IRS denies 501(c)(3) status to a climate-product venture that is primarily commercial

Plain-English summary

An organization applied (on the streamlined Form 1023-EZ) to be recognized as a
charity under IRC § 501(c)(3), describing a mission around global cooling,
carbon sequestration, and climate-friendly materials. On closer review, the IRS
found its actual plan was to develop, patent, license, franchise, and sell
products commercially, for fees and a percentage of sales, in competition with
other suppliers. The IRS denied exemption. To qualify under § 501(c)(3), an
organization must be operated exclusively for exempt purposes, and a single
substantial commercial (nonexempt) purpose defeats exemption. The IRS concluded
the venture is organized and operated primarily to run an unrelated commercial
trade or business, not a charitable, educational, or scientific one, citing
Better Business Bureau of Washington, D.C. v. United States, Easter House,
Living Faith, Asmark Institute, and Rev. Rul. 73-127. It also noted the
organizing document did not properly limit the organization's purpose or
dissolution assets and no amendment had been filed. Because the organization did
not protest within 30 days, the determination became final, donations are not
deductible, and the organization must file income tax returns. This release
bundles the final adverse determination letter with the earlier proposed adverse
determination.

Ruling snapshot

• Question: Does the organization qualify for exemption under IRC
  § 501(c)(3), or is it operated for a substantial nonexempt commercial purpose?
• Outcome: denied
• Key authorities: IRC § 501(c)(3); Treas. Reg. § 1.501(c)(3)-1(a), (c),
  (e); Rev. Rul. 73-127; Better Business Bureau v. United States, 326 U.S. 279;
  Easter House v. United States; Living Faith, Inc. v. Commissioner; Asmark
  Institute, Inc. v. Commissioner

Full text (IRS public release)

Department of the Treasury Date: 04/18/2022
Internal Revenue Service
Tax Exempt and Government Entities

Employer ID number:
PO Box 2508
Cincinnati, OH 45201 Form you must file:
Tax years:
Number: 202228015 Person to contact:
Release Date: 7/15/2022 Name:
ID number:
Telephone:

UIL: 501.03-05, 501.33-00

Dear

This letter is our final determination that you don't 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). 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 IRC Section 501(c)(3), donors generally can't
deduct contributions to you under IRC Section 170.

We may notify the appropriate state officials of our determination, as required by IRC Section 6104(c), by
sending them a copy of this final letter along with the proposed determination letter.

You must file the federal income tax forms for the tax years shown above within 30 days from the date of this
letter unless you request an extension of time to file. For further instructions, forms, and information, visit
www.irs.gov.

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

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

Letter 4038 (Rev. 11-2021)
Catalog Number 47632S

Sincerely,

Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements

Enclosures:
Redacted Letter 4034
Redacted Letter 4038

Letter 4038 (Rev. 11-2021)
Catalog Number 47632S

Department of the Treasury
Internal Revenue Service
PO Box 2508
Cincinnati, OH 45201
Date: February 8, 2022

Employer ID number:
Person to contact:
Name:
ID number:
Telephone:
Fax:

Legend: UIL:
t = number 1 501.03-05
u = number 2 501.33-00
v dollars = amount 1
W = material
X = state
Y = date
Z = individual

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 Section 501(c)(3) of the Code? No, for the reasons stated below.

Facts
You submitted Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of
the Internal Revenue Code.

You attested on Form 1023-EZ that you are organized and operated exclusively to further charitable purposes.
You also attested that you have not conducted and will not conduct prohibited activities under IRC Section 501
(c)(3).

During review of your Form 1023-EZ, detailed information was requested supplemental to the above
attestations.

You were incorporated in X on Y. Your organizational document does not properly limit your purpose or how
assets will be distributed upon dissolution. You attested that you amended the organizational document to
include the proper language to meet the organizational test under IRC Section 501(c)(3). However, to date, no
amendment has been filed with X.

Your business plan reports your mission statement as the following:

• To perform or support global cooling and carbon sequestration technologies

• To engage the public in utilizing new materials, products, and processes of benefit to the climate that are
  helpful to aquaculture, agriculture, food security and to mitigate existential threats to humanity.

You plan to co-venture with universities and private industry to create new products, primarily, W. You will do
this by establishing new product sales and through authorized franchises to mass produce your licensed products
using local artisans and approved materials meeting your design specifications. Market development and sales
start with an initial set of tools and materials. To date, you are unable to provide any details regarding
co-ventures with universities or private industry.

You plan for a profit margin of t% of full market penetration; of u% for a few which could obtain an annual
donation of v dollars. The annual donation was an expectation from consumers of your product

You intend to license and patent your products for fees and a percentage of the sales on the products sold. So far
one patent has been secured in the name of its inventor, Z, who is your director of production and product
quality assurance. Z is also a professional and educator. You did not provide any information on how
you will determine fees or what percentage of sales you will charge. Further, you did not explain how you will
obtain permissions to use Z's patents.

You list your potential customers as and You have not
demonstrated how you will negotiate with these customers directly or how they will be contracting through
authorized franchises. You do outline your plan for marketing this product, expecting W as a product line to put
control back into the hand of target consumers, increasing their production, reducing their operating risk, and
reducing exposure to environmental conditions at their sites. Your plan states industries not utilizing a product
such as W in their routine operations will not stay competitive. You recognize the barriers to entry of a product
such as W into your target markets — legitimacy and cost — and intend to prove that in real world applications no
other products (such as W) have demonstrated relative results enhancing relationships with potential and
existing clients.

Your revenue will come from membership dues, non-membership contributions and fundraising events. You
have not established a membership yet. It is unclear if members will consist of authorized franchises or some
other group. Non-member contributions will come from industrial and private philanthropy. Your expenditures
are mostly fundraising expenses and administrative costs.

Law

IRC Section 501(c)(3), in part, exempts from taxation any corporation organized and operated exclusively for
religious, charitable, scientific, testing for public safety, literary, or educational purposes, provided no part of
the net earnings inures to the benefit of any private shareholder or individual.

Treasury Regulation Section 1.501(c)(3)-1(a)(1) provides that, to be exempt as an organization described in IRC
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 or operational test, it
is not exempt.

Treas. Reg. Section 1.501(c)(3)-1(c)(1) 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 Section 501(c)(3). An organization will not be so regarded if more than
an insubstantial part of its activities is not in furtherance of an exempt purpose.

Treas. Reg. Section 1.501(c)(3)-1(e)(1) provides that an organization may meet the requirements of IRC Section
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 purposes of carrying on an unrelated trade or business.

In Rev. Rul. 73-127, 1973-1 C.B. 221, the Service held that an organization that operated a cut-price retail
grocery outlet and allocated a small portion of its earnings to provide on-the-job training to hard-core
unemployed who did not qualify for exemption. The corporation was formed to operate a retail grocery store to
sell food to residents of a poverty area at prices substantially lower than those charged by competing grocery
stores, to provide free grocery delivery service to residents who need it, to participate in the Federal food stamp
program, and to provide job training for unemployed residents. The organization's purpose of providing job
training for hardcore unemployed was charitable and educational within the meaning of the common law
concept of charity; however, the organization's purpose of operating a retail grocery store, where food was sold
to residents of a poverty area at low prices, was not recognized as a charitable purpose under the basic common
law concept of charity. The ruling went on to say the operation of the store and the operation of the training
program are two distinct purposes, that was, ends or objects sought to be accomplished by the organization
through use of its resources; and since the former purpose was not a recognized charitable purpose, the
organization was not organized and operated exclusively for charitable purposes.

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

In Easter House v. U.S., 12 Cl. Ct. 476, 486 (1987), aff'd, 846 F. 2d 78 (Fed. Cir.) cert. denied, 488 U.S. 907
(1988), the court found an organization that operated an adoption agency was not exempt under Section
501(c)(3) of the Code because a substantial purpose of the agency was a nonexempt commercial purpose. The
court concluded that the organization did not qualify for exemption under Section 501(c)(3) because its primary
activity was placing children for adoption in a manner indistinguishable from that of a commercial adoption
agency. The court found that the organization competed with for-profit adoption agencies, engaged in
substantial advertising, and accumulated substantial profits. Accordingly, the court found that the "business
purpose, and not the advancement of educational and charitable activities purpose, of plaintiff's adoption service
is its primary goal" and held that the organization was not operated exclusively for purposes described in
Section 501(c)(3).

In Living Faith, Inc. v. Commissioner, 950 F.2d 365 (7th Cir. 1991), the Court of Appeals upheld a Tax Court
decision that an organization operating restaurants and health food stores in a manner consistent with the
doctrines of the Seventh Day Adventist Church did not qualify for exemption under Section 501(c)(3) of the
Code because the organization was operated for a substantial nonexempt commercial purpose. The court found
that the organization's activities were "presumptively commercial" because the organization was in competition
with other restaurants, engaged in marketing, and generally operated in a manner similar to commercial
businesses.

In Asmark Institute, Inc. v. Commissioner, T.C. Memo. 2011-20, aff'd, 486 Fed. Appx. 566 (6th Cir. 2012), the
appeals court upheld the Tax Court decision that the organization was not entitled to exemption under Section
501(c)(3) because its operations were commercial in nature rather than charitable. The court found that the
appellant's largely fee-based business plan and its competition within a for-profit market were strong evidence
of the predominance of their nonexempt commercial purposes. The court further held that the sale of services is
commonly considered to be a nonexempt commercial purpose.

Application of law

Although your eventual products are meant to improve the environment, your primary activity is the production
of products for eventual sales, you intend to patent products for commercial purposes including eventual
franchising. You operate in a manner consistent to and in competition with other suppliers of similar products.
While your products are aimed at helping the environment this does not outweigh the commercial purposes for
which you intend on engaging your product. You are organized/operated for the primary purposes of carrying
on an unrelated trade or business rather than one that is exclusively charitable, educational or environmental.
Operating a trade or business unrelated to an exempt purpose for an unrelated commercial purpose is not
consistent with IRC Section 501(c)(3). [See Treas. Reg. Sections 1.501(c)(3)-1(a)(1), 1.501(c)(3)-1(c)(1) and
1.501(c)(3)-1(e)(1)]

You are like the organization denied exemption in Rev. Rul. 73-127. In that ruling the organization served
distinct exempt and non-exempt purposes; training and sales. Here, you are providing an environmental benefit
coupled with commercial-type sales. Based on the information provided your commercial activities, sales, and
intent to franchise demonstrate the commercial aspect of your operation is on a scale larger than that of any
exempt activities. It is the environmental, charitable or educational aspects of your programs that would
otherwise need to outweigh any commercial activity to qualify for exemption.

As held in Better Business Bureau of Washington, D.C., Inc. v. United States, a single non-exempt purpose, if
substantial, will preclude tax exemption under IRC Section 501(c)(3). Your main objective is licensing of
patents for a commercial purpose, which is a significant non-exempt purpose. Therefore, you are not operating
exclusively for an exempt purpose as described in Section 501(c)(3).

You are like the organizations described in Easter House v. U.S., Living Faith, Inc. v. Commissioner, and
Asmark Institute, Inc. v. Commissioner because you are operating for a substantial nonexempt commercial
purpose rather than for a tax-exempt purpose. You license your patents for sale in a commercial manner for a
fee and a percentage of the sales price. Therefore, you conduct the activity in a manner like for-profit businesses
and are in direct competition with such businesses.

Conclusion

Based on the information submitted, you have failed to establish that you are organized and operated
exclusively for exempt purposes within the meaning of IRC Section 501(c)(3). Rather, you appear formed to
operate for non-exempt commercial purposes. Therefore, based on the administrative record, you fail to qualify
for exemption under Section 501(c)(3). Donations to you are not deductible by the donor.

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

• 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 Determination 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
PO 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
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.

Sincerely,

Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements

Letter 4034 (Rev. 01-2021)
Catalog Number 47628K