Private foundation loses exemption after undocumented personal expenditures

View official IRS release (PDF)

Plain-English summary

A private foundation stated that it would make grants to other section 501(c)(3) organizations and create an endowment for grantmaking. During the examined years, it made no documented grants and did not establish the promised endowment. Its bank records instead showed expenditures that appeared personal and benefited trustees, but the foundation did not answer repeated requests to explain or substantiate those payments. The IRS concluded that the foundation failed the operational test, allowed earnings to inure to private parties, and did not establish that its activities or expenditures served exempt purposes. The foundation agreed to revocation effective January 1 of the redacted year and was instructed to file Form 1041 for the affected years.

Ruling snapshot

• Question: Did the private foundation operate exclusively for exempt purposes and adequately document that its expenditures and assets did not benefit insiders?
• Outcome: Revocation after the foundation failed to substantiate exempt activity or expenditures and agreed to lose exemption.
• Key authorities: IRC §§ 501(c)(3), 509, 6033, and 7428; Treas. Reg. §§ 1.501(c)(3)-1 and 1.6033-2(i)(2); Rev. Rul. 59-95 and Rev. Rul. 56-304.

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: March 2, 2016
DIVISION

Taxpayer Identification Number:

Release Number: 201641023
Release Date: 10/7/2016 Person to Contact:

Employee Identification Number:
Employee Telephone Number:

UIL: 501.03-00

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:

Organizations described in I.R.C. § 501(c)(3) and exempt under section 501(a)
must be both organized and operated exclusively for exempt purposes. 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). An
organizations will not be so regarded if more than an insubstantial part of its
activities is not in furtherance of an exempt purpose. You have not established
that you have operated exclusively for an exempt purpose.

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. If you have not already
filed these returns and the agent has not provided you instructions for converting your
previously filed Form 990 to Form 1120, you should file these income tax returns 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, you may file an action for declaratory judgment
under the provisions of section 7428 of the Code in one of the following three venues:
United States Tax Court, the United States Court of Federal Claims, or the United States
District Court for the District of Columbia. A petition or complaint in one of these three
courts must be filed before the 91st day after the date this determination was mailed to you
if you wish to seek review of our determination. Please contact the clerk of the respective
court for rules and the appropriate forms regarding filing petitions for declaratory judgment
by referring to the enclosed Publication 892. Please note that the United States Tax Court is
the only one of these courts where a declaratory judgment action can be pursued without the
services of a lawyer. You may write to the courts at the following addresses:

United States Tax Court
400 Second Street, NW
Washington, DC 20217

US Court of Federal Claims
717 Madison Place, NW
Washington, DC 20005

U. S. District Court for the District of Columbia
333 Constitution Ave., N.W.
Washington, DC 20001

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 matter that may not have 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

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

Sincerely yours,

Paul A. Marmolejo
Acting Director, EO Examinations

Enclosures:
Publication 892

Department of the Treasury Date:

Internal Revenue Service September 4, 2015
Tax Exempt and Government Entities Division Taxpayer Identification Number:
Form:
990-PF
Tax year(s) ended:

December 31, 20XX, 20XX, 20XX
Person to contact / ID number:

Contact numbers:
Phone Number:

Fax Number:
Manager's name / ID number:

Manager's contact number:
Phone Number:

Response due date:
October 5, 20XX

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

Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
December 31,
20XX
December 31,
20XX
December 31,
20XX

Issue:

Is the organized and operated exclusively for
exempt purposes under section 501(c)(3) of the Internal Revenue Code?

Facts:

On June 25th, 20XX created a trust named the
. The Trust Agreement stated the was created exclusively for
charitable, religious, scientific, literary and educational purposes,
including, for such purposes, the making of distributions to
organizations that qualify as exempt organizations under section
501(c)(3) of the Internal Revenue Code.

                received its tax exemption on March 9, 20XX via Letter

1076, with an effective date of July 29, 20XX. The was
classified as a private foundation within the meaning of section
509(a) of the Code.

                Form 1023, Application for Exemption under Section

501(c)(3), stated mission was “
.” planned to accomplish its exempt activities by making
grants exclusively to other qualified 501(c)(3) organizations.
will establish an endowment dedicated to grant making as required in
IRC 4942. will develop operating procedures to assure that
it adheres to the rules of IRC sections 4941, 4942, 4943, 4944, and
4945 as applicable to private non-operating foundations.
provided its grant Reporting Guidelines form, sample Grant
Application form, Grant Agreement form, and Grant Reporting Form.

The Trustees listed on Form 1023 were and
.

                primary asset was its bank account with                     ;

account number . The signature card shows that
(sister) and (son) had signature
authority.

The organization filed Form 990-PF for the years ending December 31,
20XX, 20XX on November 18, 20XX & May 15, 20XX, respectively.

1

Form 886-A Schedule number or exhibit
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended

December 31,
20XX
December 31,
20XX
December 31,
20XX

                reported $X revenue and $X expenses on its 20XX Form 990-PF.

It reported $XX,XXX in total revenue and $X,XXX in total
disbursements. The Bank accounts revealed the following checks and
debits:

20XX

WITHDRAWAL AMOUNT DESCRIPTION COMMENTS
DATE

$
$
$
$
$
$
$
$
$
$
$
$
$
$
$

2

Form 886-A
(Rev. January 1994)

EXPLANATIONS OF ITEMS

Schedule number or exhibit

Name of taxpayer

Tax Identification Number

Year/Period ended

December 31,
20XX
December 31,
20XX
December 31,
20XX

$
$
$
$
$
$
$
$
$
$
$
$

Total
withdrawals $

20XX

WITHDRAWAL
DATE

AMOUNT

DESCRIPTION

CHECK

COMMENTS

$
$
$

3

Form 886-A
(Rev. January 1994)

EXPLANATIONS OF ITEMS

Schedule number or exhibit

Name of taxpayer

Tax Identification Number

Year/Period ended

December 31,
20XX
December 31,
20XX
December 31,
20XX

$
$
$
$
$
$
$
$
$
$

Total
withdrawals $

20XX

WITHDRAWAL DATE AMOUNT DESCRIPTION CHECK COMMENTS

$
$
$

4

Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended

December 31,
20XX
December 31,
20XX
December 31,
20XX

Information Document Request 1 (IDR 1), issued on August 5, 20XX
asked for all books and records of assets, liabilities, receipts
and disbursements. IDR 2, issued on April 15, 20XX asked for to
explain the 1) purpose of the above expenses and 2) how did these
expenditures serve an exempt purpose. IDR 3, issued on August 7,
20XX asked again to describe 1) the purpose of the above expenses
2) explain how the expenditures serve an exempt purpose and 3) to
provide supporting substantiation. Additionally, IDR 3 asked to
provide explanations to the following questions:

b) Does the organization currently engage in any charitable
activity (including making grants)?

c) Did the organization ever (since inception) engage in any
charitable activity (including making grants)?

d) If so, please describe and provide supporting documentation
(including documents which detail the grant application and
grant selection process.)

No responses were received. has not shown that these
expenditures serve an exempt purpose.

Law:

Section 501(c)(3) of the Internal Revenue Code provides for exemption
from taxation for organizations "organized and operated exclusively
for religious, charitable, scientific, testing for public safety,
literary, or educational purposes, or to foster national or
international amateur athletic competition,..., or for the prevention
of cruelty to children or animals, no part of the net earnings of
which inures to the benefit of any private shareholder or
individual..."

Section 1.501(c)(3)-1(c)(1) of the Income tax regulations states that
"An organization will be regarded as 'operated exclusively' for one
or more exempt purposes only if it engages primarily in activities

5

Schedule number or exhibit
Form 886-A EXPLANATIONS OF ITEMS
(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended

December 31,
20XX
December 31,
20XX
December 31,
20XX

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."

Section 1.501(c)(3)-1(c)(2) of the regulations provides 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.

Section 1.501(c)-1(d)(1)(ii) of the Income tax regulations states
that "An organization is not organized or operated exclusively for
one or more of the purposes specified ... 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."

Treas. Reg. §1.501(a)-1(c) defines a private shareholder or
individual as those persons having a personal and private interest in
the activities of an organization. In general, a private shareholder
or individual is considered an “insider” with respect to the exempt
organization.

Section 1.6033-2(i)(2) of the Income tax regulations provides that
"Every organization which is exempt from tax, whether or not it is
required to file an annual information return shall submit such
additional information as may be required by the Internal Revenue
Service for the purpose in inquiring into its exempt status and
administering the provisions of subchapter F (section 501 and
following), chapter 1 of subtitle A of the Code..."

Better Business Bureau v. United States, 316 U.S. 279 (1945), holds
that the existence of a single non-exempt purpose, if substantial in
nature, will destroy the exemption under section 501(c)(3). 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 purposes.

6

Schedule number or exhibit
Form 886-A EXPLANATIONS OF ITEMS
(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended

December 31,
20XX
December 31,
20XX
December 31,
20XX

Unitary Mission Church of Long Island, Petitioner v. Commissioner of
Internal Revenue, Respondent 74 TC 507, Filed June 3, 1980--The court
found: “Net earnings benefited private individuals.--Petitioner’s
financial decisions are controlled by X, one of petitioner’s
ministers, and his wife. X received widely fluctuating ‘parsonage
allowances’ over a three year period as compensation for leading
Sunday services and for being available for pastoral counseling.
There is no evidence in the administrative record of any differing
duties that he performed over these years. ... Held, petitioner is
not entitled to exemption from Federal taxation under secs. 501(a)
and 501(c)(3), I.R.C. 1954, as amended, because a part of its net
earnings inures to the benefit of private shareholders or
individuals”.

In John Marshall Law School v. U.S., 81-2 U.S.T.C. 9514 (Ct. Cl.
1981), in which the Court found that the Commissioner acted properly
in revoking exemption under IRC 501(c)(3) on the grounds of inurement
to the controlling officers and their families. The inurement
included, but was not limited to, payments to the families as
follows: automobile, education and travel expenses, insurance
policies, basketball and hockey tickets, membership in a private
eating establishment, membership in a health spa, interest-free
loans, home repairs, personal household furnishings and appliances,
and golfing equipment.

In 63-1 USTC ¶9200, Cleveland Chiropractic College, a Corporation,
Petitioner v. Commissioner of Internal Revenue, Respondent,--, (Jan.
17, 1963) Affirming Tax Court, 21 TCM 1, Dec. 25,299(M), T. C. Memo.
1962-1 [1939 Code Sec. 101(6)--similar to 1954 Code Sec. 501]--The
court found: “A college was not entitled to exemption from corporate
income tax for 1948-1951 where part of the net earnings of the
college was found to have inured to the benefit of one of its
trustees through payment of his personal expenses.”

In 60-1 USTC ¶9371, Birmingham Business College, Inc.; John Ike
Griffith; Hulon A. Spears and Audrey Spears; Carl B. Carter and
Jewell Carter, and Jewell Carter, Petitioners v. Commissioner of
Internal Revenue, Respondent , (Apr. 04, 1960); The court found
that: “Taxpayer, an incorporated business college owned and operated
by a brother and two sisters, was not a tax-exempt educational

7

Schedule number or exhibit

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

Name of taxpayer Tax Identification Number Year/Period ended

December 31,
20XX
December 31,
20XX
December 31,
20XX

Substantial portions of its net earnings were distributed to its
owner-operators for their personal benefit.”

Rev. Rul 59-95, An organization previously held exempt from Federal
income tax was requested to produce a financial statement as of the
end of the year and a statement of its operations during such year.
However, its records were so incomplete that it was unable to furnish
such statements. Section 6033 of the Internal Revenue Code of 1954
provides that every organization, except as provided therein, exempt
from taxation under section 501(a) of the Code shall file an annual
return, stating specifically the items of gross income, receipts, and
disbursements, and shall keep such records, render under oath such
statements, make such other returns and comply with such rules and
regulations as the Secretary of the Treasury or his delegate may from
time to time prescribe. Held, failure or inability to file the
required information return or otherwise to comply with the provision
of section 6033 of the Code 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 an exempt status.

Rev. Rul. 56-304, Organizations privately established and funded as
charitable foundations which are organized and actively operated to
carry on one or more of the purposes specified in section 501(c)(3)
of the Internal Revenue Code of 1954, and which otherwise meet the
requirements for exemption from Federal income tax are not precluded
from making distributions of their funds to individuals, provided
such distributions are made on a true charitable basis in furtherance
of the purposes for which they are organized. However, organizations
of this character which make such distributions should maintain
adequate records and case histories to show the name and address of
each recipient of aid; the amount distributed to each; the purpose
for which the aid was given; the manner in which the recipient was
selected and the relationship, if any, between the recipient and (1)
members, officers, or trustees of the organization, (2) a grantor or
substantial contributor to the organization or a member of the family
of either, and (3) a corporation controlled by a grantor or
substantial contributor, in order that any or all distributions made

8

Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended

December 31,
20XX
December 31,
20XX
December 31,
20XX

to individuals can be substantiated upon request by the Internal
Revenue Service.

Government's Position:

                failed the operational test of IRC 501(c)(3) on the

following grounds:

                did not operate exclusively for one or more exempt purposes as

required under Treas. Reg. 1.501(c)(3)-1(c)(2). During the years
under audit, never provided grants to qualified 501(c)(3)
organizations’ nor did establish an endowment fund dedicated to
grant making activities as stated in Form 1023.

Rather, earnings inured to the benefit of its private
shareholder. Analysis of bank records reveal that its
expenditures were personal in nature, benefitting trustees in the
form of , , , , , and . Thus, operated in
a way that was comparable to the organizations described in Cleveland
Chiropractic College and Texas Trade School.

                provided no information on how it conducts its charitable

activity. could not explain how its expenditures served to
accomplish an exempt purpose or how these payments benefited a
charitable class. The Service asked to show how each of these
expenditures furthered the organization’s exempt purpose, and the
organization was unable to show the Service any contemporaneous
substantiation or the purpose of these expenses.

As required by Revenue Ruling 56-304, did not provide
adequate records to show the purpose for which the aid was given; the
manner in which the recipient was selected and the relationship, if
any, between the recipient and (1) officers, or trustees of the
organization, (2) a grantor or substantial contributor to the
organization or a member of the family of either, and (3) a
corporation controlled by a grantor or substantial contributor, in
order that any or all distributions made to individuals can be
substantiated upon request by the Internal Revenue Service.

9

Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended

December 31,
20XX
December 31,
20XX
December 31,
20XX

An exempt organization must respond to Internal Revenue Service
inquiries to establish that it is entitled to tax exempt status. In
this case the taxpayer had failed to establish that it was engaged in
exempt activities, that its expenditures were for the purpose of
exempt activities, or that its assets did not inure to private
shareholders or individuals.

Taxpayer's Position:

The agrees to revocation of its tax exempt status.

Conclusion

As described above, recognition as an
organization described under section 501(c)(3) should be revoked
effective January 1, 20XX, because it did not operate exclusively for
501(c)(3) exempt purposes. Form, 1041, U.S. Income Tax Return for
Estates and Trusts should be filed for tax years ending December 31,
20XX. Subsequent returns are due no later than April 15th following
the close of the accounting period for a calendar year.

Returns should be sent to the following mailing address:

Department of the Treasury
Internal Revenue Service

10