IRS denies 501(c)(3) status to a counseling-subsidy charity that funnels funds to its directors' for-profit practice

Plain-English summary

A new nonprofit was formed to raise money and subsidize mental-health counseling for individuals, couples, and families who cannot afford full-cost care. The catch: its three directors own a for-profit counseling practice (called D in the letter), and most subsidies would be paid to D for sessions delivered by D's counselors at their standard rates. The IRS denied recognition under IRC Section 501(c)(3). It found the organization fails the operational test because a substantial part of its activity serves a non-exempt purpose, generating clientele and revenue for the directors' for-profit practice, which is private benefit and inurement to the three directors. The IRS relied on Better Business Bureau v. United States (one substantial non-exempt purpose defeats exemption) and on est of Hawaii, Church by Mail, and International Postgraduate Medical Foundation, all holding that a nonprofit operated so a related for-profit controlled by the same people benefits substantially is not operated exclusively for charity. Because the organization is not exempt, donors cannot deduct contributions under Section 170. This is the final adverse determination (Letter 4038); it became final because no protest to the proposed denial (Letter 4034, reproduced below) was filed within 30 days.

Ruling snapshot

• Question: Does a charity that subsidizes mental-health counseling qualify under IRC Section 501(c)(3) when the subsidies flow to a for-profit counseling practice owned by its own directors?
• Outcome: Denied
• Key authorities: IRC § 501(a), (c)(3); § 170; Treas. Reg. § 1.501(c)(3)-1(a)(1), (c)(1), (c)(2), (d)(1)(ii); Better Business Bureau of Washington D.C. v. United States, 326 U.S. 279 (1945); est of Hawaii v. Commissioner, 71 T.C. 1067 (1979); Church by Mail, Inc. v. Commissioner, T.C. Memo 1984-349, aff'd 765 F.2d 1387 (9th Cir. 1985); International Postgraduate Medical Foundation v. Commissioner, T.C. Memo 1989-36

Full text (IRS public release)

Department of the Treasury                     Date:
Internal Revenue Service                        10/29/2025
IRS Tax Exempt and Government Entities          Employer ID number:

                                                Form you must file:
                                                Tax years:

                                                Person to contact:

Release Number: 202604001
Release Date: 1/23/2026
UIL Code: 501.03-00, 501.03-05, 501.32-00, 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:
Letter 437
Redacted Letter 4034
Redacted Letter 4038

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


Department of the Treasury
Internal Revenue Service

Date: 08/25/2025

Employer ID number:

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

Legend:                                         UIL:
B = State                                       501.03-00
C = Date                                        501.03-05
D = Entity                                       501.32-00
E = Individual                                   501.33-00
F = Individual
G = Individual
H = Number
j percent = Percentage
k percent = Percentage
m 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

You were formed as a corporation on C in B by E, F, and G. According to your Articles of Incorporation, your
purpose is to provide financial assistance for individuals, couples and families that cannot afford full cost
mental health services.

Your purpose is to raise and distribute money to subsidize mental health counseling from credentialed
professional counselors for those that could not otherwise afford these services. You will subsidize counseling
fees so that many more individuals, couples and families that need it will be able to access professional
counseling.

Your three directors, E, F, and G, own a for-profit counseling practice called D. You make distributions to D if
an individual applies for subsidized services and is a good fit for you and D. Applicants will be interviewed and
an evaluation will be made as to the level of services needed (inpatient or outpatient), the amount of subsidy
needed, and the best therapy provider for those services. If one of the approximately H counselors that provide
services for D are the best fit for the applicant, then the referral will be made and the subsidy will be distributed
to D. If one of the D therapists is not the best fit, or the applicant needs inpatient treatment that D doesn't
provide, a referral will be made to one of many inpatient treatment providers and the subsidy will be paid to that
provider. You said that at this time it's hard to predict how much of the funding will go to D and how much will
go to other providers.

The evaluation of candidates for the subsidized care will be done by your board of directors and by others they
may appoint. The activity will be centered in a couple of counties in B. Counseling will be provided by
professional counselors (master's level or higher), and by other local mental health providers. You said that
when a person seeking counseling calls D inquiring about services, after a discussion of the issues, the treatment
options and the cost of the services are presented. If the person states that they can't afford it, then that generally
prompts an application for subsidy.

You said that while some distributions may be made to D, the counseling practice owned by your board of
directors, no distributions will subsidize counseling provided by your three board members. You also stated that
because all of your providers at D specialize in one or more areas of outpatient psychotherapy and are some of
the best in your locale, if a potential client presents with an issue that D specializes in, the referral will almost
always be made to that specialist. You will determine who is eligible to receive the subsidies based on financial
need.

Most of the counselors that provide services for D are independent contractors. Some of your
counselors/contractors do offer a sliding scale, however, D cannot set rates for these independent contractors.
You said most sessions cost m dollars. You stated that while you are aware that some counselors have charged
much less per session, D cannot set their rates.

You stated that a percentage of the revenues received by D's contractors are shared with D. When asked to
provide a copy or sample of the revenue sharing agreement between D and the contractors, you did not submit
such copies. Instead, you stated that D's contractors share between j percent and k percent of their billing
revenue. In return, the contractors receive office space, billing, receiving, etc.

You said that the benefits that for-profit entities will realize through your activities are "that they will be able
to treat people from lower socioeconomic classes without suffering a loss of revenue." You said many people
can't afford the best therapists, and your purpose is to bridge the gap between people who need therapeutic
services but can't afford the fees, and the therapy providers that can't afford to take more than a few clients on a
sliding scale. You said you are making higher level care available to people that can't afford to pay the fees.

You stated that all counseling services will be billed and paid at the standard hourly rate at which the counselors
normally charge non-subsidized clients. When asked to explain how your specialized services are
distinguishable from that of other private counseling practices, if there are other counseling practices offering
these specialized services in these counties, and to explain what due diligence you exercised that would
reasonably warrant the retention of most referrals to you as incidental to your exempt purposes, you said that
the independent contractors of D can network with other members from other several peer networking
organizations to learn about their specialties and introduce them to the subsidy program.

Law

Internal Revenue Code (IRC) Section 501(c)(3) describes corporations organized and operated exclusively for
charitable purposes, no part of the net earnings of which inures to the benefit of any private shareholder or
individual.

Treasury Regulation Section 1.501(c)(3)-1(a)(1) states that in order 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 test or the
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(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 as defined in Section 1.501(a)-1(c).

Treas. Reg. Section 1.501(c)(3)-1(d)(1)(ii) provides that an exempt organization must serve a public rather than
a private interest. The organization must establish that it is not organized or operated to benefit private interests
such as "designated individuals, the creator or his family, shareholders of the organization, or persons
controlled, directly or indirectly, by such private interests."

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 the exemption
regardless of the number or importance of truly exempt purposes. The Court found that the trade association had
an "underlying commercial motive" that distinguished its educational program from that carried out by a
university.

In est of Hawaii v. Commissioner, 71 T.C. 1067 (1979), several for-profit est organizations exerted significant
indirect control over est of Hawaii, a non-profit entity, through contractual arrangements. The question for the
court was not whether the payments made to the for-profits were excessive, but whether they benefited
substantially from the operation of the applicant. The Tax Court concluded that the for-profits were able to use
the non-profit as an "instrument" to further their for-profit purposes. Neither the fact that the for-profits lacked
structural control over the organization nor the fact that amounts paid to the for-profit organizations under the
contracts were reasonable affected the court's conclusion. Consequently, est of Hawaii did not qualify as an
organization described in IRC Section 501(c)(3).

In Church by Mail, Inc. v. Commissioner, T.C. Memo 1984-349, aff'd 765 F. 2d 1387 (9th Cir. 1985), the Court
affirmed a Tax Court decision. Church by Mail sent out sermons in numerous mailings. This required a great
deal of printing services. A for-profit company, controlled by the same ministers, provided the printing and the
mailing. The services were provided under two contracts. The contracts were signed by the two ministers for
both the organization and the for-profit company. The organization's business comprised two-thirds of the
overall business done by the for-profit company. The court determined that there was ample evidence in the
record to support the finding that the organization was operated for the substantial non-exempt purpose of
providing a market for the services of the for-profit company. The Court of Appeals pointed out that "the
critical inquiry is not whether particular contractual payments to a related for-profit organization are reasonable
or excessive, but instead whether the entire enterprise is carried on in such a manner that the for-profit
organization benefits substantially from the operation of the Church." Moreover, the ministers' dual control of
both the Church and the for-profit company enables them to profit from the affiliation of the two entities
through increased compensation.

In International Postgraduate Medical Foundation v. Commissioner, TCM 1989-36 (1989), the Tax Court
considered the qualification for exemption under IRC Section 501(c)(3) of a nonprofit corporation that
conducted continuing medical education tours. The petitioner had three trustees: Mr. Helin, who was a
shareholder and the president of H & C Tours, a for-profit travel agency, Mr. Regan, an attorney, and a third
director, who was ill and did not participate. Mr. Helin served as executive director. The petitioner used H & C
Tours exclusively for all travel arrangements. There is no evidence that the petitioner ever sought a competitive
bid. The Court found that a substantial purpose of the petitioner was benefiting the for-profit travel agency. It
concluded that: "When a for-profit organization benefits substantially from the manner in which the activities of
a related organization are carried on, the latter organization is not operated exclusively within the meaning of
IRC Section 501(c)(3), even if it furthers other exempt purposes." The court found that a substantial purpose of
the applicant's operations was to increase the income of H&C Tours. H&C Tours benefits from the distribution
and production of brochures which solicit customers for tours arranged by H&C Tours.

Application of law

IRC Section 501(c)(3) and Treas. Reg. Section 1.501(c)(3)-1(a)(1) set forth two main tests for an organization
to be recognized as exempt. An organization must be both organized and operated exclusively for purposes
described in Section 501(c)(3). Based on the information you provided in your application, we conclude that
you fail the operational test.

You do not meet the operational test under Treas. Reg. Section 1.501(c)(3)-1(c)(1) because your funds flow to
your directors through D, which furthers a substantial non-exempt purpose. When funds inure to the benefit of
private individuals, an organization is not operating exclusively for an exempt purpose as required by Treas.
Reg. Section 1.501(c)(3)-1(c)(2).

You are not described in Treas. Reg. Section 1.501(c)(3)-1(d)(1)(ii) because your activities benefit E, F, and G
through their for-profit counseling practice, D. This substantially furthers private interests rather than public
interests and precludes exemption.

As stated in Better Business Bureau of Washington, D.C., Inc., 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. An organization is not operated exclusively for one or more exempt purposes if its net earnings inure
to the benefit of private shareholders or individuals, or its activities further private rather than public interests.
The revenue agreement between D and the independent contractors of D inures to the benefit of E, F, and G.
Subsidies to cover the costs of counseling sessions for those who could not otherwise afford it, would increase
the clientele of D, and promotes the for-profit purposes of D. Private inurement precludes your claim for
exemption under IRC Section 501(c)(3).

You are similar to the organizations described in est of Hawaii and Church by Mail, Inc. because you are an
instrument to further the for-profit purposes of D. D's directors and owners are also your directors, and thus
exert all control over your operations and activities. D will benefit from you, where contributions made to you
will be used to subsidize the costs of counseling services offered by D. This will generate revenue for E, F, and
G and advance business operations and increased clientele for D. Your operations and activities serves to
substantially benefit D.

You are also similar to the organization described in International Postgraduate Medical Foundation, because E,
F, and G substantially benefit from the manner in which your activities are carried on. Accordingly, you are not
operating exclusively within the meaning of IRC Section 501(c)(3).

Conclusion

Based on the facts and information submitted, you do not qualify for exemption under IRC Section 501(c)(3).
You fail the operational test because you are formed for the substantial non-exempt purpose of raising funds to
subsidize therapy provided, in pertinent part, through a for-profit entity owned by your directors. Accordingly,
you do not qualify for exemption as an organization described in Section 501(c)(3).

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