IRS revokes a private foundation whose funds inured to its sole trustee

Plain-English summary

The IRS revoked the Section 501(c)(3) status of a private non-operating foundation created to support the arts and provide scholarships to musicians, composers, and lyricists. The foundation transferred money to its sole trustee during a period of personal financial hardship and later treated the amounts as salary, expense reimbursement, or loans. The purported loans had no confirmed written agreement, collateral, fixed repayment schedule, or interest, and substantial amounts remained unpaid. The IRS concluded that the trustee and another insider used the foundation’s bank account as their own, causing the foundation’s net earnings to inure to insiders. As a trust, the organization was required to file Form 1041 in future years and continue filing Form 990-PF as a taxable private foundation unless it terminated that status under Section 507.

Ruling snapshot

• Question: Did transfers from a private foundation to its sole trustee constitute prohibited inurement that required revocation?
• Outcome: Revocation of exempt status
• Key authorities: IRC §§ 170, 501(c)(3), 507, 509(a), 4941, and 7428; Treas. Reg. §§ 1.501(a)-1(c) and 1.501(c)(3)-1; Founding Church of Scientology v. United States; John Marshall Law School v. United States

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
1100 Commerce Street, MC 4920DAL
Dallas, TX 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Date: August 6, 2020

Taxpayer ID Number:

Number: 202052026
Release Date: 12/24/2020 Form:

Tax Period(s) Ending:

UIL: 501.03-00
Person to Contact:

Identification Number:

Telephone Number:

Fax Number:

CERTIFIED MAIL — Return Receipt Requested
LAST DAY FOR FILING A PETITION WITH THE TAX COURT:

Dear

This is a final determination that you do not qualify for exemption from federal income tax
under Internal Revenue Code (IRC) Section 501(a) as an organization described in IRC
Section 501(c)(3), effective January 1, 20XX. Your determination letter dated November 19XX
is revoked.

Our adverse determination as to your exempt status was made for the following reason(s):

Organizations described in IRC Section 501 (c)(3) and exempt under Section
501(a) must be both organized and operated exclusively for exempt
purposes, and no part of their net earnings may inure to the benefit of private
shareholders or individuals. The transfer of money to

, the sole trustee of the Foundation, constituted inurement.
As such, you failed to meet the requirements of IRC Section 501(c)(3) and
Treasury Regulations Section 1.501(c)(3)-1(a), in that you have not established
that you were organized and operated exclusively for exempt purposes, and that
no part of your net earnings inured to the benefit of private shareholders or
individuals.

Organizations that are not exempt under IRC 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.

Because you were a private foundation as of the effective date of the adverse determination,
you are considered to be a taxable private foundation until you terminate your private
foundation status under section 507 of the Internal Revenue Code. In addition to your income
tax return, you must also continue to file Form 990-PF, Return of Private Foundation or
Section 4941(a)(1) Trust Treated as a Private Foundation, by the 15th day of the fifth month
after the end of your annual accounting period.

Contributions to your organization are no longer deductible under IRC Section 170.

If you decide to contest this determination, you may file an action for declaratory judgment
under the provisions of IRC Section 7428 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 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, NW
Washington, DC 20217

U. S. Court of Federal Claims
717 Madison Place, NW
Washington, DC 20439

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

We'll notify the appropriate state officials (as permitted by law) of our determination that you
aren't an organization described in IRC Section 501(c)(3).

You may be eligible for help from the Taxpayer Advocate Service (TAS). 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.

Taxpayer Advocate assistance can’t be used as substitute for established IRS procedures,
formal appeals processes, etc. The Taxpayer Advocate is not able to reverse legal or
technically correct tax determination, nor extend the time fixed by law that you have to file a
petition in Court. The Taxpayer Advocate can, however, see that a tax matter that may not have
been resolved through normal channels gets prompt and proper handling.

2

Organizations that are not exempt under IRC 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.

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

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

Sincerely,

Sean E. O'Reilly
Director, EO Examinations

Enclosures:
Publication 892

Department of the Treasury
Internal Revenue Service

Date:
March 25, 2020

Taxpayer ID number:

IRS Tax Exempt and Government Entities

Form:
Tax periods ended:

Person to contact:

ID number:

Telephone:

Fax:
Address:

Manager's contact information:
Name:
ID number:

Telephone:
Response due date:

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

Letter 3618 (Rev. 8-2019)
Catalog Number 34809F

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,

Digitally signed by Christopher M. Holmes

Christopher M. Holmes
Digitally signed by Christopher M. Holmes
Date: 2020.03.25 10:35:40 -07'00'

for Maria Hooke
Director, EO Examinations

Enclosures:
Form 886-A
Form 6018

2 Letter 3618 (Rev. 8-2019)
Catalog Number 34809F

Form 886-A
(May 2017)

Department of the Treasury — Internal Revenue Service

Explanations of Items

Schedule number
or exhibit

Name of taxpayer
Tax Identification Number (last 4 digits)
Year/Period ended

20XX — 20XX

ISSUE

Whether the transfer of money from (“Foundation”) to
, the sole trustee of the Foundation, constituted
inurement. As such, revocation of the Foundation’s exempt status is warranted.

FACTS

Foundation’s Background, Activities and Financial Information

The Foundation is a trust created by the Last Will and Testament (Will) dated January 21, 19XX,
of . See section 8(c) of the Will. The Foundation’s purposes are supporting the arts
and providing scholarship to creative and original musicians, composers and lyricists. Following
the death of , the Foundation was formed on March 22, 19XX. In May 19XX, the

Foundation applied and was recognized as a private non-operating foundation under Internal
Revenue Code (IRC) Section 501(c)(3) and 509(a) in November 19XX. The Foundation is
operated on a calendar year basis. The Foundation has made no distributions since . Per
, the Foundation had few activities in the last few years. was looking
into fundraising programs and building a web site to promote the Foundation’s profile. Due to
the high cost, did not go through with the plan.

The Foundation reports the following financial information on its Form 990-PF.

Income 20XX 20XX 20XX
Royalty income 0 0 0
Expense
Trustee fee ( ) 0 0 0
Accounting 0 0 0
Professional fee 0 - -
Tax 0 0 0
Storage 0 0 0
Office supplies 0 0 0
Website hosting - 0 0
Internet & phone - - 0
Total expense 0 0 0
Net income 0 0 0
Assets 20XX 20XX 20XX
Cash 0 0 0
Loan to 0 0 0
Total 0 0 0
Catalog Number 20810W Page 1 www.irs.gov Form 886-A (Rev. 5-2017)

Form 886-A Department of the Treasury — Internal Revenue Service Schedule number
or exhibit
(May 2017) Explanations of Items
Name of taxpayer Tax Identification Number (last 4 digits) Year/Period ended
20XX — 20XX

In the years under audit, the Foundation did not have separate accounting records. The

Foundation maintains a bank account at . The Foundation relied on receipts and
disbursements reported on its annual statement to prepare the Form 990-PF. The
annual statement reveals the following transfers to and from the bank account.
Date Description Amount
2/3/XX Online transfer to checking (0)
4/27/XX Online transfer to checking (0)
7/27/XX Online transfer to checking (0)
8/9/XX Online transfer to checking (0)
9/6/XX Online transfer to checking (0)
9/12/XX Online transfer to checking (0)
9/12/XX Online transfer to checking (0)
10/6/XX Online transfer to checking (0)
10/11/XX Online transfer to checking (0)
(0)
7/27/XX Online transfer from checking 0
8/11/XX Online transfer from checking 0
9/15/XX Online transfer from checking 0
10/17/XX Online transfer from checking 0
0
Net amount (0)

then treated $0 of the $0 as his salary. The remaining $0 was for reimbursement of
expenses. The Foundation did not furnish or file a Form W-2 or 1099-MISC to report the salary.

About

In his Will, named , his friend, as the sole trustee of the Foundation.
has been the sole trustee of the Foundation since inception.

Article 8, Section (c)(8), of the Will provides, “I authorize and empower , by instrument
in writing duly acknowledged, or by will duly admitted to probate, to appoint any citizen of the
United States or any corporation having fiduciary powers to be successor to him as Trustee of
the Foundation, and to revoke any such appointment prior to the time such successor has
undertaken his duties and to appoint a different successor.”

Although his wife is not a trustee, she also has access to the Foundation’s
bank account. states that she is the one paying the bills and transferring money to
the ’ bank account.

Transfers of Money from the Foundation to

Catalog Number 20810W Page 2 www.irs.gov Form 886-A (Rev. 5-2017)

Form 886-A Department of the Treasury — Internal Revenue Service Schedule number
or exhibit
(May 2017) Explanations of Items
Name of taxpayer Tax Identification Number (last 4 digits) Year/Period ended
20XX — 20XX

During the meeting on February 4, 20XX, stated that in 20XX, they experienced
financial hardship. began drawing fund from the Foundation for salary. Per , the
Foundation’s outside accountant later advised to treat the amounts withdrew in
excess of trustee salary as loan. recalls hearing the accountant verbally advising

that he could draw amounts equaled to 0 to 0 percent of the Foundation assets for
salary. The salary could increase if the Foundation generates more revenue.

In the fax transmittal dated March 12, 20XX, recanted the disclosure above and
stated that ’s business manager advised that could
borrow from the Foundation. The amounts withdrawn were documented as a loan not as salary
by and then given to for official accounting by
. did not provide written records to support the above disclosure.
passed away in 20XX.

The examining agent requested a written loan agreement in Information Document Request #1
and #2. During the meeting on February 4, 20XX, stated that there was no written
loan agreement and unable to provide the agreement. In the fax transmittal dated March 12,
20XX, recanted the above statement and stated that cannot confirm whether
there was a written loan agreement.

                                 put up no collaterals for the loan.                                      confirmed neither the Foundation

nor established a fixed schedule of repayments. Since 20XX, neither
accrued nor paid interest on the loans. stated that made repayments

when financially able. The Form 990-PF shows the following year-end loan balances.

End of year balance
Increase Decrease
from from Decrease
20XX 20XX 20XX 20XX 20XX 20XX from 20XX 20X
0 0 0 0 (0) 0 (0) 0
End of year balance
Increase Increase
from from Decrease
20XX 20XX 20XX 20XX 20XX from 20XX 20XX 20XX
0 0 0 0 0 (0) 0 0
Separately, provided a schedule showing loan balance dating back to 20XX. The

schedule is reproduced below.

20XX Beginning balance: $0
20XX Loan to date: $0

Catalog Number 20810W Page 3 www.irs.gov Form 886-A (Rev. 5-2017)

Form 886-A Department of the Treasury — Internal Revenue Service Schedule number
or exhibit

(May 2017) Explanations of Items

Name of taxpayer Tax Identification Number (last 4 digits) Year/Period ended
20XX — 20XX

Repayments and additions Year-end balance
20XX $0 repayment 0
20XX $0 trustee salary applied to loan 0
20XX No repayment 0
20XX $0 additional loan taken 0
20XX $0 additional loan taken 0
20XX $0 trustee salary applied to loan 0
20XX No repayment 0
20XX No repayment 0
20XX $0 trustee salary applied to loan 0

0

Below were additional money transferred from the Foundation to in 20XX and
20XX.

Date Amount
10/20/XX 0
12/18/XX 0

0

Date Amount Date Amount
1/6/XX 0 7/21/XX 0
1/16/XX 0 8/3/XX 0
3/10/XX 0 8/17/XX 0
3/13/XX 0 8/28/XX 0
5/5/XX 0 9/1/XX 0
5/27/XX 0 12/1/XX 0
6/5/XX 0 12/31/XX 0
6/18/XX 0

0 0 0

LAW

IRC Section 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

Catalog Number 20810W Page 4 www.irs.gov Form 886-A (Rev. 5-2017)

Form 886-A Department of the Treasury — Internal Revenue Service Schedule number
or exhibit
(May 2017) Explanations of Items
Name of taxpayer Tax Identification Number (last 4 digits) Year/Period ended
20XX — 20XX

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.

Treasury Regulations (Regs.) Section 1.501(c)(3)-1(a)(1) provides that, in order to be exempt as
an organization 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 an
organization fails to meet either the organizational test or the operational test, it is not exempt.

Regs. Section 1.501(c)(3)-1(c)(2) 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.

Regs. Section 1.501(a)-1(c) defines the words private shareholder or individual in section 501
as persons having a personal and private interest in the activities of the organization.

The courts have broadly construed the term net earnings to include more than gross receipts
minus disbursements as shown on the organization's books and records.

Founding Church of Scientology v. U.S., 412 F.2d 1197 (Ct. Cl. 1969), involved a classic
across-the-board channeling of an organization's funds to those in control of the organization. In
that case, a wide variety of devices were employed, including fees, commissions, excessive
rental payments, loans and excessive salaries, to divert the organization's funds to its founder,
L. Ron Hubbard, and his immediate family. The principle of inurement was neatly summarized
when the Court stated, "what emerges from these facts is the inference that the Hubbard family
was entitled to make ready personal use of the corporate earnings.”

In John Marshall Law School v. U.S., 228 Ct. Cl. 902 (1981), the Court ruled that interest-free
and unsecured loans to insiders constituted inurement. The Court detailed with particularity
each of a series of interest-free and unsecured loans used by the Fensters to purchase a home
and furnish it. Although one of the loans was evidenced by a promissory note, the note made no
provision for a definite repayment schedule.

TAXPAYER'S POSITION

The Foundation’s position is not known.

GOVERNMENT’S POSITION

Regs. Section 1.501(c)(3)-1(a)(1) provides that an organization must be both organized and
operated exclusively for one or more of the purposes. If an organization fails to meet either the
organizational test or the operational test, it is not exempt. 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. Regs. Section 1.501(c)(3)-1(c)(2). See also
Founding Church of Scientology v. U.S. and John Marshall Law School v. U.S.

Catalog Number 20810W Page 5 www.irs.gov Form 886-A (Rev. 5-2017)

Form 886-A Department of the Treasury — Internal Revenue Service Schedule number
or exhibit
(May 2017) Explanations of Items
Name of taxpayer Tax Identification Number (last 4 digits) Year/Period ended
20XX — 20XX

The facts of this case are similar to those of Founding Church of Scientology v. U.S. In
Founding Church of Scientology v. U.S., the Court noted, "what emerges from these facts is the
inference that the Hubbard family was entitled to make ready personal use of the corporate
earnings." The Court ruled that the use of the corporate earnings constituted inurement.

In this case, the readily and conveniently used the Foundation’s bank account as if it
was theirs. They withdraw money from the Foundation’s bank account as needed. While the

repaid some of the money, the unpaid amount remain substantial. As of the end of 20XX,
the unpaid amount totaled $0. The forms, amounts, and infrequency of repayments raise doubt
whether is able to make future repayments.

The personal uses of the Foundation’s money derived the Foundation of the ability to
generate income on the money. The Foundation could have invested the $ in certificate
of deposit (CD) to generate interest income. The Foundation was not able to do that because it
no longer has that $ . All the while, the paid zero interest to the Foundation for
using the $

The facts of this case are also similar to those of John Marshall Law School v. U.S. The Court
detailed with particularity each of a series of interest-free and unsecured loans used by the
Fensters to purchase a home and furnish it. The Court ruled the interest-free and unsecured
loans to the Fensters constituted inurement.

In this case, the treated the money they withdrew from the Foundation as loans. Yet,
they accrued and paid zero interest on the loans since . They also put up no collaterals to
secure the loans. The Foundation has little recourses in the event the decided not to
repay the loans.

CONCLUSION

Based on the above facts, it is concluded that the Foundation’ net earnings have inured to the
benefits of its insiders, the . The Foundation’s tax-exempt status should be revoked.
Since the Foundation is a trust, it is required to file a Form 1041, Income Tax Return of Estates
and Trusts, for all future years. In addition to the Form 1041, the Foundation is required to file
the Form 990-PF as a taxable private foundation for all future years.

Catalog Number 20810W Page 6 www.irs.gov Form 886-A (Rev. 5-2017)