IRS revokes a community theater's 501(c)(3) status for running commercial tribute-band concerts and benefiting its founders' catering company

Plain-English summary

A community theater arts nonprofit had been recognized as a tax-exempt
charity under Code Section 501(c)(3) since the 1990s, originally for producing
plays and musicals for the public. To cut costs, it stopped staging its own
productions and switched almost entirely to promoting professional "tribute
band" concerts, contracting the bands through a commercial booking agency and
selling tickets to the public at prices in line with for-profit venues. The IRS
revoked its exemption, finding the concerts were a substantial commercial
activity with no charitable purpose, which under the Supreme Court's Better
Business Bureau rule destroys exemption even if the organization also does some
exempt work. The IRS also found improper private benefit: the founders' own
for-profit catering company was used exclusively for the organization's events
without arm's-length contracts, and the profitable concerts let the founder
officers put less of their own money into the group. As a result, the
organization lost its exemption effective the start of the tax year, must file
regular corporate income tax returns, and donations to it are no longer
deductible under Section 170.

Ruling snapshot

• Question: Should the organization's 501(c)(3) exemption be revoked for engaging in a substantial non-exempt commercial purpose and conferring private benefit?
• Outcome: Revocation (final adverse determination)
• Key authorities: IRC § 501(c)(3); IRC § 513; Treas. Reg. § 1.501(c)(3)-1(c)(1), (d)(1)(ii), (e); Treas. Reg. § 1.513-1(a); Rev. Rul. 64-174; Rev. Rul. 72-369; Better Business Bureau of Washington, D.C. v. United States, 326 U.S. 279 (1945)

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
TEGE EO Examinations Mail Stop 4920 DAL
1100 Commerce St.
Dallas, Texas 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Date: August 2, 2018

Release Number: 201846007
Release Date: 11/16/2018

UIL Code: 501.03-00
Tax Year Ending: June 30, 20XX
Taxpayer Identification Number:

Person to Contact:
Employee Identification Number:

Employee Telephone Number:
(Phone)
(Fax)

CERTIFIED MAIL — RETURN RECEIPT

Dear

This is a final determination that you do not qualify for exemption from Federal income tax under
Internal Revenue Code (the "Code") section 501(a) as an organization described in Code section
501(c)(3) effective July 1, 20XX. Your determination letter dated March 11, 19XX is revoked.

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

Organizations described in section 501(c)(3) of the Internal Revenue Code and exempt from tax
under section 501(a) must be both organized and operated exclusively for exempt purposes. You
operated a for-profit commercial business by promoting and presenting professional tribute band
concerts. Also, your rental and services activities are commercial and lacking a charitable
purpose. Also, you exclusively used the for-profit catering company owned by your officers to
provide all catering services to you for your fundraising events. The catering company benefited
from its dealings with you thereby causing you to fail to operate for public purposes under Reg.
1.501(c)(3)-1(d)(1)(ii). These dealing are also inurement from you to the benefit of the catering
company.

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

Organizations that are not exempt under section 501 generally are required to file federal income
tax returns and pay tax, where applicable. For further instructions, forms, and information, please
visit www.irs.gov.

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 and the appropriate forms for filing petitions for declaratory judgment
by referring to the enclosed Publication 892. You may write to the courts at the following
addresses:

United States Tax Court
400 Second Street, N.W.
Washington, D.C. 20217

U.S. Court of Federal Claims
717 Madison Place, N.W.
Washington, D.C. 20439

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

Processing of income tax returns and assessments of any taxes due will not be delayed if you file
a petition for declaratory judgment under section 7428 of the Internal Revenue Code.

The Taxpayer Advocate Service (TAS) is an independent organization within the IRS that can help
protect your taxpayer rights. TAS can offer you help if your tax problem is causing a hardship, or
you've tried but haven't been able to resolve your problem with the IRS. If you qualify for TAS
assistance, which is always free, TAS will do everything possible to help you. Visit
www.taxpayeradvocate.irs.gov or call 1-877-777-4778.

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

Sincerely,

Maria Hooke
Director, EO Examinations

Enclosure:
Publication 892

Date: March 29, 2018

Taxpayer Identification Number:

Tax Exempt and Government Entities

Department of the Treasury
Internal Revenue Service
IRS Exempt Organizations Examinations

Form:

Tax Year(s) Ended:
June 30, 20XX
Person to Contact:

Employee ID:
Telephone:
Fax:
Manager's Contact Information:

Employee ID:
Telephone:
Response Due Date:
April 30, 2018

CERTIFIED MAIL — Return Receipt Requested

Dear

Why you're receiving this letter
We enclosed a copy of our audit report, Form 886-A, Explanation of Items, explaining that we
propose to revoke your tax-exempt status as an organization described in Internal Revenue
Code (IRC) Section 501(c)(3).

If you agree
If you haven't already, please sign the enclosed Form 6018, Consent to Proposed Action, and
return it to the contact person shown at the top of this letter. We'll issue a final adverse letter
determining that you aren't an organization described in IRC Section 501(c)(3) for the periods
above.

After we issue the final adverse determination letter, we'll announce that your organization is no
longer eligible to receive tax deductible contributions under IRC Section 170.

If you disagree

1. Request a meeting or telephone conference with the manager shown at the top of this
   letter.

2. Send any information you want us to consider.

3. File a protest with the IRS Appeals Office. If you request a meeting with the manager or
   send additional information as stated in 1 and 2, above, you'll still be able to file a protest
   with IRS Appeals Office after the meeting or after we consider the information.

The IRS Appeals Office is independent of the Exempt Organizations division and
resolves most disputes informally. If you file a protest, the auditing agent may ask you to
sign a consent to extend the period of limitations for assessing tax. This is to allow the
IRS Appeals Office enough time to consider your case. For your protest to be valid, it
must contain certain specific information, including a statement of the facts, applicable
law, and arguments in support of your position. For specific information needed for a
valid protest, refer to Publication 892, How to Appeal an IRS Determination on Tax-
Exempt Status.

Fast Track Mediation (FTM) referred to in Publication 3498, The Examination Process,
generally doesn't apply now that we've issued this letter.

4. Request technical advice from the Office of Associate Chief Counsel (Tax Exempt
   Government Entities) if you feel the issue hasn't been addressed in published precedent
   or has been treated inconsistently by the IRS.

If you're considering requesting technical advice, contact the person shown at the top of
this letter. If you disagree with the technical advice decision, you will be able to appeal
to the IRS Appeals Office, as explained above. A decision made in a technical advice
memorandum, however, generally is final and binding on Appeals.

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 adverse determination letter.

Contacting the Taxpayer Advocate Office is a taxpayer right

The Taxpayer Advocate Service (TAS) is an independent organization within the IRS that can
help protect your taxpayer rights. TAS can offer you help if your tax problem is causing a
hardship, or you've tried but haven't been able to resolve your problem with the IRS. If you
qualify for TAS assistance, which is always free, TAS will do everything possible to help you.
Visit www.taxpayeradvocate.irs.gov or call 877-777-4778.

For additional information
You can get any of the forms and publications mentioned in this letter by visiting our website at
www.irs.gov/forms-pubs or by calling 800-TAX-FORM (800-829-3676).

If you have questions, you can contact the person shown at the top of this letter.

Sincerely,

[illegible signature]
for Maria Hooke
Director, Exempt Organizations
Examinations

Enclosures:
Form 886-A
Form 6018
Form 4621-A

Letter 3618 (Rev. 9-2017)
Catalog Number 34809F

[The following is Form 886-A, Explanation of Items (Rev. 5-2017). Each page
carries the same form furniture: "Department of the Treasury - Internal Revenue
Service; Explanation of Items; Schedule number or exhibit: N/A; Name of
taxpayer: [redacted]; Tax Identification Number (last 4 digits): [redacted];
Year/Period ended: June 30, 20XX / June 30, 20XX." That repeated header/footer
furniture is marked below as page breaks; the substantive text is reproduced
verbatim.]

[Page 1 — Form 886-A]

Issue

Whether section 501(c)(3) exempt status should be revoked on
the grounds that:

1) It has engaged in a substantial non-exempt purpose, and

2) Its earnings have resulted in private benefit.

Facts

( ) was incorporated in the State of on June 13,
19XX. Its purpose, as stated in an amendment (filed August 6, 19XX) to its Articles of Incorporation, is
"to provide the public with education in the theater arts". The Internal Revenue Service (IRS) issued a
determination letter, dated March 11, 19XX, recognizing as tax-exempt under Internal Revenue
Code (IRC) section § 501(c)(3). The letter stated that was not a Private Foundation because it
was an organization described in IRC § 509(a)(2). To date, this determination has not been changed.

initially engaged in producing theatrical productions presented at its leased facility, a theater. In
addition, the Organization allowed use of the theater and provided some staging support to a few other
community theater groups. The Organization also allowed occasional use of the theater by the City for
meetings. Fundraising events were held at the theater on occasion to benefit the Organization (i.e. wine
walk, benefactor event).

(Chair/Director) and (Treasurer/Director) are the Organization's
founders and primary officers. They are also the founders and Trustees of the
. The also own a for-profit catering company, (also known
as
), which provided services to for its fundraising events.
The Organization's theater facility is leased from the , a Private
Foundation exempt under IRC § 501(c)(3). The facility also includes banquet room, a bar area,
concession and reception area. The lease document provided (effective June 1, 20XX) indicates the
lease is renewable annually upon notification with $0 rent payable monthly. is responsible for
paying the utilities and the Foundation is responsible for property taxes and major repairs.

The Board of Director Meeting Minutes for the indicated periods reveal the following:
October 20XX — March 20XX

• Overhead costs to keep the theater open was estimated at $0/day.
• The Board expressed concern at maintaining a positive cash flow for each event held (i.e. cost
  cutting methods and fundraising).

[Page 2 — Form 886-A]

January 14, 20XX

• The theater was not being sold or shut down.
• Effective 20XX the Organization will only book tribute bands and no longer stage plays or
  musicals.

December 8, 20XX

• It was reported that nearly all the concerts since August had made a profit and the "decision to
  do concerts and not productions was a good move at this time."
• It was indicated the had to contribute only $0 to keep doors
  open."

[OCR note: the theater schedule below is presented as a table in the scan
("Date / Name / Type of event"); the OCR interleaved the date and event-type
cells onto separate lines and several cells are blank or redacted ($0, names).
The readable entries are reproduced in document order.]

The 20XX and 20XX theater schedules listed the following events:
Date — Name — Type of event
July 10-11, 20XX — Tribute Band
July 17-18, 20XX — Tribute Band
July 24-August 1, 20XX — Productions (by ) — Play/Musical
— Musical
August 13-16, 20XX
August 21-22, 20XX — Tribute Band
August 28-29, 20XX — Tribute Band
September 11-12, 20XX — Tribute Band
September 18-19, 20XX — Dinner Theater
September 24-27, 20XX — Musical
October 2-18, 20XX — Musical
October 23-24, 20XX — Tribute Band
November 13 - December 13, 20XX — Musical
January 29-31, 20XX — Tribute Band
February 19-20, 20XX — Tribute Band
February 27, 20XX — Tribute Band
March 4-5, 20XX — Tribute Band
March 18-19, 20XX — Tribute Band
April 8-9, 20XX — Tribute Band
April 23, 20XX — Tribute Band
May 20-22, 20XX — Tribute Band
June 10, 20XX — Tribute Band

[Page 3 — Form 886-A]

June 24-25, 20XX — Tribute Band

(@) Produced by the indicated theater group using their instructed youth performers. lighting and sound
employees used at theater.
QA event.

The Organization rented the facility to a theater arts organization to stage their productions (0 days,
ranging from 0 to 0 hours/day). In addition to the theater facility, the Organization also provided a
combination of sound, lighting and technical technicians. charged $0 to $0/day. The invoices only
identified the dates the theater would be used, the technicians to be provided and the total fee charged.

Other use of the theater during the June 30, 20XX tax year end was as follows:
the City of (0 days for meetings; and another day for a luncheon)
and to an unrelated arts organization (0 days).

• Free use of the marquee was granted on a couple of occasions to publicize the local
• Free use was given to and a Parks &
  Recreation recital.

did contract for a 0/0 split of ticket sales for their one night performance.

used a booking agent, , DBA Booking Agency (the Agency), to contract the
tribute bands appearing at the theater. The Organization entered into a contract with the Agency
specifying the band appearance dates and payment. Bands were contracted to perform once a night for
one to three nights (Friday through Sunday), with contract fees usually at $0 per performance. One band
used a ticketing management system and software to sell tickets on its website. Tickets prices
ranged from $0-$0, with special suite boxes for $0 (0 tickets provided).

staff are used in the theater box office (open 0 hours before performances) and theater operations (theater manager,
lighting/sound technicians, bartender).

The Dinner (held September 18-19, 20XX), was identified as a event
held as a "community event." ticketing system was used to sell tickets (0 tickets sold at $0/each).
The event was held at the banquet room.
All ticket sales less ticketing fees ($0) were turned over to .

It is indicated that approximately 0 percent of 20XX receipts came from .
contracted with informally for catering services-no contracts were drawn up. It is
indicated that fees were based on the "actual costs of food and related labor for preparation and
service." Billing invoices provided for review showed no detail on the services provided other than the
event name and the total amount billed

[Page 4 — Form 886-A]

Law

IRC § 501(c)(3) provides for exemption from Income Tax for corporations, and any community chest,
fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for
public safety, literary, or educational purposes, or to foster national or international amateur sports
competition (but only if no part of its activities involve the provision of athletic facilities or equipment), 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, no substantial part of the activities of which is carrying
on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in
subsection (h)), and which does not participate in, or intervene in (including the publishing or distributing
of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.

IRC § 513(a) defines 'unrelated trade or business' of an exempt organization as any trade or business
the conduct of which is not substantially related (aside from the need of such organization for income or
funds or the use it makes of the profits derived) to the exercise or performance by such organization of
its charitable, educational or other purpose or function constituting the basis for its exemption under
section 501.

Income Tax Regulations (Tax Regs.) §1.501(c)(3)-1(a)(1) provides that, in order to be exempt as an
organization described in IRC § 501(c)(3), an organization must be both organized and operated
exclusively for one or more of the purposes specified in such section. If an organization fails to meet
either the organizational test or the operational test, it is not exempt.

Tax Regs. § 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 of such exempt purposes specified in IRC § 501(c)(3).

Tax Regs. § 1.501(c)(3)-1(d)(1)(ii) states "An organization is not organized or operated exclusively for
one or more of the purposes specified in subdivision (i) of this subparagraph unless it serves a public
rather than a private interest. Thus, to meet the requirement of this subdivision, it is necessary for an
organization to establish that it is not organized or operated for the benefit of private interests such as
designated individuals, the creator or his family, shareholders of the organization, or persons controlled,
directly or indirectly, by such private interests."

Tax Regs. § 1.501(c)(3)-1(e) states that an organization may meet the requirements of IRC § 501(c)(3)
although it operates a trade or business as a substantial part of its activities, if the operation of such
trade or business is in furtherance of the organization's exempt purpose or purposes and if the
organization is not organized or operated for the primary purpose of carrying on an unrelated trade or
business, as defined in IRC § 513.

Tax Regs. § 1.513-1(a) provides that gross income of an exempt organization subject to the tax
imposed by IRC § 511 is includible in the computation of unrelated business taxable income if:

[Page 5 — Form 886-A]

(1) The activity must be a trade or business;
(2) The trade or business is regularly carried on by the organization; and
(3) The trade or business is not substantially related to the organization's
exempt purpose.

Revenue Ruling 64-174, 1964-1 C.B. 183, states cultural organizations devoted to the promotion of the
arts may qualify for exemption under section 501(c)(3) as educational or charitable.

Revenue Ruling 72-369, 1972-2 C.B. 245, states an organization formed to provide managerial and
consulting services at cost to unrelated organizations does not qualify for exemption under section
501(c)(3). Provision of services on a regular basis is a trade or business and the provision at cost lacks
a donative element to characterize the activity as charitable.

In Better Business Bureau of Washington, D.C. v. U.S., 326 U.S. 279, 283 (1945), the Supreme Court
held that the "presence of a single...(nonexempt) purpose, if substantial in nature, will destroy the
exemption regardless of the number or importance of truly...(exempt) purposes."

Government Position

In order for an organization to retain its exempt status under IRC § 501(c)(3) it must demonstrate to the
Service that it meets both the organizational and the operational tests per Tax Regs. § 1.501(c)(3)-
1(a)(1).

Revenue Ruling 64-174 established that activities promoting the arts can qualify as either charitable or
educational for purposes of exemption under IRC 501(c)(3). production of plays/musicals for the
public did promote the arts and further IRC 501(c)(3) purposes.

However, ceased producing in-house plays/musicals after 20XX. Board meeting minutes reflect
that the decision to cease producing and presenting plays/musicals resulted from the need to reduce
operating costs. The Organization estimated overhead costs associated with having the theater open
(i.e. utilities, staff) was $0/day. The production of plays/musicals require many days of cast rehearsals
for weeks before the shows. The Organization was concerned with activities being held requiring the
theater to be open and no income associated.

Starting in 20XX, the primary activity became the tribute band concerts. used a professional
booking agency to contract with bands performing music of well known classic rock bands. The
concerts were publicized and tickets were sold to the public on website through a ticketing
management system used by . Ticket prices were consistent with tribute band concerts offered by
for-profit organizations. staff were used for theater operations during the performances (manager,
lighting and sound technicians, bartender).

[Page 6 — Form 886-A]

Many IRC § 501(c)(3) organizations engage in activities that generate a profit. The existence of profit
from an activity does not alone give rise to liability for the tax, or endanger the organization's exemption.
Tax Regs. §1.501(c)(3)-1(e) specifically states an organization may qualify under § 501(c)(3) even
though it operates a trade or business, even as a substantial part of its activities, if the operation thereof
is in furtherance of the organization's exempt purposes, and the organization is not otherwise organized
or operated for the primary purpose of carrying on an unrelated trade or business.

The promotion and presentation of professional concerts (tribute bands) through a commercial booking
agency is an activity ordinarily carried on by a commercial for-profit entity. Like a for-profit entity,
contracted with and paid for the bands to appear, used paid staff to operate the events and sold tickets
to the public for prices consistent with similar concerts held by for-profit venues. The concerts were
primary activity and regularly carried on. The Organization made a conscious decision to stop
producing and presenting plays due to the cost involved. The concerts were specifically held because
they "made a profit." As noted in Board minutes, the Organization's greater income from the concerts
meant the principal officers (the ) could provide a smaller contribution to keep the
Organization running.

In this case, the concerts are a substantial commercial activity which does not further any exempt
purpose and constitutes the operation of a trade or business per Reg. § 1.513-1(a). Therefore, is
like the organization described in Better Business Bureau of Washington DC, where the "presence of a
single...(nonexempt) purpose, if substantial in nature, will destroy the exemption regardless of the
number or importance of truly...(exempt) purposes."

While the organization let the City use their theater for free (for a couple of days) and provided free
marquee advertising to a couple of organizations to publicize their community events, this activity is
insubstantial. The only other activity was renting out the theater to an arts organization and a church for
their activities. The fees charged largely covered the Organization's expenses incurred for having the
theater open (i.e. utilities, staff compensation).

rental activity and provision of support services cannot be said to have an exempt purpose either.
not only rented the facility, but also provided lighting, sound and technician services. Per Revenue
Ruling 72-369, an organization providing managerial and consulting services to other exempt
organizations at cost was not sufficient to characterize the activity as charitable due to the lack of a
donative element. Therefore, the rental and services activity could be characterized as commercial and
lacking a charitable purpose.

IRC 501(c)(3) organizations must not benefit private interests. Private benefit is indicated on several
levels. used exclusively to provide all catering services. Contracts were not
executed and invoices issued to only listed the event catered and the total amount due. It was
indicated that approximately 0% of business income came from . Also,
held a dinner theater event which was publicized by on its theater schedule and used

[Page 7 — Form 886-A]

ticketing system to sell tickets to the dinner. turned over all ticket receipts less the ticketing system
fee incurred to . It does not appear that dealings with
were at arms-length. There is insufficient detail to determine if the services were provided at fair market
value. Also, business constituted a substantial amount of gross revenues.
promoted business activity (dinner theater) and allowed use of its ticketing
system for free. It appears that benefited from its dealings with , thereby failing to
operate for public purposes under §1.501(c)(3)-1(d)(1)(ii). Also, the decision to only hold tribute band
concerts could also be considered private benefit as the funds earned from ticket sales meant less
contributions were required from the principal officers (the ). is not operated for
exempt purposes if net earnings inure in whole or in part to the benefit of private stakeholders or
individuals (Tax Regs. § 1.501(c)(3)-1(d)(1)(ii)). The activities described indicate fails to meet the
operational test under Regs. §1.501(c)(3)-1(c)(1). is not exempt under IRC 501(c)(3).

Taxpayer Position

The Organization considers the tribute band concerts as fundraising.
The Taxpayer position regarding the Organization revocation is unknown.

Conclusion

As a result of the examination, we have determined that the is not operating for exempt purposes
as an IRC 501(c)(3) organization. Accordingly, since failed to operate primarily for exempt
purposes, we are proposing revocation of their tax-exempt status, effective July 1, 20XX.

Since the organization will no longer have tax-exempt status beginning July 1, 20XX, they are liable for
filing Form 1120, U.S. Corporation Income Tax Return, as of that date.