Daycare organization loses exemption over records and insider transfers

Plain-English summary

The IRS revoked the exemption of an organization that operated three full-time daycare facilities and participated in government-subsidized child-care and food programs. After repeated document requests, the organization provided some ledgers and bank statements but not substantial supporting records for expenses, debts, rental arrangements, and other transactions. Its president said parent fees did not differ because of nonprofit status, and the organization did not show how its operations differed from comparable for-profit daycare providers. It also transferred two facilities to a for-profit entity owned by the founder and former president. The IRS concluded that the organization failed to substantiate its exempt operations or show that the insider transfers were at arm's length and did not confer private benefit. The organization agreed to revocation effective January 1 of the redacted year.

Ruling snapshot

• Question: Did the daycare organization substantiate exempt operations, adequate records, and the absence of private benefit from facility transfers?
• Outcome: Revocation effective January 1 of the redacted year
• Key authorities: IRC §§ 501, 6001, and 6033; Treas. Reg. §§ 1.6001-1 and 1.6033-1; Rev. Rul. 59-95 and Rev. Rul. 68-166

Full text (IRS public release)

DEPARTMENT OF THE TREASURY

Internal Revenue Service
TE/GE EO Examinations
1100 Commerce Street M/C 4920 DAL

Dallas, TX 75242

TAX EXEMPT AND ‘
GOVERNMENT ENTITIES Date: SEP 17 2015
DIVISION
Person to Contact:
Release Number: 201603035 Identification Number:
Release Date: 1/15/2016 Telephone Number:
UIL Code: 501.03-00 In Reply Refer to: TE/GE Review Staff

LAST DATE FOR FILING A PETITION
WITH THE TAX COURT:
DEC 16 2015

CERTIFIED MAIL — Return Receipt Requested

Dear:

This is a Final Adverse Determination Letter that your organization was not exempt from
taxation under section 501(a) as described under section 501(c)(3) of the Internal Revenue
Code (IRC). The denial of your tax exempt status is effective January 1, 20XX.

Our adverse determination was made for the following reasons:

You have not established that you are operated exclusively for an exempt
purpose or that you have been engaged primarily in activities that accomplish
one or more exempt purposes.

You have not established that no part of your net earnings inure to the benefit
of any private shareholder or individual.

Contributions to your organization are not 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.

The Taxpayer Advocate Service (TAS) is an independent organization within the IRS that
can help protect your taxpayer rights. We can offer you help if your tax problem is causing a
hardship, or you've tried but haven’t been able to resolve your problem with the IRS. If you
qualify for our assistance, which is always free, we will do everything possible to help you.
Visit taxpayeradvocate.irs.gov or call 1-877-777-4778.

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,
John A. Koskinen
Commissioner
By

Margaret Von Lienen
Director
EO Examinations

Enclosures:
Publication 892

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

Exempt Organizations: Examinations

1100 Commerce Street MS 4900 DAL

Dallas, TX 75242-1100

Date:
May 19, 2015
Taxpayer Identification Number:

Form:

990 Return
Tax Year(s) Ended:

Dec. 31, 20XX and Dec. 31, 20XX
Person to Contact/ID Number:

Contact Numbers:
Telephone:
Fax:

Manager’s name/ID number:

Manager’s contact number:

Response due date:
June 19, 2015

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.

Sincerely,

Margaret Von Lienen
Director, EO Examinations

Enclosures:

Report of Examination
Form 6018
Publication 892
Publication 3498

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

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
20XX
20XX
ISSUE:
Whether ( ) qualifies for exemption under Section 501(c)(3) of the Internal

Revenue Code.

FACTS:

filed the Form 1023, Application for Recognition of Exemption Under Section
501(c)(3) of the International Revenue Code, on September 6, 19XX, stating that the primary purpose and

mission of , Inc. is a childcare organization which provides services to working
parents. Internal Revenue Service granted exempt status to on July 10, 19XX.
The Form 990 for the year 20XX was filed by the vice president, , on November 29, 20XX. Part I

of the Form 990 stated that its exempt activities were to operate day care centers for infants through
school-aged children for working parents. The Form 990 for the year 20XX was not filed by the
organization as of this date.

On August 19, 20XX, a letter was issued to the organization requesting documents for review during a
field examination on September 8-10, 20XX. However, during a field examination on September 8
through September 10, 20XX, none of the requested information was provided. On October 2, 20XX, a
second request was issued to the organization. On February 18, 20XX, after a request for an extension
of time, a third request was issued. On March 17, 20XX, a fourth request was issued. On May 7, 20XX,
a second field examination was conducted at the facility of . During the field
examination, the organization provided some of the requested documents, such as the general ledger
for the year 20XX, bank statements, and some requested documents. However, the organization still
failed to provide substantial documentation, including cancelled checks, credit card statements,
mortgages and notes payable, invoices, rental agreements for , and

facilities, records for any food reimbursement payments, and receipts for office expenses, food,
supplies, transportation, and other uncategorized expenses.

is a Licensed Child Care Center. In the year under examination, it operated full time
daycare centers from Monday through Friday in three daycare facilities: , and
accepted child categories of: infant, toddler, preschooler, and school age.
participated in the government subsidized child care program. It participated in the federally

funded Child Care Food Program in its facility.
A question was asked of the president of ; , regarding how
differs from other for-profit day care providers. provided explanation indicated that there

was no difference in fees paid by the parents due to its not-for-profit status. There is a difference in fees
paid if the family qualifies for government assistance through the state, but the fee determination has
nothing to do with a for-profit or not-for-profit status. The fee is determined by family income, family size
and the number of your children that will be in child care.

During the second field examination, provided documents to the examiner indicating that
sold and transferred its two facilities in and to a for-profit
entity, the . in 20XX. The sale price of the two facilities

Form 886-A (1-1994) Catalog Number 20810W Page_1 publish.no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
20XX
20XX
was for the assumption of debts of $ plus $. The owner
is who was the founder and prior president of
LAW:

IRC § 6001 provides that every person liable for any tax imposed by the IRC, or for the collection thereof,
shall keep adequate records as the Secretary of the Treasury or his delegate may from time to time
prescribe.

IRC § 6033(a)(1) provides, except as provided in IRC § 6033(a)(2), every organization exempt from tax
under section 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.

Treas. Reg. § 1.6001-1(a) in conjunction with Treas. Reg. § 1.6001-1(c) provides that every organization
exempt from tax under IRC § 501(a) and subject to the tax imposed by IRC § 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 IRC § 6033.

Treas. Reg. § 1.6001-1(e) states that the books or records required by this section shall be kept at all times
available for inspection by authorized internal revenue officers or employees, and shall be retained as long
as the contents thereof may be material in the administration of any internal revenue law.

Treas. Reg § 1.6033-1(h)(2) provides that every organization which has established its right to exemption
from tax, whether or not it is required to file an annual return of information, shall submit such additional
information as may be required by the district director for the purpose of enabling him to inquire further into
its exempt status and to administer the provisions of subchapter F (section 501 and the following), chapter
1 of the Code and IRC § 6033.

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. However, its records were so
incomplete that the organization was unable to furnish such statements. The Service held that the failure or
inability to file the required information return or otherwise to comply with the provisions of IRC § 6033 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 exempt status.

In accordance with the above cited provisions of the Code and regulations under IRC §§ 6001 and 6033,
organizations recognized as exempt from federal income tax must meet certain reporting requirements.
These requirements relate to the filing of a complete and accurate annual information (and other
required federal tax forms) and the retention of records sufficient to determine whether such entity is
operated for the purposes for which it was granted tax-exempt status and to determine its liability for any
unrelated business income tax.

Form 886-A (1-1994) Catalog Number 20810W Page 2 publish.no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended

20XX
20XX

Rev. Rul. 68-166, 1968-1 C.B. 255, provides that a nonprofit organization formed to operate a day care
center for young children of needy working parents, who have no means to provide care for their
children during the day, qualifies for exemption under IRC 501(c)(3). The organization charged a
nominal fee and was largely dependent on contributions for support.

GOVERNMENT’S POSITION:

In order to claim tax-exempt status a corporation must keep records sufficient to show specifically its
items of gross income, receipts and disbursements and show that it is entitled to the exemption, as
specified under IRC §6001 and Treasury Regulation §1.6001-1(c).

The documents provided by the organization were not enough to demonstrate whether the funds used
were for its exempt purpose. The records for the year 20XX were not complete and no other records for
the year 20XX were provided except the bank statements.

has failed to keep and provide records adequate to determine the full nature of its
operations and failed to show that its operations do not inure in part to the private benefit of its officers.

Further, the president of indicated in her response that there is no difference in fees paid
by the parents due to its not-for-profit status. could not demonstrate how its
operations differ from other compatible for-profit daycare providers.

Finally, could not demonstrate that the transfers of its and
facilities to an insider were arm’s length, failing to demonstrate that no part of the net earnings of which
inured to the benefit of any private shareholder or individual.

has failed to demonstrate its operations meet the requirements under IRC 501(c)(3) as a
charitable organization, and should be revoked effective the beginning of the examination period.

TAXPAYER'S POSITION:

The organization agreed to the revocation proposed by IRS. The effective date of the revocation is
January 1, 20XX.

The organization signed the Form 6018 Consent to Proposed Action — Section 7428 on May 7, 20XX.

CONCLUSION:

has failed to keep and provide adequate records as required by IRC §§ 6001 and 6033,
and has failed to demonstrate its daycare operations meet the requirements under IRC 501(c)(3) of the
Internal Revenue Code. Accordingly the organization’s exempt status is revoked effective January 1,
20XX.

Form 886-A (1-1994) Catalog Number 20810W Page 3 publish.no.irs.gov Department of the Treasury-Internal Revenue Service