Inactive charity fails the operational test

Plain-English summary

A charitable organization had conducted fundraising through telemarketing and advertising sales. A state attorney general investigated indications that an officer or key employee used organization funds for personal benefit, and a court-appointed receiver dissolved the organization and distributed its assets to other charities. The IRS examination found that the organization had stopped all exempt activities and failed the operational test under IRC § 501(c)(3). The organization agreed to revocation. The IRS revoked its exemption effective on the redacted date stated in the letter and ended the deductibility of later contributions.

Ruling snapshot

• Question: Did an inactive organization under receivership continue to satisfy the operational requirements for charitable exemption?
• Outcome: Revoked effective on the redacted date stated in the letter
• Key authorities: IRC §§ 170, 501(a), 501(c)(3), 502, and 7428; Treas. Reg. § 1.501(c)(3)-1

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
TE/GE: EO Examinations
1100 Commerce Street, MC 4920 DAL
Dallas, TX 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION April 12, 2016

Taxpayer Identification Number:

Release Number: 201631013
Release Date: 7/29/2016 Person to Contact:

UIL Code: 501.03-00 Identification Number:

Contact Telephone Number:

CERTIFIED MAIL
Dear

This is a final adverse determination regarding your exempt status under section
501(c)(3) of the Internal Revenue Code (the Code). Our favorable determination letter
to you dated May 12, 19XX is hereby revoked and you are no longer exempt under
section 501(a) of the Code effective January 1, 20XX.

The revocation of your exempt status was made for the following reason(s):

As a result of our examination for the tax year ended December 31, 20XX, it was
determined that your organization became inactive since January 1, 20XX and that
there have been no operations or regular financial activities conducted or planned. As
such, you failed to meet the operational requirements for continued exemption under
IRC 501(c)(3).

Contributions to your organization are no longer deductible under IRC §170 after
January 1, 20XX.

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

Processing of income tax returns and assessments 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 under the declaratory judgment provisions of
section 7428 of the Code, a petition to the United States Tax Court, the United States
Claims Court, or the district court of the United States for the District of Columbia must
be filed before the 91st Day after the date this determination was mailed to you. Please
contact the clerk of the appropriate court for rules regarding filing petitions for
declaratory judgments by referring to the enclosed Publication 892. You may write to
these courts at the following addresses:

United States Tax Court United States Court of Federal Claims

400 Second Street, NW 717 Madison Place, NW
Washington, D.C. 20217 Washington, D.C. 20005

United States District Court for the District of Columbia
333 Constitution Avenue, NW
Washington, D.C. 20001

The Taxpayer Advocate Service (TAS) is an independent organization within the
IRS that can help protect your taxpayer rights. TAS 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 TAS assistance, which is always
free, TAS will do everything possible to help you. Visit taxpayeradvocate.irs.gov
or call 1-877-777-4778.

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

Sincerely,
Paul A. Marmolejo
Acting Director, EO Examinations

Enclosure:

Publication 892
34198J

Department of the Treasury Date:

Internal Revenue Service 4/22/2015
IRS Tax Exempt and Government Entities Division Taxpayer Identification Number:
Form:

Tax year(s) ended:

January 1,20XX

Person to contact / ID number:

Contact numbers:

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.

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

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

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.

Thank you for your cooperation.

Sincerely,

Margaret Von Lienen
Director, EO Examinations

Enclosures:

Report of Examination
Form 6018
Publication 892
Publication 3498

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

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
December 31,
20XX
ISSUES:
Whether (EO) is qualified to be exempt under Internal

Revenue Code (IRC) section 501(c)(3) since it ceased activities starting January 1,
20XX.

FACTS:

EO was incorporated in the state of on June 8, 19XX. On May 12,
19XX determination was made that organization is exempt from Federal Income Tax
under section 501(a) of the Internal Revenue Code as an organization described in
section 501(c)(3).

Form 1023 stated that the EO was organized to plan, develop, construct, and operate

a honoring , both present and past.
The organization’s purpose in so doing is to promote public awareness and
understanding about this branch of in the State of

will receive in the

EO jointly operated a fund-raising operation through telemarketing to the general
public and selling advertisements in a monthly magazine. The stated charitable
purpose was to serve the need of . They had no affiliation with the
. The for-profit company putting out the magazine had three leased call centers in

, one leased call center in and one leased office in

The Attorney General was investigating the EO because there were
indication that an officer/key employee of the EO was utilizing exempt organization
funds for personal benefit and inurement. The AG completed their examination with
the issuance of "Agreed Final Judgment and Permanent
Injunction".

The "Agreed Final Judgment and Permanent Injunction":
• The individual officers/key employees were to turn any EO assets in their
possession over to the court appointed receiver.
• The receiver was to sell all EO assets and turn over all money and to
the and the
• The officer/employee mentioned above is to pay $XX to the State of
representing attorney fees, and $XX for penalties.

The AG’s office seized control of the EO and an attorney, , was
appointed by the courts to act as receiver for the dissolution of the EO as of December
of 20XX. EO has not been conducting any exempt activities since January 1, 20XX.
has completed the process of closing down the EO, collect any amount that is owed by

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
Name of Taxpayer Year/Period Ended
December 31,
20XX

the defendants to the EO as ordered by the court and to distribute EO’s assets per
court order.

eliminated all of the leases and liquidated the office equipment. EO owned
two real properties, one in and one in sold both,
under court supervision. The sales proceeds were distributed to bona fide charities
which actually serves the purported charitable purpose of the receivership entities.

As of 12/31/20XX, has distributed the assets to two other 501(c)(3)
organizations — and . There is around $XX
in the operating account which is being used to pay for storage, fees

and accountant fees.
LAW:

Internal Revenue Code (IRC) section 501(a) provides, in part, that organizations
described in section 501(c) are exempt from federal income tax. Section 501(c)(3)
provides in pertinent part, that an organization must be organized and operated
exclusively for religious, charitable, or educational purposes and no part of its net
earnings may inure to the benefit of any private shareholder or individual.

IRC 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.

IRC 502 states that an organization operated for the primary purpose of carrying on a
trade or business for profit shall not be exempt from taxation under IRC 501 on the
ground that all of its profits are payable to one or more organizations exempt from
taxation under IRC 501.

Treasury Regulation §1.501(c)(3)-1(a)(1) of the Income Tax Regulations provides
that in order for an organization to be exempt under section 501(c)(3) of the Code it
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 or
operational test, it is not exempt.

Treasury Regulation §1.501(a)-1(b)(3)(c) states that the words “private shareholder
or individual” in section 501 refer to persons having a personal and private interest in
the activities of the organization. The word “shareholder,” as used here, does not
have the same meaning as it does in a for-profit corporation. An exempt organization
cannot have shareholders, or it would not meet the organizational test. However,
these are terms that Congress gave us.

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

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

Treasury Regulation §1.501(c)(3)-1(b)(4) provides that an organization is not
organized exclusively for one or more exempt purposes unless its assets are dedicated
to an exempt purpose. Further, it provides that an organization does not meet the
organizational test if its articles or the law of the State in which it was created provide
that its assets would, upon dissolution, be distributed to its members or
shareholders.

Treasury Regulation §1.501(c)(3)-1(c)(1) provides 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 such exempt purposes specified
in section 501(c)(3) of the Code. An organization will not be so regarded if more than
an insubstantial part of its activities is not in furtherance of an exempt purpose.

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

Treasury Regulations §1.501(c)(3)-1(d)(ii) 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.

Treasury Regulations §1.501(c)(3)-1(d)(1)(ii), states that an organization is not
operated exclusively for one or more exempt purposes if its net earnings inure in
whole or in part to the benefit of private shareholders or individuals.

Treasury Regulation §1.501(c)(3)-1(d)(1)(ii) states that an organization is not
organized or operated exclusively for one or more of the purposes specified in
subdivision (i) of this subparagraph 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, the creator or his family, shareholders of the
organization, or persons controlled, directly or indirectly, by such private interests.
This group of individuals is generally referred to as “insiders.” This 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.

TAXPAYER’S POSITION:

Taxpayer has agreed to the revocation.

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

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

GOVERNMENT’S POSITION:

IRC Section 501(c)(3) of the Code exempts from federal income tax organizations
organized and operated exclusively for charitable, educational, and other exempt
purposes. As of , the EO is not organized or operated exclusively for charitable,
educational purpose and is in the process of terminating all its activities.

Treasury Regulations §1.501(c)(3)-1(d)(1)(ii) states that the EO needs to meet the
three requirements of the Operational Test to qualify for exemption.

The three requirements are:

1. Engage primarily in activities which accomplish one or more of the
   exempt purposes specified in IRC section 501(c)(3) and (Treas. Reg.
   Section 1.501(c)(3)-1(c)(1)): Conclusion —- The EO has not been conducting any
   exempt purpose activities beginning of 20XX. The Attorney General
   started its investigation of the EO’s activities and decided to shut down the EO
   in 20XX. , the court appointed receiver, is in the process of
   terminating the EO. Therefore, the EO does not meet the primary activities
   test.

2. Not allow its net earnings to inure to the benefit of private shareholders or
   individuals (Treas. Reg. Section 1.501(c)(3)-1(c)(2)): Conclusion — there were
   indication that an officer/key employee of the EO was utilizing exempt
   organization funds for personal benefit and inurement. Therefore, the AG
   decided to shut down the EO, liquidate all assets and donate all proceeds to
   other bona fide 501(c)(3) charities. Therefore, the EO does not meet the
   requirement that no net earnings inure to the benefit of private shareholders of
   individuals.

3. Not engage in substantial lobbying activity (Treas. Reg. Section 1.501(c)(3)-
   1(c)(3)), and not engage in any political activity (Treas. Reg. Section
   1.501(c)(3)-1(c)(3)).: Conclusion — EO did not engage in any political or
   lobbying activity.

The above mentioned treasury regulations state that if an organization fails to comply
with any of these requirements, it will fail the operational test and lose its IRC section
501(c)(3) exemption. Its therefore, government’s position that EO does not qualify to
be exempt under 501(c)(3).

CONCLUSION:

As stated above, EO does not qualify to be exempt under IRC section 501(c)(3) or any
other section of the Code because it did not meet the operational test.

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

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

The service will not secure form 1120-H from the EO because all the proceeds have
been donated to bona fide charities as per instructions of the court.

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -5-