Charity loses exemption after failing to substantiate its activities and spending

Number

201826013

Outcome

Revocation

Document type

Determination Letter

IRS subject

Religious, Charitable, etc., Institutions and Community Chest

Topics

Tax-exempt organizations

Code sections

§ 170, § 401, § 501, § 4942, § 6001, § 6033, § 7428, § 7602

Ruling dated

November 30, 2017

Publicly released

June 29, 2018

Source

View Official PDF

Apply this to your situation

This page covers one taxpayer's determination, issued in 2018, which can't be cited as precedent. Ask about your situation and see what the current Code and IRS guidance say, with citations.

Not precedent. Under 26 U.S.C. § 6110(k)(3), this written determination may not be used or cited as precedent. It resolved one taxpayer's situation on its specific facts, and identifying details were redacted by the IRS before release. The official IRS release (linked on this page as a PDF) is the authoritative source.

About this page: The plain-English summary and ruling snapshot below were written by Ezel based on the official IRS release. The full text is the IRS's own document.

Transcribed from a scanned original: the IRS released this determination as an image-only PDF. The full text below is a machine transcription, proofread against the scan. Check the original PDF before quoting exact language.

View official IRS release (PDF)

Plain-English summary

A charity proposed a broad range of community programs and later operated thrift stores that it said benefited military veterans. By the examination period, it had no current activities and had not substantiated its earlier charitable work with books, receipts, publications, meeting minutes, or complete bank records. The limited bank statements it did provide showed large cash withdrawals, transfers to personal accounts, and checks and card purchases with no established business purpose. Its founder stopped cooperating with the examination and did not explain the transactions. The IRS revoked the Section 501(c)(3) exemption because the organization failed the operational test and allowed earnings to benefit its founder and his family.

Ruling snapshot

Question: Did the organization remain operated exclusively for exempt purposes without adequate activity and financial records?
Outcome: Revocation, effective January 1 of the redacted year.
Key authorities: IRC §§ 501(a), 501(c)(3), 6001, 6033(a), 7602; Treas. Reg. §§ 1.501(c)(3)-1, 1.6001-1(a); Rev. Rul. 59-95

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

Date: NOV 30 2017

Release Number: 201826013
Release Date: 6/29/2018

Person to Contact:
Identification Number:
Contact Telephone Number:
In Reply Refer to:
EIN:

UIL: 501.03-00

CERTIFIED MAIL - Return Receipt Requested

Dear
:

This is a final revocation letter as to your exempt status under section 501(c)(3) of the Internal Revenue Code. The Internal Revenue Service's recognition of your organization as an organization described in section 501(c)(3) is hereby revoked effective January 1, 20xx.

We have made this determination for the following reasons:

You have failed to produce documents to establish that you are operated exclusively for exempt purposes within the meaning of Internal Revenue Code section 501(c)(3), and that no part of your net earnings inure to the benefit of private shareholders or individuals. You failed to respond to repeated reasonable requests to allow the Internal Revenue Service to examine your records regarding your receipts, expenditures, or activities as required by I.R.C. §§ 6001, 6033(a)(1) and Rev. Rul. 59-95, 1959-1 C.B. 627.

As such, you failed to meet the requirements of I.R.C. section 501(c)(3) and Treasury Regulation section 1.501(c)(3)-1(d), in that you failed to establish that you are 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. These returns should be filed with the appropriate Service Center for the year ending January 1, 20xx, and for all years thereafter.

Processing of income tax returns and assessment of any taxes due will not be delayed should a petition for declaratory judgment be filed under section 7428 of the Internal Revenue Code.

If you decide to contest this determination in court, you must initiate a suit for declaratory judgment in the United States Tax Court, the United States Claim Court or the District Court of the United States for the District of Columbia before the 91st day after the date this determination was mailed to you. Contact the clerk of the appropriate court for the rules for initiating suits for declaratory judgment. 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 may call the IRS telephone number listed in your local directory. An IRS employee there may be able to help you, but the contact person at the address shown on this letter is most familiar with your case. You may also call the Internal Revenue Service Taxpayer Advocate. 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

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, EO Examinations

Enclosure:
Publication 892

Date:
May 26, 2017

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

Taxpayer Identification Number:
Form:
Tax Year(s) Ended:
Person to Contact / ID Number:
Contact numbers:
Telephone:
Fax:
Manager's Name / ID Number:
Manager's Contact Number:
Telephone:
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 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

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,

Maria Hooke
Director, Exempt Organizations
Examinations

Enclosures:
Report of Examination
Form 6018
Publication 892
Publication 3498

Form 886-A
(Rev. January 1994)

EXPLANATIONS OF ITEMS

Year/Period ended
Dec. 31, 20xx

ISSUE:

Whether [redacted], (hereinafter referred to as “[redacted]”) qualifies for recognition of exempt status under § 501(c)(3) of the Internal Revenue Code (hereinafter referred to as “Code”).

FACTS:

[Redacted] originally incorporated as “[redacted]” in the state of [redacted] in 20xx. In 20xx it amended its articles of incorporation to change its entity name to “[redacted]”, however the structure continued to be a tax exempt C-Corporation. Later that year it incorporated in the state of [redacted]. In 20xx it issued an addendum to the articles of incorporation which amended the certificate of registration and changed the entity name to “[redacted]” ([redacted] being deleted).

[Redacted] is overseen by [redacted], its founder and President. Each of [redacted] annual returns lists
[redacted] as the only officer, director, trustee, or key employee. During a scheduled in-person interview with [redacted], he verbally confirmed there are no other officers or directors aside from himself.

In 20xx [redacted] filed an application to be recognized as an exempt organization under § 501(c)(3) of the Code. In this application, [redacted] wrote that [redacted] would serve many charitable causes. In no certain order, these causes include: disseminating information on affordable housing, rental assistance, utility assistance, food assistance, medical/dental expense assistance, occupational training, daycare for job seekers, counseling programs for individuals with emotional issues, and the developing a community center. Within this community center, [redacted] planned youth training programs, assistance for the unemployed, free meals for military personnel, and a recreational facility which would feature game and entertainment rooms, an indoor swimming facility, study room, library, full kitchen, and an on-site food retail center. [Redacted] application for exemption was approved later in 20xx and it was issued a determination letter which recognized it as a public charity under § 501(c)(3) of the Code.

[Redacted] filed Form 990-series returns for calendar year tax periods 20xx through 20xx. On each of these returns it reported receiving charitable contributions. On returns filed for 20xx through 20xx, it reported gross receipts from the operation of thrift stores. To prepare [redacted] tax returns [redacted] generally provided a summary of its financial activity to a paid return preparer. The summary for the examination tax period contains projected figures—not actual figures. Projected monthly income and expenses are multiplied by 12 to compute yearly financials. To date, [redacted] has not filed an annual return for calendar year 20xx or any tax period thereafter.

While discussing the organization he founded, [redacted] acknowledged [redacted] has no current activities. Additionally, he stated that some of [redacted] planned activities (as listed in its application for exemption) were not realized. One particular project—the community center—closed less than seven months after it opened. The activities that occurred within the community center were discontinued when it closed. Other planned activities were never started. The last of [redacted] activities was operating multiple thrift stores in the
[redacted] metropolitan area. [Redacted] stated these thrift stores made cash and in-kind donations to military veterans and provided them with employment opportunities. [Redacted] last thrift store closed in June 20xx.

[Redacted] did not provide any printed publications in support of its activities. In particular, it did not provide any newsletters, pamphlets, flyers, brochures, fundraising solicitations, membership applications, meeting minutes, websites, or related media. [Redacted] said records of this type were stored on his computer which is no longer available because it was stolen by one of his volunteers. [Redacted] said he did not file a police report to report this theft.

[Redacted] did not provide any bookkeeping records, journals, ledgers, receipts, invoices, or similar financial records. [Redacted] said he cannot find any records from 20xx and they have likely been thrown away. He originally suggested this situation was unique to the 20xx tax period, however he did not respond to multiple requests to provide the same records for 20xx and 20xx.

[Redacted] provided bank statements for only three of its accounts in 20xx and none of its accounts thereafter.
[Redacted] did not respond to multiple requests to provide bank statements for [redacted] remaining accounts in 20xx and all of [redacted] accounts in 20xx and 20xx. Upon receiving the government's request for bank statements,
[redacted] initially claimed he could not provide any of [redacted] bank statements due to a pending lawsuit between himself and [redacted] bank. He did not explain how this lawsuit would prevent him from obtaining these records.

On [redacted] bank statements that were provided are numerous cash withdrawals and checks made to cash
[Exhibit A], electronic transfers to personal accounts [Exhibit B], and checks and check card purchases [Exhibit C] for which no business purpose has been established. [Redacted] did not respond to multiple requests to explain, substantiate, or identify the purpose of these transactions.

[Redacted] bylaws contain a clause which provides a description of officers' duties. Among the duties listed for the office of president are: “He shall see all books, reports, and certificates required by law are properly kept or filed.”

[Redacted] articles of incorporation contain an express statement which says: “No part of the net earnings of the organization shall inure to the benefit of, or be distributable to its members, trustees, officers, or other private persons...”

[Redacted] failed to reply to multiple requests for records during the examination. Specifically, it did not fulfill the following requests with corresponding dates: IDR1A dated 10/14/20xx, IDR2A dated 01/17/20xx, IDR2B dated 02/03/20xx, IDR3A dated 03/10/20xx, IDR3B dated 03/22/20xx.

LAW:

§ 501(a) of the Code provides that certain organizations described in § 501(c), 501(d), or 401(a) shall be exempt from taxation unless exemption is denied under another Code section.

§ 501(c)(3) of the Code exempts from Federal income tax entities that are organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes. Public charities that are granted recognition of exempt status are classified under this section.

§ 1.501(c)(3)-1(c) of the Treasury Regulations (hereinafter referred to as “Regulations”) is the Operational Test.

§ 1.501(c)(3)-1(c)(1) of the Regulations 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 exempt purposes specified in § 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.

Malat v. Riddle, 383 U.S. 569 (1966) defined “primarily” as “of first importance” or “principally”. In this context, the application of the term “primarily” is “greater than 50%”.

§ 53.4942(b)-1(c) of the Regulations, provides that the term “insubstantial”, in regard to the section it addresses, means “less than 15%”.

§ 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.

§ 1.501(c)(3)-1(d)(1)(ii) of the Regulations states an organization is not organized or operated exclusively for one or more exempt purposes unless it serves a public rather than private interests. To meet this requirement, 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 private interests.

In Lowry Hospital Association v. Commissioner 66 T.C. 850 (1976) the court commented that inurement is incompatible with being organized and operated exclusively for charitable purposes.

Harding Hospital, Inc. v. U.S., 505 F. 2d 1068, 1072 (6th Cir. 1974) established that if an organization fails to comply with any part of the requirements in § 1.501(c)(3)-1(c) of the Regulations, it will fail the Operational Test and lose its status as a public charity.

§ 6033(a) of the Code provides that every organization (subject to certain exceptions) exempt from taxation under
§ 501(a) shall file an annual return, stating specifically the items of gross income, receipts, and disbursements, and such other information for the purpose of carrying out the Internal Revenue laws as the Secretary may by forms or regulations prescribe.

§ 1.6001-1(a) of the Regulations provides that taxpayers must keep books of account or records sufficient to establish the amount of gross income, deductions, credits, or other matters required to be shown by such person in any return.

§ 7602 of the Code provides the authority of the examiner to conduct audits by examining books, papers, records, or other data that may be relevant or material to such inquiry, including the taking of relevant testimony.

ANALYSIS AND POSITION:

After careful examination of the facts at hand, [redacted] does not qualify for continued recognition of exempt status as a public charity because it fails the Operational Test described in § 1.501(c)(3)-1(c) of the Regulations. To meet the Operational Test an organization must: 1) engage primarily activities which accomplish one or more exempt purposes, and 2) not allow its net earnings to inure to the benefit of private shareholders or individuals.
[Redacted] does not meet either of these requirements.

§ 1.501(c)(3)-1(c)(1) of the Regulations specifies that a public charity must engage primarily in activities which accomplish one or more exempt purposes. Presently—and for a period of time nearly one full year prior to the date of this report—[redacted] does not perform any activities of any nature. The most recent activity it claims is operating thrift stores for the benefit of military veterans; this activity was discontinued in June 20xx. [Redacted] stated that he hired military veterans as employees and made cash and in-kind donations to them. However, these claims are not supported by [redacted] books and records or through any other means.

§ 1.6001-1(a) of the Regulations requires that books and records be kept in sufficient order to evaluate the accuracy of data reported with IRS. [Redacted] did not provide any meaningful information to support its claim its primary activities accomplish one or more exempt purposes. It failed to fulfill repeated requests to review operational and financial documents including: newsletters, pamphlets, flyers, brochures, fundraising solicitations, bookkeeping records, journals, ledgers, receipts, invoices, and multiple bank statements with copies of checks
[IDR1A dated 10/14/20xx, IDR2A dated 01/17/20xx, IDR2B dated 02/03/20xx].

In fact, the only financial records [redacted] did provide were account statements from three of its bank accounts. These statements show a series of transactions with no apparent connection to charitable activities. There is no evidence to suggest the thrift stores were operated in a manner different from a for-profit retail store. Since
[redacted] has not shown it engaged primarily in activities which accomplish one or more exempt purposes, it fails the first part of the Operational Test described in § 1.501(c)(3)-1(c) of the Regulations.

In Harding Hospital, Inc. v. U.S. the courts ruled that if an organization fails to comply with any part of the requirements in § 1.501(c)(3)-1(c) of the Regulations, it will fail the Operational Test and lose its status as a public charity. Therefore, [redacted] does not qualify for recognition of exempt status under § 501(c)(3) of the Code. Regardless, consideration is given below to the second part of the Operational Test.

§ 1.501(c)(3)-1(c)(2) of the Regulations specifies that a public charity must also not allow its net earnings to inure to the benefit of private shareholders or individuals. Despite the explicit prohibition on ‘inurement’, neither the Code nor the Regulations defines the term. The prohibition of inurement was not contained in the original act that recognized certain corporations as exempt from Federal income tax, indicating that perhaps it was a concept so obvious it need not be mentioned. The concept of inurement contemplates a transaction between an exempt organization and an individual who is an insider. An insider, by virtue of his position within the organization, has the ability to influence or control application of the organization's net earnings.

In calendar year 20xx, [redacted] bank statements show [redacted] made:

Cash withdrawals and checks made to cash ($xx,xxx.xx) [Exhibit A]
Electronic transfers ($xxx,xxx.xx) [Exhibit B]
Checks and check card purchases ($xxx,xxx.xx) [Exhibit C]

[Redacted] did not respond to multiple requests to explain, substantiate, or identify the business purpose of the above transactions. There is no apparent causal relationship between these transactions and [redacted] claimed exempt purposes. There is also no indication these transactions arose through a compensation arrangement with
[redacted]. He personally made cash withdrawals and wrote checks to cash, electronically transferred funds to personal accounts including credit card accounts of himself and his family members, and made additional purchases for which no business purpose has been established. [Redacted] withdrew and transferred funds at his own discretion for personal use for himself and his family whenever he chose to do so.

With regard to inurement, any taking of the profits (net earnings) is fatal to exemption because the organization does not exclusively serve the public interest. § 1.501(c)(3)-1(d)(1)(ii) of the Regulations provides it is necessary for an organization to establish that it is not operated for the benefit of private interests, including its creator or his family, in order to be operated exclusively for exempt purposes. In Lowry Hospital Association v. Commissioner the court determined that inurement is incompatible with being organized and operated exclusively for charitable purposes. Therefore, [redacted] also fails the second part of the Operational Test described in § 1.501(c)(3)-1(c)(2) of the Regulations. It does not qualify for recognition of exempt status under § 501(c)(3) of the Code.

TAXPAYER'S POSITION:

The taxpayer has discontinued all contact with the examiner and refused to participate in the examination process.

CONCLUSION:

Based on the facts and application of the law, [redacted] does not qualify for exempt status under § 501(c)(3) of the Code for the tax year ending December 31, 20xx. Its effective date of revocation is January 1, 20xx. Any remaining assets shall be distributed to one or more exempt purposes within § 501(c)(3) of the Code.

EXHIBIT A – CASH WITHDRAWALS AND CHECKS MADE TO CASH

[redacted account]

[redacted account]

2/11/xx | Withdrawal Made In A Branch/Store | $x,xxx.xx
4/17/xx | Withdrawal Made In A Branch/Store | $xxx.xx
Total: $x,xxx.xx

[redacted account]

2/24/xx | Withdrawal Made in A Branch/Store | $x,xxx.xx
Total: $x,xxx.xx

Total Cash Withdrawals and Checks Made to Cash: $xx,xxx.xx

EXHIBIT B – ELECTRONIC TRANSFERS

[redacted account]

[redacted account]

[redacted account]

Total Electronic Transfers: $xxx,xxx.xx

EXHIBIT C – CHECKS AND CHECK CARD PURCHASES

[redacted account]

[redacted account]

N/A | [redacted] | $x.xx
Total: $x.xx

[redacted account]

N/A | [redacted] | $x.xx
Total: $x.xx

Total Checks and Check Card Purchases: $xxx,xxx.xx

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