Charity loses exemption for commercial catering operation

Plain-English summary

An organization had charitable, educational, religious, cultural, and relief purposes in its governing documents. An IRS examination found that its primary activity was operating a catering hall with a liquor license from its own premises, including online advertising for weddings, parties, corporate events, and an open-bar New Year's Eve event. The IRS determined that catering supplied substantially all revenue and that the Forms 990 did not accurately separate or reconcile the catering income and expenses. Applying the operational test and the commerciality doctrine, the IRS found a substantial nonexempt commercial purpose. It revoked section 501(c)(3) status effective January 1 of a redacted year and stated that contributions were no longer deductible.

Ruling snapshot

• Question: Did the organization remain operated primarily for section 501(c)(3) purposes while running its commercial catering hall?
• Outcome: Revocation effective January 1, 20xx.
• Key authorities: IRC §§ 170, 501(c)(3), 509(a)(1), 6104(c), and 7428; Treas. Reg. § 1.501(c)(3)-1; Better Business Bureau v. United States; Airlie Foundation v. IRS

Full text (IRS public release)

[Redaction note: the IRS release blanks the organization's identity, location, taxpayer and employee identification numbers, contact information, years, amounts, percentages, liquor-license issuer, catering name, web addresses, and other identifying details.]

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 Date AUG 312017
DIVISION

Person to Contact:

Release Number: 201806010 Identification Number:
Release Date: 2/9/2018 Telephone Number:
UIL Code: 501.03-00 InReply Refer to:

LAST DATE FOR FILING A PETITION
’ WITH THE TAX COURT:

CERTIFIED MAIL -Return Receipt Requested

Dear [illegible]:

This is a Final Adverse Determination Letter that your exempt status under section 501(c)(3)
of the Internal Revenue Code (IRC) is revoked. Recognition of your exemption under IRC

section 501(c)(3) is revoked effective January 1, 20xx.
Our adverse determination was made for the following reasons:

You are not described in section 501(c)(3) of the Code because you are not
operated exclusively for exempt purposes within the meaning of Internal
Revenue Code section 501(c)(3) and Treasury Regulations section
1.501(c)(3)- 1 (c)(1). You do not engage primarily in activities that accomplish
one or more of the exempt purposes specified in section 501(c)(3) and
Treasury Regulations section 1.501(c)(3)-1(d).

Contributions to your organization are no longer deductible under section 170 of the Code.

You are required to file Federal iincome 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 iincome 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. 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

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,

Maria Hooke
Director, Exempt Organizations Examinations

Enclosures:
Publication 892

Date:

APR 052017

Taxpayer Identification Number:

Department of the Treasury
Internal Revenue Service

Tax Exempt and Government Entities
IRS Exempt Organizations Examinations

Form:
990 Return

Tax Year(s) Ended:
December 31, 20xx
December 31, 20xx

Person to Contact / ID Number:

Employee ID:
Contact numbers:
Telephone:

Fax:
Refer Reply To:

Dear [illegible]:

We're sending the enclosed material under the provisions of your power of attorney or other
authorization on file with us, for the taxpayer listed below.

If you have questions, you can contact the person listed above.

Sincerely,

Maria Hooke
Director, EO Examinations

Taxpayer Name:
Enclosures: Letter 3618

Letter 3597 (Rev. 12-2016)
Catalog Number 34786R

Department of the Treasury Date: APR 05 2017

Internal Revenue Service
Tax Exempt and Government Entities Taxpayer Identification Number
IRS Exempt Organizations Examinations

Form:

Tax Year(s) Ended:

Person to Contact / ID Number:

Employee ID:
Contact numbers:
Telephone:
Fax:
Manager's Name / ID Number:

Employee ID:
Manager's Contact Number:

Response Due Date:

Certified Mail- Return Receipt Requested

Dear [illegible]:

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 iincome 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

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

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

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

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,

Maria Hooke
Director EO Examinations

Enclosures:

Report of Examination Form 6018
Publication 892

Publication 3498

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

Form 886-A Department of the Treasury - Internal Revenue Service | Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
12/31/20xx &
12/31/20xx
Issue:

Should the tax exempt status of under IRC Section

501(c)(3) be revoked as of January 1, 20xx?

Facts:

was incorporated in the State of
on March 5, 19xx. The is tax exempt under Internal Revenue Code (IRC)
section 501(c)(3). as an organization described in IRC sections 509(a)(1) and 170(b)(1)(A)(vi).

The Certificate of Incorporation states the purposes of the are:

a) To rendersupport and assistance for the study and promotion ofthe arts and sciences by
means of contributions and grants

b) To rendersupport and assistance by means of contributions and grants to exempt
organizations established to benefit the aged sick, infirm, indigent, and destitute

c) To encourage the interchange of ideas and personal contacts between and
people by sponsoring and conducting meetings, lectures andsymposiaand to distribute
material andto publish printed matter in order to encourage and promote education and
understanding among these people

d) To encourage and promote good citizenship on the part ofimmigrants to the United States,
to issue publications or such purpose, to sponsor meetings and forums for such purpose,

and to engage in otherappropriate educational efforts
To contribute toreligious instructions regardless of creed for the purpose of promoting

understanding andharmony among persons ofall faiths

f) To rendersupportto the relief of humanity from hardship and privation caused by war,
disasters, andact of God; tocontributeto organizations established for such purposes

g) To render support by means ofcontributions and grants to established religious, charitable,

scientific, literary and educational endeavors ofallkinds and descriptions; to contribute to

community chests and social welfare funds and generally to support activities of a charitable

nature

The constitution, effective October 29, 20xx, state its purposes are to organize and
coordinate patriotic, cultural, educational ,charitable and religious activities forthe perpetuation ofthe

language, ethnicity and civilization.

e)

In return years ending 12/31/20xxand 12/31/20xx, the reported its gross revenue and

primary sources of iincome, as reflected in the table below.

Gross Gross Total Rents &
Period Ending Revenue Gross Rents Fundraising Fundraising
12/31/20xx $XXX, XXX $ XXX, XXX $ XXX, XXX $ XXX, XXX
12/31/20xx $XXX, XXX $XXxX,XXX $ OK, XXX $XXX,XXX

Form 886-A (Rev.4-68)

Department ofthe Treasury - Internal Revenue Service

Page: -+

Form 886-A Department of the Treasury - Internal Revenue Service | Schedule No. or
_ Explanation ofitems Exhibit
Name of Taxpayer Year/Period Ended
12/31/20xx &
12/31/20xx

Our examination ofthe Form 990, filed for years ending 12/31/20xx and 12/31/20xx, determined that
the primary activity isthe operation ofa commercial catering facility. The hasa
club liquor license Ssued bythe and operates the catering
business from itswholly owned premises. The returns as filed do not accurately reflect items of
iincome andexpenditure. We were unable to reconcile the income andexpenses reported onthe Form
990tothe organization's books andrecords. A significant amount ofthe revenue,
reported as derived from rents andfundraising events, were determined to be from the operation ofa

catering service and include the sale of liquor, as follows:

rev r
20xx 20xx
Gross Rents: $ XX,XXxX $ XXX, XXX
Gross Fundraising: XXX, XXX XX, XXX
Total Catering Revenue: $XXX,XXX - $ XXX,XXX
Total catering revenue for years ending 12/31/20xx and 12/31/20xxwere derived from the
trial balances.
Revenue from this commercial activity represents xx% and xx% ofthe reported gross

revenue.

The files the Form 990-T. For the return year ending 12/31/20xx, it reported $xxx, xxx as
taxable iincome and $xxx, xxx in related expenses. Our examination determinedtaxableiincome from
the catering service to be at least $xxx,xxx. Similarly, for year ending 12/31/20xx, the

reports $xxx,xxx as taxable iincome and $xxx,xxx in related expenses. Based on a review of the trial

balance, taxable iincome is at least $xxx,xxx.

Our examinationfurther determined thatthe expenditures are consistentwith those ofa
commercial operation and include disbursements for liquor/beverage/food purchases. laundry services

and payroll.
The referenced expenditures are not separately identified within the 990 returns under examination or
within the 990-T return filed for calendar year ending 12/31/20xx. The expenditures are mingled with
rental and direct fundraising expenseswithin the 990 returns subject to examination.

The operates the catering hail service under the name
. They are one and the same entity. The advertises online as a catering service
located in ( ), ; The posts its catering menu, address andcontact

information on internet web pages. The posted address andcontactinformation forthe commercial
operation isthe same asthe . Catering hall advertisements can be found within the

following website addresses:

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

Form 886-A Department of the Treasury - Internal Revenue Service | Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
12/31/20xx &
12/31/20xx

Within the third bulleted website, the catering hall is described as being in business for xx years, as
being favorite catering service, locally recognized as the catering servicewith delicious food
and affordable prices. It also states that its catering service is perfect for weddings, birthdays, senior
events, baby showers, corporate events, fundraising events, and more. The last bulleted website
solicits patronage to a New Year's Eve 20xx celebration where an open bar is part of the offering. (

).

Law:

Section 501(c)(3) ofthe Internal Revenue Code exempts from federal iincometax organizations
organized and operated exclusively for religious, charitable, educational, and other exempt purposes,
provided that no part ofthe organization's net earnings inures to the benefit of any private shareholder

or individual.

Treasury Regulation 1.501(c)(3)-1(a)(1) provides that in order tobeexemptas anorganization
described in section 501(c)(3), an organization must be both organized and operated exclusively for
one or more of the purposes specified in such section. If the organization fails to meet either the

organizational test or the operational test, it is not exempt.

Treasury Regulation 1.501(c)(3)-1(c)(1) provides that an organization will be regarded as operated
exclusively for exempt purposes only if itengages primarily in activities which accomplish one or more
exempt purposes. 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 1501(c)(3)-1(d)(1)(ii) provides, in part, that an organization is not organized or
operated exclusively for one or more of the purposes mentioned in section 501(c}(3) ofthe Code
unless it serves a public rather than a private interest. An organization may not be exempt if it is
operated for the benefit of private individuals. Thus, even if an organization has many activities which
further exempt purposes, exemption may be precludedif it serves a private interest.

In Better Business Bureau of Washington, D.C. Inc. v. U.S., 326 U.S. 279 (1945), the Supreme Court
interpreted the requirement in section 501(c)(3) that an organization be "operated exclusively" by
indicating that an organization must be devoted to exempt purposes exclusively. This plainly means
that the presence of a single non-exempt purpose, ifsubstantial in nature, will destroy the exemption
regardless of the number and importance of truly exempt purposes. The activities ofthe organization

in Better Business Bureau of Washington DC, Inc. v. U.S. were in part aimed at promoting the
prosperity and standing of the business community and were held to serve asubstantial non-exempt

purpose.

In Airlie Foundation v. Internal Revenue Service, 283 F.Supp. 2d 58 (D.D.C., 2003), the district court
relied on the "commerciality doctrine" in applying the operational test. The operational test requires
both that an organization engage "primarily" in activities that accomplish its exempt purpose and that
not more than an "insubstantial part of its activities" further a non-exempt purpose. Because ofthe
commercial manner inwhich the organization conducted its activities, the court found that it was
operated for anon-exempt commercial purpose, rather than for a tax exempt purpose. The court

stated:

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

Form 886-A Department of the Treasury — internal Revenue Service | Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
12/31/20xx &
12/31/20xx

Among the major factors courts have considered in assessing commerciality are competition with for
profit commercialentities; extent and degree of below-cost services provided; pricing policies; and
reasonableness of financial reserves. Additional factors include whether the organization uses
commercial promotional methods (e.g., advertising) and the extent to which the organization receives

charitable donations.

Taxpayer's Position:

The organization does not agree that the tax exempt status of
should be revoked.

Government's Position:

It is the government's position that the tax exempt status of the be revoked because it holds
a club liquor license, and itis primarily engaged inthe operation of a catering service indistinguishable

froma commercial business.

The has failed to demonstrate that it meets the operational test, required of a § 501(c)(3)

organization. In order to meet the operational test, the must show that it isengaged
primarily in activities which accomplish one or more of such exempt purposes specified in section §
501(c)(3). We will not regard an organization as having met this test ifmore than an insubstantial part

of its activities is not in furtherance of anexempt purpose.

The operation ofacatering hall is not an exempt purpose. The internet postings further demonstrate
that the organization is operating similar to a commercial catering service, from which it derives

substantially all of its revenue.

The is similar to the organization described in Better Business Bureau of Washington, DC.,
Inc. v. United States because it has a substantial non-exempt purpose. The presence ofa single non-
exempt purpose, ifsubstantialin nature, will destroy aclaim for exemption regardless of the number or

importance of truly exempt purposes.

This is also illustrated in Airlie Foundation v. Internal Revenue Service. The operational test requires
boththat an organization engage "primarily" in activities that accomplish its exempt purpose and that
not more than an"insubstantial part of its activities" further a non-exempt purpose. Because ofthe
commercial manner inwhich the organization conducted its activities, the court found that it was
operated for anon-exempt commercial purpose, rather than for a tax exempt purpose. The
advertises its catering service onthe internet and also posts the menu offered. This advertising
demonstrates that they are operating in a commercial manner and competing with similar for-profit

entities.

Conclusion
is not operating as an organization described in

Section 501(c)(3) of the Internal Revenue Code. Accordingly, we propose to revoke the organization's
exempt status effective as of January 1, 20xx.

Form 886-A (Rev4-68) Department of the Treasury - Internal Revenue Service
Page: -4-