Charity loses exemption for serving a telemarketer's private interests

Plain-English summary

A charity's only activity was a corporate sponsorship program operated by a related for-profit home-improvement company. The company used its employees to make solicitation calls in the charity's name, schedule sales appointments, and make payments to the charity, which passed net proceeds to another charity. The IRS found that this arrangement let the company use the charity exception to Do-Not-Call restrictions, reach prospective customers it otherwise could not contact, and gain a substantial competitive benefit. Replacing related board members did not cure the problem because the sponsorship program continued to serve the company's private and commercial interests. The IRS revoked the organization's section 501(c)(3) status effective January 1, 2010.

Ruling snapshot

• Question: Did the organization's telemarketing sponsorship program operate exclusively for charitable purposes rather than substantially benefiting a for-profit company?
• Outcome: Exemption revoked effective January 1, 2010.
• Key authorities: IRC § 501(c)(3); Treas. Reg. § 1.501(c)(3)-1; Better Business Bureau v. United States; EST of Hawaii v. Commissioner.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Appeals Office

San Jose Appeals, MS-7100 Employer Identification Number:
55 S. Market St., Suite 440

San Jose, CA 95113

Person to Contact:

Date: MAY 26 2016

Number: 201634029 Employee ID Number:
Release Date: 8/19/2016 Tel:
Fax:

Contact Hours:
UIL:

0501.09-03
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”). It is determined that you do not qualify as exempt from Federal
income tax under section § 501(c)(3) of the Code effective January 1, 2010.

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

You are not operated exclusively for exempt purposes within the meaning of Internal Revenue Code
§ 501(c)(3) and Treasury Regulation § 1.501(c)(3)-1. You are operated for substantial private and
commercial purposes, rather than exclusively for public purposes.

Contributions to your organization are not deductible under section 170 of the Code.

You are required to file Federal income tax returns on Forms 1120. File your return with the appropriate
Internal Revenue Service Center per the instructions of the return. For further instructions, forms, and

information please visit www.irs.gov.

If you were a private foundation as of the effective date of the adverse determination, you are considered
to be taxable private foundation until you terminate your private foundation status under section 507 of
the Code. In addition to your income tax return, you must also continue to file Form 990-PF by the 15th
Day of the fifth month after the end of your annual accounting period.

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 Code.

We will make this letter and the proposed adverse determination letter available for public inspection
under Code section 6110 after deleting certain identifying information. We have provided to you, in a
separate mailing, Notice 437, Notice of Intention to Disclose. Please review the Notice 437 and the
documents attached that show our proposed deletions. If you disagree with our proposed deletions, follow
the instructions in Notice 437.

If you decide to contest this determination, you may file an action for declaratory judgment under the
provisions of section 7428 of the Code in one of the following three venues: 1) United States Tax Court,
2) the United States Court of Federal Claims, or 3) the United States District Court for the District of
Columbia. A petition or complaint in one of these three courts must be filed within 90 days from the date
this determination letter was mailed to you. Please contact the clerk of the appropriate court for rules for

filing petitions for declaratory judgment. To secure a petition form from the United States Tax Court, write
to the United States Tax Court, 400 Second Street, N.W., Washington, D.C. 20217. See also Publication
892.

You also have the right to contact the office of the Taxpayer Advocate. Taxpayer Advocate assistance is
not a substitute for established IRS procedures, such as the formal appeals process. The Taxpayer
Advocate cannot reverse a legally correct tax determination, or extend the time fixed by law that you have
to file a petition in a United States Court. The Taxpayer Advocate can however, see that a tax matters
that may not have been resolved through normal channels get prompt and proper handling. If you want
Taxpayer Advocate assistance, please contact the Taxpayer Advocate for the IRS office that issued this
letter. You may call toll-free, 1-877-777-4778, for the Taxpayer Advocate or visit www.irs.gov/advocate
for more information.

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

Sincerely Yours,

Appeals Team Manager

Enclosure: Publication 892 and/or 556

CC:

Department of the Treasury Date: JAN 12 2015
Internal Revenue Service
IRS Tax Exempt and Government Entities Division Taxpayer Identification Number:

Form:
Tax year(s) ended:

Person to contact / ID number:

Contact numbers:
Phone:

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.

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,

Michael E. Bagley

for 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 886-A Schedule number or exhibit
EXPLANATION OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended

ORG December 31, 20XX
ISSUES

1. Should the IRC section 501(c)(3) tax exempt status of the taxpayer, ORG ("TP"), be revoked because it is
not operated exclusively for tax exempt purposes?

TP was incorporated December 21, 20XX, pursuant to the provisions of the Nonprofit Corporations Act of the
State of State ("State"). TP's original and amended Articles of Incorporation ("AOI") filed with the State provides,
in part, that its purpose is to receive and administer funds for the Foundation of Southeastern State ("FDNSS")
and to contract with a third party business to raise funds and awareness of the FDNSS. The FDNSS is a
501(c)(3) public charity that provides temporary housing for families of hospitalized children. In December,
20XX, TP filed Form 1023, Application for Recognition of Exemption under Section 501(c)(3) of the Internal
Revenue Code, with the IRS. In August, 20XX, pursuant to a ruling issued by the IRS, TP was granted
exemption from federal income taxation as an organization described in IRC section 501(c)(3). The organization
was expected to be a publicly supported charity within the meaning of IRC sections

170(b)(1)(A)(vi) and 509(a)(1).

An examination of TP's 20XX, 20XX, and 20XX Form 990 returns, along with oral testimony provided by
TP's founder and president during the course of the examination disclosed the following:

1. TP's only activity is the administration of a corporate sponsorship program (“CSP”) whereby TP
partners with CO-1 ("CO-1"), a State for-profit home improvement company specializing in home
replacement windows. TP disclosed during the examination that it also plans to expand its CSP in
the future to include other for-profit organizations.

2. TP's board of directors consists of three individuals, two of whom are related by marriage. TP's
founder/president and its secretary are married to principal officers of CO-1 (who are also
related). TP's treasurer is not related to any parties affiliated with either TP or CO-1.

TP's only source of income is derived through its CSP with CO-1, which administers a telephone solicitation
program on behalf of TP using its own employees. TP has no employees or volunteers (other than board
members) and engages in no other activities other than its CSP with CO-1. Further, TP did not solicit, nor did it
receive, contributions from the general public or any governmental entities during the periods under
examination. Gross receipts generated from TP's CSP during the 20XX, 20XX and 20XX tax periods totaled
$0, $0, and $0 respectively.

Based on interviews with TP's founder/president, as well as a review of telephone solicitation scripts used by
CO-1, the operation of TP's CSP is as follows:

1. CO-1 uses an automatic/ predictive dialer to place phone calls to potential customers of CO-1.
Hundreds of phone calls are placed by the auto dialer each day.

2. Once a live pickup is detected, the auto dialer either plays a recorded message or connects the call to
an available live operator.

3. Once connected, the live operator, an employee of CO-1, identifies themselves by first name and
conveys to the prospective customer that they are calling on behalf of TP.

4. The live operator then informs the prospective customer that TP sponsors home improvement companies for
the purpose of helping local children's charities and that TP receives a donation from CO-1 for every home
owner that accepts a product demonstration and free estimate.

5. If successful, the live operator schedules an appointment with the prospective customer for a free in-home
product demonstration and estimate by a representative of CO-1.

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

Form 886-A Schedule number or exhibit
EXPLANATION OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended

ORG December 31, 20XX

6. Between 6 and 20 in-home appointments per day are normally scheduled with prospective
customers through this program. CO-1 makes a donation to TP for each potential customer
contacted and an additional $0 for each successful in-home appointment scheduled.

7. TP remits all donations from CO-1, minus general and administrative expenses, to FDNSS.

It should be noted that TP’s activities related to its CSP during the tax periods under examination were not materially
different from the description of planned activities it provided to the IRS as an addendum to its Form 1023 application.

LAW

Internal Revenue Code ("IRC") section 501(a) exempts organizations described in IRC 501(c) from federal
income taxes.

An organization exempt under IRC section 501(a) and described in IRC section 501(c)(3), must be both
organized and operated exclusively for one or more of the purposes specified in such Code section. If an
organization fails to meet either the organizational test or the operational test, it is not exempt (Treasury
Regulation ("Treas. Reg.") section 1.501(c)(3)-1(a)(1)).

An organization is organized exclusively for one or more 501(c)(3) exempt purposes only if its organizing
documents: limits the purposes of such organizations to one or more exempt purposes; does not expressly
empower the organization to engage, other than as an insubstantial part of its activities, in activities which in
themselves are not in furtherance of one or more exempt purposes, and; permanently dedicates the
organization's assets to 501(c)(3) purposes upon dissolution unless the operation of state law or court action
produces the same result (Treas. Reg. section 1.501(c)(3)-1(b)).

Organizations described in IRC section 501(c)(3) must: absolutely refrain from participating in any political
activities; not engage substantially in legislative activities; not permit its earnings to inure to the benefit of any
private individual or shareholder; not substantially engage in a trade or business that is not related to its exempt
purpose; and must not engage in any activities that are illegal or violate fundamental public policy (Treas. Reg.
section 1.501(c)(3)-1).

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

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 (Treas. Reg. Section 1.501(c)(3)-1(c)(2)).

The words 'private shareholder or individual' in Section 501 refer to persons having a personal and private
interest in the activities of the organization (Treas. Reg. Section 1.501(a)-1(c)).

An organization is not organized or operated exclusively for one or more exempt purposes unless it serves a
public rather than a private interest. To meet the requirement of this subsection, the burden of proof is on the
organization to show 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. Section 1.501(c)(3)-1(d)(1)(ii)).

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

Form 886-A Schedule number or exhibit
EXPLANATION OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended

ORG December 31, 20XX

The presence of a single non-exempt purpose, if substantial in nature, will destroy the exemption regardless of
the number or importance of truly exempt purposes (Better Business Bureau of Washington. D.C. v. United
States, 326 U.S. 279,283,66 S. Ct.112, 90 L. Ed. 67, 1945 C.B. 375 (1945)).

When an organization operates for the benefit of private interest, the organization by definition does not operate
exclusively for exempt purposes. Prohibited private benefits may include an advantage, profit, fruit, privilege, gain,
or interest (American Campaign Academy v. Commissioner, 92 T.C. 1053, 1065-1066 (1989)).

Operating under the control of one person or a small, related group suggests that an organization operates
primarily for non-exempt private purposes, rather than exclusively for public purposes (Rev. Rul. 55-656,
1955-1 C.B, 262).

Although control by a small group may not necessarily disqualify [an organization] for exemption, it provides an
obvious opportunity for abuse of the claimed tax-exempt status (Church of Ethereal Joy, 83 T.C. 20 at 23
(1984). See also: United States Fifth Circuit Court of Appeals case St. David's Health Care System v. U.S., 349
F.3d 232 (2003)).

In EST of Hawaii v. Commissioner, 71 T.C. 1067 (1979), several for-profit organizations exerted significant indirect
control over a non-profit entity through contractual arrangements. The Tax Court concluded that the for-profits
were able to use the nonprofit as an "instrument" to further their for-profit purposes. Consequently, the Tax Court
held that the non-profit was operated for private and commercial purposes and therefore did not qualify as an
organization described in section 501(c)(3).

Operating for the benefit of private parties constitutes a substantial non-exempt purpose (Old Dominion Box Co. v.
United States, 477 F2d 344 (4th Cir. 1973) cert. Denied 413 U.S. 910 (1973)).

A nonprofit organization may form partnerships, or enter into contracts, with private parties to further its charitable
purposes on mutually beneficial terms, “so long as the nonprofit organization does not thereby impermissibly serve
private interests.”. The operational standard is not satisfied merely by establishing “whatever charitable benefits [the
partnership] may produce,” (Redlands Surgical Services, 113 T.C. 47, 92-93 (1999), aff'd 242 F.3d 904 (9th Cir. 2001)).

Under the Do-Not-Call Implementation Act of 2003 (Public Law No. 108-10), telemarketers are required to stop
calling consumers within 31 days of the consumer registering their phone number with the National Do-Not-Call
Registry. Telemarketers are required to search the registry every 31 days and delete from their call lists phone
numbers that are in the registry. Exceptions to the law includes calls from or on behalf of charities; political
organizations; telephone surveyors; companies with which registered consumers have an existing business
relationship; or companies to whom the consumer has provided an express agreement in writing to receive their
calls.

GOVERNMENT'S POSITION

Based on an examination of TP's 20XX and 20XX Form 990, oral testimony provided by TP's Founder during
the course of the examination, and the application of the provisions at law cited above to the facts and
circumstances of the case, TP is not operated exclusively for purposes described in section 501(c)(3) of the
Code and in accordance with section 1.501(c)(3)-1(a)(1) of the regulations. Accordingly, TP no longer qualifies
for exemption as an organization described in IRC 501(c)(3). An analysis of this finding is as follows:

1. TP is governed by a small group of individuals in which two of the three officers are related by marriage.
While this fact alone may not necessarily disqualify TP for exemption, it provides an opportunity for abuse

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

Form 886-A Schedule number or exhibit
EXPLANATION OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended

ORG December 31, 20XX

of the claimed tax-exempt status and suggests that TP operates primarily for non-exempt private
purposes, rather than exclusively for public purposes (Church of Ethereal Joy, 83 T.C. 20 at 23 (1984),
see also: Rev. Rul. 55-656, 1955-1 C.B, 262).

2. Two of TP's three officers are married to two principal officers of CO-1, who are also related.

Accordingly, the two principal officers of CO-1 are in a position to exert indirect control over TP's activities
through their relationships with their spouses. CO-1 is therefore in a position to use TP as an instrument
to further its own for-profit purposes to a substantial and impermissible degree. We find that such indirect
control has taken place during the years under examination (see item# 3 below) and CO-1 has
effectively been able to use the tax-exempt status of TP to further its own private and commercial
interests to a substantial and impermissible degree. Accordingly, TP is operated for private and
commercial purposes and therefore does not qualify as an organization described in IRC section
501(c)(3) (EST of Hawaii v. Commissioner, 71 T.C. 1067 (1979)).

3. TP appears to be operating in a manner designed to allow its for-profit corporate sponsors to avoid

regulation under the Do Not Call Registry laws. Under Public Law No. 108-10, telemarketers and for-profit
companies are expressly prohibited from cold calling consumers listed in the National Do-Not-Call-
Registry. PL 108-10 does not apply to several types of organizations, including public charities. As a
for-profit organization, CO-1 does not qualify for any of the exceptions listed in PL 108-10 other than
circumstances where it has a prior business relationship with the registered consumer or has obtained
prior written permission to call the registered consumer.

CO-1's affiliation with TP therefore allows it to circumvent the provisions of PL 108-10 and gain access
to an extensive prospective consumer base it would not otherwise have. This arrangement gives CO-1 a
significant and unfair competitive advantage over similar companies in its industry that must otherwise
comply with the provisions of the Do Not Call Registry laws.

TP's CSP therefore allows CO-1 (and any other corporate sponsor under a similar arrangement) to exploit
TP's exempt status to further its own private and commercial interests to a substantial degree. Accordingly
TP's activities in this capacity serve an impermissible private, rather than public, interest. TP, therefore,
does not operate exclusively for exempt purposes and accordingly does not qualify for exemption as an
organization described in IRC 501(c)(3) (Treas. Reg. Section 1.501(c)(3)-1(d)(1)(ii)).

4. The IRS recognizes that TP's remittance of all proceeds from its corporate sponsorship program to a
bona-fide 501(c)(3) organization may serve a truly exempt purpose. However, the presence of the
substantial, non-exempt activities it engages in relative to its affiliation with CO-1 precludes it

from being recognized as exempt as an organization described in IRC 501(c)(3) (Better Business Bureau
of Washington. D.C. v. United States, 326 U.S. 279,283,66 S. Ct. 112,90 L. Ed. 67, 1945 C.B. 375
(1945)).

TAXPAYER'S POSITION

TP has taken action to replace the two board members that are related by marriage and are also related to principal
officers of CO-1. TP contends that with these changes, no member of its board is related to any member of CO-1.
TP also contends it is operated solely as a non-profit as these changes have eliminated any perception that any for-
profit entity is in a position to use TP as an instrument to further its own private and commercial purposes.

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

Form 886-A Schedule number or exhibit
EXPLANATION OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended

ORG December 31, 20XX
GOVERNMENT’S REBUTTAL

We concur that the changes TP made to its board of directors reduces the perception that members of CO-1 are in a
position to further their own private and commercial purposes by exerting indirect control over TP. Notwithstanding
the changes to TP’s governance structure, the primary issue remains that TP is operating in a manner that appears to
be designed to specifically allow CO-1 (and potentially other for-profit organizations) to avoid regulation under the Do
Not Call Registry laws. Further, the substantial private and commercial benefits of TP’s CSP to CO-1 (with respect to
having the ability to circumvent regulation under PL 108-10) are prevalent irrespective of whether CO-1 is in a position
to directly or indirectly control TP. Hence, TP no longer qualifies for exemption as an organization described in IRC
501(c)(3) as it continues to operate and engage in activities that serve a substantial, impermissible, and non-exempt
purpose that benefits the private and commercial interests of a for-profit corporation.

CONCLUSION

TP no longer qualifies for exemption because it is not operated exclusively for IRC § 501(c)(3) purposes as required
and defined by Treasury regulation § 1.501(c)(3)-1(d)(1)(i). TP is operated to serve the private and commercial
interests of a for-profit corporation to a substantial and impermissible degree, and more than an insubstantial part of
its activities is not in furtherance of an exempt purpose (Treas. Reg. Section 1.501(c)(3)-1(c).

We are therefore proposing revocation of TP's exempt status under IRC section 501(c)(3). Should the
proposed revocation be upheld, TP may be eligible for discretionary relief under IRC section 7805(b). If relief
under IRC § 7805(b) is granted, retroactivity of the revocation, and the required annual filing of Form 1120, will be
limited to a date not earlier than that on which the original ruling or determination letter was revoked.

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