purpose the private benefit to an individual or
a group of individuals is greater than the public benefit. There was no public benefit
presented by for the year under exam. has not
performed any exempt function from the beginning of 20XX to present. This instance
private benefit is considered the only function presented by the exempt organization.
Therefore, it is the services position that exempt status must be revoked.

It is the Government's position that the Executive Director has not provided any
consistency in the information provided in this examination.

CONCLUSION

Regs. 1.501(c)(3)-1(d)(1)(ii) states that an organization is not organized or operated
exclusively for exempt purposes unless it serves a public rather than a private interest.
The regulation places the burden of proof on the organization to demonstrate 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. This agent asked
about its revenues and activities during the year ending December 31, 20XX and
indicated there were no activities, nor was there any revenues received by the exempt
organization. would Terminate its exemption in February of 20XX.

Based on the foregoing reasons, the organization does not qualify for exemption
under section 501(c)(3) and its tax exempt status should be revoked as of January 1
20XX.

should have their exempt status revoked due to lack of exempt purposes
and no activities. There were no exempt activities were performed during the year
under exam.

TAXPAYER’S POSITION

position is that they did not do anything wrong.

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