Final adverse determination revoking a private foundation's 501(c)(3) exemption for private inurement to its sole trustee

Plain-English summary

A private non-operating foundation, created under a person's will to support the arts and provide scholarships to musicians, composers, and lyricists, lost its § 501(c)(3) exemption for private inurement. The friend named in the will as the foundation's sole trustee treated the foundation's bank account as his own: over several years he transferred money out for what he variously called salary and loans. The loans were interest-free, unsecured, backed by no written agreement, no fixed repayment schedule, and no collateral, and a substantial amount stayed unpaid. Under § 501(c)(3), none of a charity's net earnings may inure to the benefit of a private individual. Relying on Founding Church of Scientology v. United States and John Marshall Law School v. United States, both of which found inurement where insiders drew on or borrowed an organization's funds, the IRS concluded the foundation's earnings had inured to its trustee and revoked the exemption effective January 1 of the examined year. Because the foundation is a private foundation and a trust, it must file Form 990-PF as a taxable private foundation and Form 1041, and it remains a taxable private foundation until it terminates that status under § 507. Contributions are no longer deductible under § 170. This matters because it shows that labeling insider withdrawals as loans does not avoid inurement when the loans have no interest, no security, and no real repayment terms.

Ruling snapshot

• Question: Did a private foundation's transfers of money to its sole trustee, taken as interest-free unsecured loans and salary, constitute private inurement warranting revocation of § 501(c)(3) exemption?
• Outcome: Revocation (final adverse determination; exemption revoked effective January 1 of the examined year; foundation must file Form 990-PF and Form 1041; § 170 deductibility ends)
• Key authorities: IRC §§ 501(c)(3), 507, 509(a); Treas. Reg. §§ 1.501(c)(3)-1(a)(1), (c)(2), 1.501(a)-1(c); Founding Church of Scientology v. U.S., 412 F.2d 1197 (Ct. Cl. 1969); John Marshall Law School v. U.S., 228 Ct. Cl. 902 (1981)

Full text (IRS public release)

This document is an OCR transcription of a scanned IRS release. Wording is preserved verbatim; obvious scanning misreads have been corrected, page furniture and footers are transcribed as scanned, redacted values are shown as [redacted], and the several dense financial tables (in which every dollar figure was redacted in the original) are summarized in bracket-notes listing their readable row and column labels. Unreadable spots are marked [illegible].

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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

Number: 202151007
Release Date: 12/23/2021

Taxpayer ID Number:
Form:
Tax Period(s) Ending:
Person to Contact:
Identification Number:
Telephone Number:
Fax Number:

UIL: 501.03-00

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 4947(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

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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.

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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

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Department of the Treasury
Date: March 25, 2020
Internal Revenue Service
IRS Tax Exempt and Government Entities Taxpayer ID number:

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

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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,

Christopher M. Hol[illegible] Digitally signed by Christopher M. Hol[illegible]. Date: 2020.03.25 10:35:40 -07'00'

for Maria Hooke
Director, EO Examinations

Enclosures:
Form 886-A
Form 6018

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

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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

ISSUE

Whether the transfer of money from ("Foundation") to , the sole trustee, 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) of dated January 21, 19XX. 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, she did not go through with the plan.

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

[Table: Form 990-PF income, expense, and asset summary across three tax years (columns 20XX / 20XX / 20XX). Income row: Royalty income. Expense rows: Trustee fee, Accounting, Professional fee, Tax, Storage, Office supplies, Website hosting, Internet & phone, Total expense. Net income. Assets rows: Cash, Loan to [redacted], Total. Every dollar figure is redacted in the original.]

Catalog Number 20810W Page 1 www.irs.gov Form 886-A (Rev. 5-2017)

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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.

[Table: dated online transfers to and from the checking account, with an amount column and a net amount total. Rows (transfers to checking): 2/3/XX, 4/27/XX, 7/27/XX, 8/9/XX, 9/6/XX, 9/12/XX, 9/12/XX, 10/6/XX, 10/11/XX. Rows (transfers from checking): 7/27/XX, 8/11/XX, 8/15/XX, 10/17/XX. Net amount total. Every dollar amount is redacted in the original.]
then treated $[redacted] of the $[redacted] as his salary. The remaining $[redacted] 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.

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

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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

Transfers of Money from the Foundation to

During the meeting on February 4, 20XX, stated that in 20XX, they experienced financial hardship. He began drawing funds from the Foundation for salary. Per , the Foundation's outside accountant later advised to treat the amounts withdrawn in excess of trustee salary as a loan. recalls hearing the accountant verbally advising that he could draw amounts equaled to [redacted] to [redacted] 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 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 was unable to provide the agreement. In the fax transmittal dated March 12, 20XX, recanted the above statement and stated that she 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.

[Table: Form 990-PF year-end loan balances by year, with increase-from and decrease-from columns across several 20XX years. Every dollar figure is redacted in the original.]

Separately, provided a schedule showing loan balances dating back to 20XX. The schedule is reproduced below.

20XX Beginning balance: $[redacted]
20XX Loan to date: $[redacted]

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

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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

[Table: "Repayments and additions" against "Year-end balance." Row entries by year, with each year-end balance redacted in the original: 20XX $[redacted] repayment 20XX $[redacted] trustee salary applied to loan 20XX No repayment 20XX $[redacted] additional loan taken 20XX $[redacted] additional loan taken 20XX $[redacted] trustee salary applied to loan 20XX No repayment 20XX No repayment 20XX $[redacted] trustee salary applied to loan]

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

[Table: additional transfer dates and (redacted) amounts.
Dates: 10/20/XX, 12/18/XX. And a further list of dates: 1/6/XX, 1/16/XX, 3/10/XX, 3/13/XX, 5/5/XX, 5/27/XX, 6/8/XX, 6/18/XX, 7/12/XX, 8/3/XX, 8/17/XX, 8/28/XX, 9/1/XX, 12/1/XX, 12/31/XX. Every dollar amount is redacted in the original.]

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)

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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)

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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 $[redacted]. 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 $[redacted] in certificate of deposit (CD) to generate interest income. The Foundation was not able to do that because it no longer has that $[redacted]. All the while, the paid zero interest to the Foundation for using the $[redacted].

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's 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)