Energy-monitoring service denied charitable exemption

Plain-English summary

A nonprofit proposed operating a cloud-based energy monitoring platform and related analyst services for affordable housing developers. Members, including some for-profit businesses, would pay annual fixed and usage-based fees intended to cover software, staff, overhead, and field-support costs. The organization argued that better energy performance would reduce housing costs, environmental impacts, and reliance on subsidies. The IRS concluded that the organization's sole activity was a regularly conducted, fee-supported service business that competed with commercial providers and primarily carried out an unrelated trade or business. It denied section 501(c)(3) exemption, and the determination became final when no protest was filed.

Ruling snapshot

• Question: Does the fee-supported energy-monitoring platform operate primarily for exempt charitable or educational purposes under section 501(c)(3)?
• Outcome: denied
• Key authorities: IRC §§ 501(c)(3), 513; Treas. Reg. § 1.501(c)(3)-1; Rev. Rul. 72-369; Better Business Bureau of Washington, D.C., Inc. v. United States, 326 U.S. 279 (1945); B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978); Living Faith, Inc. v. Commissioner, 950 F.2d 365 (7th Cir. 1991)

Full text (IRS public release)

Department of the Treasury
Internal Revenue Service
P.O. Box 2508
Cincinnati, OH 45201

Date: January 23, 2020

Employer ID number:

Release Number: 202016028
Release Date: 4/17/2020
Contact person/ID number:
UIL: 501.00-00, 501.03-30, 501.36-01

Contact telephone number:
Form you must file:

Tax years:

Dear

This letter is our final determination that you don’t qualify for tax-exempt status under Section 501(c)(3) of the
Internal Revenue Code (the Code). Recently, we sent you a proposed adverse determination in response to your
application. The proposed adverse determination explained the facts, law, and basis for our conclusion, and it
gave you 30 days to file a protest. Because we didn’t receive a protest within the required 30 days, the proposed

determination is now final.

Because you don’t qualify as a tax-exempt organization under Section 501(c)(3) of the Code, donors can’t
deduct contributions to you under Section 170 of the Code. You must file federal income tax returns for the tax
years listed at the top of this letter using the required form (also listed at the top of this letter) within 30 days of
this letter unless you request an extension of time to file.

We'll make this final adverse determination letter and the proposed adverse determination letter available for
public inspection (as required under Section 6110 of the Code) after deleting certain identifying information.
Please read the enclosed Notice 437, Notice of Intention to Disclose, and review the two attached letters that
show our proposed deletions. If you disagree with our proposed deletions, follow the instructions in the Notice
437 on how to notify us. If you agree with our deletions, you don’t need to take any further action.

We'll also notify the appropriate state officials of our determination by sending them a copy of this final letter
and the proposed determination letter (under Section 6104(c) of the Code). You should contact your state
officials if you have questions about how this determination will affect your state responsibilities and
requirements.

Letter 4038 (Rev. 7-2014)
Catalog Number 47632S

If you have questions about this letter, you can contact the person listed at the top of this letter. If you have
questions about your federal income tax status and responsibilities, call our customer service number at
1-800-829-1040 (TTY 1-800-829-4933 for deaf or hard of hearing) or customer service for businesses at
1-800-829-4933.

We sent a copy of this letter to your representative as indicated in your power of attorney.

Sincerely,

Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements

Enclosures:

Notice 437

Redacted Letter 4036, Proposed Adverse Determination Under IRC Section 501(c)(3)
Redacted Letter 4038, Final Adverse Determination Under IRC Section 501(c)(3) - No Protest

Letter 4038 (Rev. 7-2014)
Catalog Number 47632S

Department of the Treasury
Internal Revenue Service
P.O. Box 2508
Cincinnati, OH 45201

Date: November 14, 2019

Employer ID number:
Contact person/ID number:
Contact telephone number:

Contact fax number:

Legend:                                     UIL:

B = Organization                            501.00-00
C = State                                   501.03-30
D = Date                                    501.36-01
E = Name
F = Date
G = Number
H = Number

w dollars = Amount
x dollars = Amount

Dear

We considered your application for recognition of exemption from federal income tax under Internal Revenue
Code (IRC) Section 501(a). We determined that you don’t qualify for exemption under IRC Section 501(c)(3).
This letter explains the reasons for our conclusion. Please keep it for your records.

Issues

Do you qualify for exemption under IRC Section 501(c)(3)? No, for the reasons stated below.

Facts

B, which is an IRC Section 501(c)(3) corporation that develops affordable housing, and makes investments in
low income communities, developed E. B owns the licensing rights to E, which is a cloud-based data collection
and monitoring system platform for energy related investments. B subsequently formed you under the C
nonprofit statute to operate E on D. Your purpose was then amended on F to read that you are organized and
are to be operated exclusively for charitable and educational purposes within the meaning of Section 501(c)(3)
of the United States Internal Revenue Code.

Your mission consists of collecting, monitoring, analyzing, and sharing energy data through E in order to:

Letter 4034 (Rev. 11-2018)
Catalog Number 47628K

• Reduce the environmental impact of housing,

• Decrease the cost of building and maintaining housing,

• Improve the operational efficiency,

• Develop scientific knowledge of best practices for energy efficiency and building systems operations.

To accomplish your mission, you will make E available to a network of members. E, which uses off-the-shelf
hardware will be installed at your members’ sites to acquire energy related data from your members’ building
management systems, HVAC components, electrical panels, and other energy devices. The data will be
collected for each member in a single location so that an analyst employed by you can provide regular
monitoring of the systems and help local staff identify and address system issues as well as help the member
optimize building energy performance. Furthermore, your members will use the data to improve energy
outcomes, control operating expenses, and plan new energy system investments in their portfolio. Through E,
you will also help members use existing energy systems more effectively and efficiently to reduce overall
energy costs while also reducing maintenance and replacement costs.

Per your bylaws, you will have two classes of members comprised of member institutions and associate
members. Your initial member institution is B and membership institutions must generally be IRC Section
501(c)(3) organizations while associate members are other developers of affordable housing projects that
include for-profit businesses. Furthermore, only developers of affordable housing projects that serve low-and
moderate-income households that qualify for certain state programs and the Internal Revenue Code Section 42
low- income housing tax credit program will be eligible for your membership.

You will provide the following services to all members:

• Installation of E on-site hardware at their affordable housing developments;

• Web-based data collection and data analysis as well as monthly reports;

• Guidance of an energy analyst to assist the member understand the data gathered and implement cost-
saving and efficiency-improving measures.

A paid staff will conduct your services in close contact with property managers and maintenance staff at your
members’ affordable housing developments. You will employ a team of analysts and support personnel who
will work closely with the members to support the analysis of data as well as respond to system alerts.

You expect the cost to operate E be paid by members through an annual fee that includes a fixed amount and
an amount based on the member’s usage of E. The fixed amount of w dollars per year includes the license to
use E and the service agreement as well as the ongoing cost of maintaining your software, organizational
overhead costs and, field costs to troubleshoot issues. The fee based on usage will be a per site fee. A “site” is
a development, which typically includes multiple housing units. The annual per site fee will start at x dollars
for a site with G housing units, with no minimum number of sites. Furthermore, B will contribute E and
related intellectual property to you in exchange for a note payable based on a determination of the fair market
value of E based on the expected member fees you will collect for the use of E.

Membership fees will be your primary source of support although you have received one grant and plan
to continue to apply for additional grants. Expenses consist of salaries, marketing expenses, and
operational support.

Letter 4034 (Rev. 11-2018)
Catalog Number 47628K

You have as -person board including B’s legal counsel and H employees of B. You indicated that you will
benefit from your relationship with B to connect with affordable housing developers and managers.

Moreover, you stated that the use of E will decrease the capital costs and maintenance costs associated with the
construction and operation of affordable housing by reducing demand and stress on building systems, which
increases the life span of those systems. This will then reduce the reliance on government support and subsidies
to fund construction and management of affordable housing. Lower capital cost for existing affordable housing,
in turn, makes more resources available to affordable housing developers for new affordable housing projects,
by improving energy efficiency, E will also help reduce the environmental impact of affordable housing and
make affordable housing more economically and environmentally sustainable.

Finally, you wrote that through the provision of E and related services, you will:

• Aid the poor and the distressed by making housing, a critical necessity of life, more affordable and
available,

• Educate affordable housing developers, owners, operators and the general public about best practices in
energy efficient operations using the data that results from the use of E.

Law

Internal Revenue Code Section 501(c)(3) provides for exemption 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 sports 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 513(a) of the Code describes an “unrelated trade or business” as any trade or business the conduct of
which is not substantially related 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 Code.

Section 513(c) of the Code provides that a “trade or business” includes any activity which is carried on
producing income from the sale of goods or the performance of services. Where an activity carried on for-profit
constitutes an unrelated trade or business, no part of such trade or business shall be excluded from such
classification merely because it does not result in profit.

Treasury Regulations Section 1.501(c)(3)-1(a)(1) states that to be exempt as an organization described in
Section 501(c)(3) of the Code, 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.

Treas. Reg. Section 1.501(c)(3)-1(c)(1) states that in order to meet the operational test, an organization will be
regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities
which accomplish one or more of such exempt purposes specified in Section 501(c)(3) of the Code. An
organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an

exempt purpose.

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4

Treas. Reg. Section 1.501(c)(3)-1(e)(1) states an organization may meet the requirements of Section 501(c)(3)
of the Code 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
Section 513 of the Code. An organization which is organized and operated for the primary purpose of carrying
on an unrelated trade or business is not exempt under Section 501(c)(3) of the Code, even if it has certain
religious purposes, its property is held in common, and its profits do not inure to the benefit of individual

members of the organization.

In Rev. Rul. 72-369, 1972-2 C.B. 245, an organization was formed to provide managerial and consulting
services for section 501(c)(3) organizations to improve the administration of their charitable programs. The
organization enters into agreements with unrelated section 501(c)(3) organizations to furnish managerial and
consulting services on a cost basis. This revenue ruling stated that:

An organization is not exempt merely because its operations are not conducted for the purpose of producing
a profit. To satisfy the ‘operational test,’ the organization's resources must be devoted to purposes that
qualify as exclusively charitable within the meaning of section 501(c)(3) of the Code and the applicable
regulations. Providing managerial and consulting services on a regular basis for a fee is a trade or business
ordinarily carried on for-profit. The fact that the services in this case are provided at cost and solely for
exempt organizations is not sufficient to characterize this activity as charitable within the meaning of
section 501(c)(3) of the Code. Furnishing the services at cost lacks the donative element necessary to
establish this activity as charitable.

In Better Business Bureau of Washington, D.C., Inc. v. United States, 326 U.S. 279 (1945), the Supreme Court
found that the “commercial hue” permeating the organization was reflected in its charter provisions, which was
dedicated to the securing of “educational and scientific advancements of business methods” so that merchants
might “successfully and profitably conduct their business.” The organization’s activities were largely animated
by this commercial purpose. The Supreme Court held that the presence of a single nonexempt purpose, if
substantial in nature, will destroy a claim for exemption regardless of the number or importance of truly exempt

purposes.

In B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978), the organization’s sole activity was to offer
consulting services on rural-related policy and program development to limited-resource organizations for a fee.
The organization did not limit its clientele to organizations which were themselves organizations described
under Section 501(c)(3) of the Code, but only to organizations which were either nonprofit or exempt. The fees
charged were set at or close to cost but were not less than its full cost of providing its services. The
organization’s financing did not resemble that of the typical organization described under Section 501(c)(3) of
the Code. The organization had not solicited or received voluntary contributions from the public. Its only
source of income was from fees for services, and those fees were set high enough to recoup all projected costs
and to produce a net profit. It failed to show it would not be in competition with commercial enterprises. The
provision of managerial and consulting services on a regular basis for a fee is a trade or business ordinarily
carried on for-profit. The Court held that the organization’s primary purpose was not educational, scientific, or
charitable, but rather was the conduct of an ordinary commercial consulting enterprise in competition with other
commercial firms. The organization was not operated exclusively for tax-exempt purposes within the meaning
of Section 501(c)(3) of the Code.

Letter 4034 (Rev. 11-2018)
Catalog Number 47628K

5

In Easter House v. United States, 846 F. 2d 78 (Fed. Cir. 1988), aff’g 12 Cl. Ct. 476 (1987), the court found an
organization that operated an adoption agency was not exempt under Section 501(c)(3) of the Code. The
organization was operated for a substantial nonexempt purpose rather than for the exempt purposes of providing
educational and charitable services to unwed mothers and children. The court stated that “adoption services do
not in and of themselves constitute an exempt purpose.” The court found that the adoption agency was operated
in a commercial manner. The agency’s operation was funded completely by the fixed fees charged to adoptive
parents. It relied entirely on those fees and sought no funds from federal, state or local sources, nor engaged in
fund raising programs, nor did it solicit contributions. Ultimately, the agency was not entitled to tax exempt
status on basis that it was “not distinguishable from commercial adoption agency.” The court found that the
adoption agency’s primary goal was furthering of a “business purpose” rather than the advancement of an

educational or a charitable purpose.

In Living Faith, Inc. v. Commissioner, 950 F.2d 365 (7th Cir. 1991), the court of appeals upheld a Tax Court
decision stating that the organization operated its restaurants and health food stores for a substantial commercial
purpose, and it did not qualify for exemption under Section 501(c)(3) of the Code. The appellate court provided
the factors that may indicate a substantial nonexempt commercial purpose. These factors include:

• Direct competition with other for-profit businesses

• Existence and amount of annual and accumulated profits

• Competitive pricing policies and lack of below-cost pricing

• Use of promotional materials to enhance sales

• Advertising of goods and services

• Lack of plans to solicit charitable contributions

• Hours of operation that are competitive with other commercial enterprises

In Airlie Foundation v. Internal Revenue Service, 283 F. Supp. 2d 58 (D.D.C., 2003), due to the commercial
manner in which the organization conducted its activities, the court held that the organization was operated for a
nonexempt commercial purpose, rather than for a tax-exempt purpose. The court found that the organization
operated its conference center in a manner consistent with that of a commercial business. “Among the major

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

Application of law

You do not meet the requirements for recognition of tax exemption under IRC Section 501(c)(3) because you
do not operate for a tax-exempt purpose under Section 501(c)(3). Your sole activity is the conduct of a trade or
business for the production of income. You conduct no other activity aside from providing the right to use the
monitoring system platform, E, and related services to your member clients to optimize energy usage for a fee
in order for them to reduce energy costs. Your clients are comprised of affordable housing developers and
organizations whether operated on a for-profit basis or a non-profit basis who are able and willing to pay your
fees. Your fees include a fixed amount and an amount based on the member’s usage of E. Compensated
employees conduct your operations on a regular and continuous basis. Based on Treas. Reg. Section
1.501(c)(3)-1(e)(1), you do not meet the requirements for recognition of tax exemption under Section 501(c)(3)

Letter 4034 (Rev. 11-2018)
Catalog Number 47628K

6

because you are operated for the primary purpose of carrying on an unrelated trade or business, as defined in
IRC Section 513.

In addition, you do not meet the operational requirements for recognition of tax exemption under IRC Section
501(c)(3) and you fail the operational test as described in Treas. Reg. Section 1.501(c)(3)-1(a)(1). You are not
operating per Treas. Reg. Section 1.501(c)(3)-1(c)(1) because you operate for a substantial nonexempt purpose
because more than an insubstantial part of your activities is not in furtherance of an exempt purpose.

You are like the organization described in Rev. Rul. 72-369, 1972-2 C.B. 245 because you are operating in a
commercial manner. The organization described in the revenue ruling was conducting commercial services
only for organizations exempt under IRC Section 501(c)(3). Your activities consist of the provisions of E and
related services to optimize energy usage to any individual or organization who is able to pay your fees. The
facts that you believe you are improving energy efficiency in housing developments to reduce the
environmental impact of housing, including affordable housing units, and making housing more sustainable, as
well as educating housing developers, owners, operators, and the general public about best practices in energy
efficient operations, are not sufficient to characterize the activity as charitable.

In Better Business Bureau of Washington, D.C., Inc., the United States Supreme Court provided 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.” Since your primary purpose is the conduct of an unrelated
trade or business for-profit, by providing the use of E and related services to members for a fee based on their
consumption to optimize their energy usage, you serve a substantial nonexempt purpose, which precludes tax
exemption under IRC Section 501(c)(3).

You are operated for a substantial nonexempt purpose similar to the organization described in Airlie Foundation
v. Internal Revenue Service, supra. Applying the factors stated in Airlie Foundation as demonstrating a
substantial nonexempt commercial purpose, your provision of E, which is a monitoring system platform, and
related services for a fee directly competes with other providers of similar services. Like a commercial business,
your services are generally available to any individual or organization who are affordable housing developers
willing to pay your fees.

In addition, like the organization in Airlie, you do not limit members to organizations that are described under
IRC Section 501(c)(3). Another factor considered in assessing the commercial manner of operations is the
extent and degree of below cost services provided. You indicated that you provide services to members and
that the cost to operate E is expected to be paid by members through an annual fee that includes a fixed amount
and an amount based on the member’s usage of E. The fixed amount includes the license to use E, the service
agreement as well as the ongoing cost of maintaining the software, organizational overhead costs and field costs
to troubleshoot issues. In addition, the fee based on usage will be based on a per site fee and the more units
there are, the higher the fee. Thus, you meet most of the factors indicated by the courts as operating for a
substantial nonexempt purpose.

You are like the organization described in Living Faith, Inc. v. Commissioner, supra, where the court of appeals
upheld a Tax Court decision stating that the organization operated its restaurants and health food stores for a
substantial commercial purpose. You also meet most of the factors provided by the appellate court in Living
Faith, Inc. as exhibiting a substantial nonexempt commercial purpose. Your provision of E and related services
to member clients for a fee is in direct competition with other for-profit providers of similar services. The

Letter 4034 (Rev. 11-2018)
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7

financial data you submitted shows that your revenue is from fees for services rendered. You are not supported
by gifts, grants and charitable contributions from the general public. Your expenses consist of salaries,
marketing expenses, and operational support expenses for members. You are operated in a manner
indistinguishable from a commercial enterprise. By operating in the manner described, you are furthering a
substantial nonexempt purpose.

You are like the organization described in Easter House v. United States, supra, where the court determined that
the organization was not exempt because its conduct of adoption services activity was in furtherance of a
nonexempt commercial purpose. Similar to adoption services, your provision of E and related services to
member clients for a fee do not in and of themselves constitute an exempt purpose. Your sole activity is to
render services to your member clients in exchange for a fee. Your activities are not carried out to accomplish
a tax-exempt purpose under IRC Section 501(c)(3).

You are comparable to the organization described in B.S.W. Group, Inc. v. Commissioner, supra, where the
court indicated that the provision of managerial and consulting services on a regular basis for a fee is a
trade or business ordinarily carried on for-profit. Your activities constitute the conduct of a trade or
business that is ordinarily carried on by commercial ventures organized for-profit. Like a for-profit
business, your revenues are from fees paid by your member clients for the use of the monitoring system
platform, E and related services. While charitable institutions often do provide services to individuals, the
cost is generally subsidized by contributors who do not receive anything in return. You stated that you
expect to be spending 100% of total time and resources on activities that are supported by the members’
fees. This illustrates that your fees however, are set high enough to recoup all projected costs. Thus, based
on the totality of the facts and circumstances, you are operated for the substantial nonexempt purpose.

Conclusion
Based on the facts, we conclude that you are not in compliance with the above stated laws and precedence. You

do not meet the operational test under IRC Section 501(c)(3) because the manner in which you operate is
commercial. Accordingly, you do not qualify for exemption as an organization described in Section 501(c)(3).
Contributions to you are not deductible under IRC Section 170.

If you agree

If you agree with our proposed adverse determination, you don’t need to do anything. If we don’t hear from
you within 30 days, we’ll issue a final adverse determination letter. That letter will provide information on

your income tax filing requirements.
If you don't agree

You have a right to protest if you don’t agree with our proposed adverse determination. To do so, send us a
protest within 30 days of the date of this letter. You must include:

• Your name, address, employer identification number (EIN), and a daytime phone number
• A statement of the facts, law, and arguments supporting your position

• A statement indicating whether you are requesting an Appeals Office conference

Letter 4034 (Rev. 11-2018)
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8

• The signature of an officer, director, trustee, or other official who is authorized to sign for the
organization or your authorized representative

• The following declaration:

For an officer, director, trustee, or other official who is authorized to sign for the organization:
Under penalties of perjury, I declare that I have examined this request, or this modification to the
request, including accompanying documents, and to the best of my knowledge and belief, the request
or the modification contains all relevant facts relating to the request, and such facts are true, correct,
and complete.

Your representative (attorney, certified public accountant, or other individual enrolled to practice before the
IRS) must file a Form 2848, Power of Attorney and Declaration of Representative, with us if they haven’t
already done so. You can find more information about representation in Publication 947, Practice Before the
IRS and Power of Attorney.

We’ll review your protest statement and decide if you gave us a basis to reconsider our determination. If so,
we’ll continue to process your case considering the information you provided. If you haven’t given us a basis
for reconsideration, we'll send your case to the Appeals Office and notify you. You can find more information
in Publication 892, How to Appeal an IRS Decision on Tax-Exempt Status.

If you don’t file a protest within 30 days, you can’t seek a declaratory judgment in court later because the
law requires that you use the IRC administrative process first (IRC Section 7428(b)(2)).

Where to send your protest
Send your protest, Form 2848, if applicable, and any supporting documents to the applicable address:

U.S. mail: Street address for delivery service:
Internal Revenue Service Internal Revenue Service

EO Determinations Quality Assurance EO Determinations Quality Assurance
Mail Stop 6403 550 Main Street, Mail Stop 6403

P.O. Box 2508 Cincinnati, OH 45202

Cincinnati, OH 45201

You can also fax your protest and supporting documents to the fax number listed at the top of this letter. If you
fax your statement, please contact the person listed at the top of this letter to confirm that they received it.

You can get 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 listed at
the top of this letter.

Contacting the Taxpayer Advocate Service
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 if you’ve tried but haven’t

Letter 4034 (Rev. 11-2018)
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9

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.

We sent a copy of this letter to your representative as indicated in your power of attorney.

Sincerely,

Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements

Letter 4034 (Rev. 11-2018)
Catalog Number 47628K