For-profit construction operation denied 501(c)(3) exemption

Plain-English summary

A for-profit stock corporation sought section 501(c)(3) status for a program that would train ex-felons through highway construction, hauling, debris removal, and related work. It planned to bid for government and private contracts, pay the trainees as permanent employees, acquire substantial equipment, advertise commercially, and earn market-rate service revenue. Its articles authorized stock and did not limit the corporation to exempt purposes or dedicate its assets to exempt uses on dissolution. The IRS concluded that the planned construction business was a substantial commercial purpose and that stock ownership permitted prohibited private inurement. It denied exemption because the corporation failed both the organizational and operational tests. The denial became final after the corporation did not protest within 30 days.

Ruling snapshot

• Question: Did the stock corporation's construction-based training program qualify under section 501(c)(3)?
• Outcome: Denied
• Key authorities: IRC §§ 170 and 501(c)(3); Treas. Reg. § 1.501(c)(3)-1

Full text (IRS public release)

Department of the Treasury
Internal Revenue Service
P.O. Box 2508
IRS Cincinnati, OH 45201
Release Number: 201525012
Release Date: 6/19/2015
UIL Code: 501.03-30
501.32-01
501.36-00

Date: March 25, 2015
Employer ID number:
Contact person/ID number:
Contact telephone number:
Form you must file:
Tax years:
Dear :

This letter is our final determination that you don’t qualify for tax-exempt status under Section 501(c)(3) of the
Internal Revenue Code (the Code). Recently, we sent you a proposed adverse determination in response to your
application. The proposed adverse determination explained the facts, law, and basis for our conclusion, and it
gave you 30 days to file a protest. Because we didn’t receive a protest within the required 30 days, the proposed
determination is now final.

Because you don’t qualify as a tax-exempt organization under Section 501(c)(3) of the Code, donors can’t
deduct contributions to you under Section 170 of the Code. You must file federal income tax returns for the tax
years listed at the top of this letter using the required form (also listed at the top of this letter) within 30 days of
this letter unless you request an extension of time to file.

We’ll make this final adverse determination letter and the proposed adverse determination letter available for
public inspection (as required under Section 6110 of the Code) after deleting certain identifying information.
Please read the enclosed Notice 437, Notice of Intention to Disclose, and review the two attached letters that
show our proposed deletions. If you disagree with our proposed deletions, follow the instructions in the Notice
437 on how to notify us. If you agree with our deletions, you don’t need to take any further action.

We'll also notify the appropriate state officials of our determination by sending them a copy of this final letter
and the proposed determination letter (under Section 6104(c) of the Code). You should contact your state
officials if you have questions about how this determination will affect your state responsibilities and
requirements.

Letter 4038 (Rev. 7-2014)
Catalog Number 47632S

If you have questions about this letter, you can contact the person listed at the top of this letter. If you have
questions about your federal income tax status and responsibilities, call our customer service number at

1-800-829-1040 (TTY 1-800-829-4933 for deaf or hard of hearing) or customer service for businesses at
1-800-829-4933.

Sincerely,

Director, Exempt Organizations

Enclosures:

Notice 437

Redacted Letter 4036, Proposed Adverse Determination Under IRC Section 501(c)(3)
Redacted Letter 4038, Final Adverse Determination Under IRC Section 501(c)(3) - No Protest

Letter 4038 (Rev. 7-2014)
Catalog Number 47632S

Department of the Treasury

Internal Revenue Service

Cincinnati, OH 45201
Date: December 16, 2014
Employer ID number:
Contact person/ID number:

Contact telephone number:

Contact fax number:

Legend: UIL:

C= Law 501.03-30
B= Law 501.32-01
S = Number 501.36-00
T = Number

v = Dollar Range

W = Date

X = State

y = Dollar Amount
z = Dollar Amount

Dear :
We considered your application for recognition of exemption from federal income tax under Section 501(a) of
the Internal Revenue Code (the Code). Based on the information provided, we determined that you don’t qualify

for exemption under Section 501(c)(3) of the Code. This letter explains the basis for our conclusion. Please
keep it for your records.

Issues
Do you qualify for exemption under section 501(c)(3) of the Code? No, for the reasons described below.

Facts

You formed as a business corporation on W in the state of X. Your Articles of Incorporation state that you are
authorized to issue ownership shares, and your Bylaws outline how those shares are to be issued.

You are one hundred percent minority owned and operated. The four members of your board of directors are all
related through family.

Letter 4036 (Rev. 7-2014)
Catalog Number 47630W

You were formed to relieve the poor, disadvantaged, distressed, underprivileged, and in particular ex-felons in
seeking gainful employment. Your goal is to convert ex-felons into productive citizens. Your primary activity
to accomplish this goal is to provide ex-felons training on how to operate and maintain various types of
construction equipment. You were established to take advantage of the enormous growth in the highway
building and highway maintenance industry through the state and federal highway budget program. After the
ex-felons receive training, they can be employed and become beneficial citizens in the community. This will
help them successfully integrate back into society to benefit the community as a whole.

You plan to be involved in all aspects of highway construction and maintenance, concrete and asphalt
application, and in debris removal. You will primarily do this by contracting with state and federal
governments in the construction, enhancement, and maintenance of highway infrastructure. Because you are
minority owned and operated and will be large enough to handle the size of the jobs, you will be in a better
position to bid on large projects. You plan to comply with Federal Laws C and B, which set aside funds for
state and federal projects. You state there are large amounts of government funds set aside for minority owned
businesses, which will give you a stronger opportunity to negotiate contracts in the governmental sector and
provide personal service at a competitive rate, creating a dedicated customer base. You also plan to establish
joint ventures with larger and more established companies to bid on future projects.

According to the business plan included with your application, you will handle the hauling of sand and gravel,
asphalt, and debris for the state and private sector. You state you have no competition in bidding for jobs with
more than S dump trucks with the advantage of C. You will have at least T dump trucks with at least that many
employees to operate them. You will have several acres of land and a warehouse to house equipment and a
classroom. You will also target other markets that will include private businesses looking to upgrade their
grounds, such as business parks and office parks. You will advertise your services to the private sector through
advertisements in the trucking and hauling section of local papers and various business directories.

The ex-felons will complete their initial training with you. You will provide classroom training on how to
operate and repair dump trucks, dump trailers, earth movers, dozers, track hoes, mixing machines, etc.
Supervised instruction and training will continue on the job during your various work projects. These trainees
will remain with you as full-time employees once their initial training is complete. You will compensate
employees at three times the minimum wage and provide an employee benefit package with medical, dental,
vision, disability, life, and cancer insurance, a section 125 plan, sick leave, vacation pay, 401(k) matching,
income tax planning and income tax preparation. You will also provide financial planning and estate planning.
You will require ex-felons to contribute a small percentage of earnings to a charitable organization and
participate in charitable mentoring.

You also plan to create subsidiary businesses in the future. The first subsidiary would be related to purchasing
and rehabilitating run down and dilapidated homes. These homes will then be made available to lower middle
class and upper lower class individuals for purchase. All of the work related to this activity will be done by ex-
felons, but supervised by your board of directors. A second subsidiary would involve a temporary shelter
divided into two units; one unit for battered women and another for at-risk teens. You are not currently
operating any subsidiary businesses.

You plan to receive income from grants and services rendered to the public and private sector, expecting to
receive grants of $y and expecting to receive $z in income in the next three years. For example, you state the
average rate of revenue for debris removal service is approximately between $v an hour depending on the
project. Expenses expected to be incurred include those related to the acquisition of land and equipment, and

Letter 4036 (Rev. 7-2014)
Catalog Number 47630W

normal expenses related to the maintenance of equipment and facilities. Expenses also include compensation to
your employees and each member of your board of directors. You also plan to maintain a reserve sinking fund
designed to withstand hard financial times.

Law

Section 501(c)(3) of the Code provides for the exemption from Federal income tax of organizations organized
and operated exclusively for charitable and educational purposes.

Section 1.501(c)(3)-1(a)(1) of the Income Tax Regulations states that, in order to be exempt as an organization
described in section 501(c)(3) of the Code, 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.

Section 1.501(c)(3)-1(b)(1)(i) of the Regulations provides that an organization is organized exclusively for one
or more exempt purposes only if its articles of organization:

(a) Limit the purposes of such organization to one or more exempt purposes; and
(b) Do not expressly empower the organization engage, otherwise than as an insubstantial part of its
activities, in activities that in themselves are not in furtherance of one or more exempt purposes.

Section 1.501(c)(3)-1(b)(4) of the Regulations holds that an organization is not organized exclusively for one or
more exempt purposes unless its assets are dedicated to an exempt purposes. An organization’s assets will be
considered dedicated to an exempt purpose, for exempt, if, upon dissolution, such assets would, by reason of a
provision in the organization’s articles or operation of law, be distributed for one or more exempt purposes.

Section 1.501(c)(3)-1(c)(1) of the Regulations provides that an organization will be regarded as "operated
exclusively" for one or more exempt purposes only if it engages primarily in activities that 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.

Section 1.501(c)(3)-1(d)(1)(ii) of the Regulations states 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, to
meet the requirement of this subdivision, it is necessary for an organization to establish that it is not organized
or operated for the benefit of private interests such as designated individuals, shareholders of the organization,
or persons controlled, directly or indirectly, by such private interests.

Revenue Ruling 67-150 1, 1967-1 CB 133, describes on organization whose only activity is to rehabilitate ex-
convicts and parolees in order to make them self-supporting and useful citizens. This was conducted through
discussion groups, forums, and various different programs to assist them as well as educate the general public
on various issues. The income of the organization was derived from contributions and all funds were expended
for the programs of the organization. This organization was found to be exempt under section 501(c)(3).

Revenue Ruling 73-127, 1973-1 CB 221, states that a nonprofit organization that operated a cut-price retail
grocery outlet and allocates a small portion of its earnings to provide on-the-job training to hard core
unemployed does not qualify for exemption under section 501(c)(3). The store operated in a similar manner to
profit-making businesses in the area, and its gross earnings are used to principally pay salaries and other

Letter 4036 (Rev. 7-2014)
Catalog Number 47630W

customary operating expenses incurred in the operation of a grocery store and to expand the operations of the
store. It was concluded that the operation of the store and operation of the training program were two distinct
purposes sought to be accomplished by the organization through its use of resources. Since the commercial
operation of a grocery store is not a recognized exempt purpose and this activity was substantial and conducted
on a scale larger than reasonably necessary to conduct the training program, the organization was found not to
be exempt.

Revenue Ruling 73-128, 1973-1 CB 222, describes an organization that was formed to provide educational and
vocational training and guidance to non-skilled persons who are unable to find employment or cannot advance
from poorly paid employment due to inadequate education. The organization’s job training program centered
on the manufacture and sale of a line of toy products. Those hired as trainees are not hired as permanent
employees and the organization tries to place them in permanent positions in the community as soon as they are
adequately trained. Most of the merchandise is sold through normal channels, although, some are donated to
other community organizations. Any additional income received is used to finance the organization’s other
community service activities. The question in this case was whether there is a clear and causal relationship
between the manufacturing activity and the training of individuals for the purpose of improving their
capabilities, and whether the scale of the endeavor suggests that it is being conducted on a scale larger than
reasonably necessary to accomplish the organization’s charitable purpose. The organization in question was
granted exemption under section 501(c)(3) as it was found that the manufacturing activities were an integral
part of the training process and there was no evidence to suggest that it is being conducted on a scale larger than
reasonably necessary.

Better Business Bureau of Washington, D.C., Inc v. United States, 326 U. S. 279 (1945), states that the presence
of a single non-exempt purpose, if substantial in nature, will destroy the exemption regardless of the number
and importance of truly exempt purposes.

In Living Faith Inc. v Comm’r, 60 T.C.M., 710, 713(1990), aff'd 950 F.2d 365 (& Cir. 1991), the court wrote

that the activities were conducted as a business and the organization was in direct competition with other
restaurants and health food stores; thus it did not qualify for exemption under Section 501(c)(3). The appellate
court stated the factors that the court relied on to find commerciality and thus offered the best contemporary
explanation of the commerciality doctrine.

In Arlie Foundation, Inc. v. U.S., 283F. Supp. 2d 58 (D. D.C., 2003), the organization operated a conference
facility made available primarily to exempt organizations and governmental units. It was found that even
though the organization argued that serving non-profit and governmental clients is indicative of an exempt
purpose, the organization was found not to be exempt under section 501(c)(3). This was because it was found
to be operating in a manner not significantly distinguishable from a commercial endeavor, and thus furthering a
substantial non-exempt purpose. The court also found that the organization’s patrons were not limited to
exempt entities, or a charitable class.

Application of law

Section 501(c)(3) of the Code sets forth two main tests to qualify for exempt status. An organization must be
both organized and operated exclusively for purposes described in section 501(c)(3). You are formed with the
state as a for-profit, stock corporation. The provisions of your Articles of Incorporation do not limit your
purposes to exclusively 501(c)(3) purposes, nor do they require you to distribute your assets for exclusively

Letter 4036 (Rev. 7-2014)
Catalog Number 47630W

501(c)(3) purposes upon dissolution. As a result, you have not satisfied the organizational test required by
Sections 1.501(c)(3)-1(b)(1)(i) and 1.501(c)(3)-1(b)(4) of the Regulations.

You are operating for substantial commercial purposes, which furthers private, rather than public, purposes.
Therefore, you are not operated for exclusively charitable and educational purposes under Section 1.501(c)(3)-
1(c)(1) of the Regulations. Some of your proposed activities do further educational purposes, such as providing
training and employment to ex-convicts. However, a substantial portion of your time is dedicated to the
commercial purpose of securing contracts and performing services for a fee similar to an ordinary business.
Despite any charitable or educational purposes you may achieve, your operations do not further exclusively
501(c)(3) purposes.

Your Articles of Incorporation and Bylaws authorize you to issue capital stock and to make distributions to
stockholders. The holding of stock by any private individual that entitles that individual to any part of your
assets or income constitutes inurement prohibited under Section 501(c)(3) of the Code. As a result your net
earnings are set to inure to private individuals, which precludes exemption under Section 1.501(c)(3)-1(d)(1)(ii)
of the Regulations. Because your organizing documents are structured in this manner, you do not meet the
organizational and operational tests of Section 1.501(c)(3)-1(a)(1) of the Regulations.

You are not like the organizations described in Revenue Rulings 67-150 and 73-128. The ex-felons that you
train will be permanent employees, and you will provide them a competitive compensation and benefit package.
This demonstrates that they will be long-term employees to further your commercial operations. Your planned
expenses are to further the operation of your business, such as land and equipment acquisition and maintenance
and compensation. While you may provide some charitable and educational assistance as outlined in Revenue
Ruling 67-150, the scale of your commercial endeavor is larger than reasonably necessary to accomplish any
charitable purpose, demonstrating you are operating for substantial commercial purposes.

You are operating similarly to the organization described in Revenue Ruling 73-127. You provide job training
to individuals who are chronically unemployed. However, you plan for these individuals to be permanent
employees when training is complete. You are organized as a for-profit organization and operate in a fashion
similar to for-profit businesses. You will compete in bidding processes with other for-profit businesses. Since
your commercial operations are a substantial non-exempt purpose, you are not organized and operated
exclusively for charitable purposes.

As with the case of the Better Business Bureau of Washington D.C., operating a business to assist in the normal
construction and maintenance of highways as well as providing services in debris removal and concrete and
asphalt application is a substantial non-exempt purpose. As this case outlines, any evidence of a substantial
non-exempt purpose precludes exemption under section 501(c)(3) of the Code.

Similar to the Arlie Foundation and Living Faith, you have not sufficiently represented that you are
significantly distinguishable from a commercial endeavor. You are formed as a for-profit corporation. To
provide services to state and federal governments, you plan to bid for contracts in competition with for-profit
enterprises. You plan to earn market rate for services you provide. Your expenses primarily relate to
maintaining and operating facilities and equipment, compensation, and benefits. You will advertise in ordinary
business publications and maintain a reserve of funds for hard economic times. Thus, even though you may
provide some education and training to employees, you are also serving a substantial non-exempt purpose of
operating a business.

Letter 4036 (Rev. 7-2014)
Catalog Number 47630W

Conclusion

Based on the information provided, you do not qualify for exemption because you are not organized or operated
for exclusively 501(c)(3) purposes. While you may provide some training to individuals representing a
charitable class, a substantial part of your activities are commercial in nature. Your operations also inure to the
benefit your shareholders since you are for-profit, stock corporation. Therefore, you do not qualify for
exemption under 501(c)(3) of the Code.

If you don’t agree
You have a right to file a protest if you don’t agree with our proposed adverse determination. To do so, you
must send a statement to us within 30 days of the date of this letter. The statement must include:

• Your name, address, employer identification number (EIN), and a daytime phone
number

• A copy of this letter highlighting the findings you disagree with
• An explanation of why you disagree, including any supporting documents
• The law or authority, if any, you are relying on

• The signature of an officer, director, trustee, or other official who is authorized to sign for the
organization, or your authorized representative

• One of the following declarations:

For an officer, director, trustee, or other official who is authorized to sign for the organization:
Under penalties of perjury, I declare that I examined this protest statement, including

accompanying documents, and to the best of my knowledge and belief, the statement contains all
relevant facts and such facts are true, correct, and complete.

For authorized representatives:

Under penalties of perjury, I declare that I prepared this protest statement, including
accompanying documents, and to the best of my knowledge and belief, the statement contains all
relevant facts and such facts are true, correct, and complete.

Your representative (attorney, certified public accountant, or other individual enrolled to practice before the
IRS) must file a Form 2848, Power of Attorney and Declaration of Representative, with us if he or she hasn’t
already done so. You can find more information about representation in Publication 947, Practice Before the
IRS and Power of Attorney.

We’ll review your protest statement and decide if you provided a basis for us to reconsider our determination. If
so, we'll continue to process your case considering the information you provided. If you haven’t provided a
basis for reconsideration, we’ll forward your case to the Office of Appeals and notify you. You can find more
information about the role of the Appeals Office in Publication 892, How to Appeal an IRS Decision on Tax-
Exempt Status.

Letter 4036 (Rev. 7-2014)
Catalog Number 47630W

If you don’t file a protest within 30 days, you can’t seek a declaratory judgment in court at a later date because
the law requires that you use the IRS administrative process first (Section 7428(b)(2) of the Code).

Where to send your protest
Please send your protest statement, Form 2848, if needed, and any supporting documents to the applicable
address:

U.S. mail: Street address for delivery service:
Internal Revenue Service Internal Revenue Service

EO Determinations Quality Assurance EO Determinations Quality Assurance
Room 7-008 550 Main Street, Room 7-008

P.O. Box 2508 Cincinnati, OH 45202

Cincinnati, OH 45201

You can also fax your statement and supporting documents to the fax number listed at the top of this letter. If
you fax your statement, please contact the person listed at the top of this letter to confirm that he or she received
it.

If you agree

If you agree with our proposed adverse determination, you don’t need to do anything. If we don’t hear from you
within 30 days, we’ll issue a final adverse determination letter. That letter will provide information on your
income tax filing requirements.

You can find all forms and publications mentioned in this letter on our website at www.irs.gov/formspubs. If
you have questions, you can contact the person listed at the top of this letter.

Sincerely,

Director, Exempt Organizations

Enclosure:
Publication 892

Letter 4036 (Rev. 7-2014)
Catalog Number 47630W