501(c)(3) exemption denied to government-formed entity operating as a commercial bank

Plain-English summary

A government-created "semi-autonomous agency" that operates as a lending bank
applied to be recognized as a charity under IRC Section 501(c)(3). The IRS
denied it on both required tests. On the organizational test, the entity's
bylaws list "development" as a purpose, which is not one of the exempt purposes
allowed in a 501(c)(3) charter. On the operational test, the IRS found it runs
like a for-profit commercial bank: it charges interest rates it would not fully
disclose, raises the rate and accelerates the full balance when borrowers
default, and did not show that it lends below cost or only to people who cannot
get regular loans. The IRS distinguished the charitable-lending revenue rulings
(such as below-cost student and home-repair loans) and applied Better Business
Bureau v. United States, which holds that one substantial non-exempt purpose
defeats exemption. Because the entity would not provide details on its
charitable activity and filed no protest, the denial became final, and donors
cannot deduct contributions under Section 170.

Ruling snapshot

• Question: Does the entity qualify for exemption as a charitable organization under IRC § 501(c)(3)?
• Outcome: Denied (final adverse determination; fails both organizational and operational tests)
• Key authorities: IRC § 501(c)(3); Treas. Reg. § 1.501(c)(3)-1(a), (b), (c), (d); Rev. Rul. 61-87, 63-220, 71-259, 74-587, 76-408, 81-284; Better Business Bureau of Washington, D.C., Inc. v. United States; B.S.W. Group, Inc. v. Commissioner; Share Network Foundation v. Commissioner

Full text (IRS public release)

Department of the Treasury
Internal Revenue Service
IRS Tax Exempt and Government Entities

Date: 04/14/2026

Employer ID number:
Form you must file:
Tax years:
Person to contact:

Release Number: 202628011
Release Date: 7/10/26
UIL Code: 501.03-00, 501.03-30, 501.35-00

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.

Sincerely,

Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements

Enclosures:
Letter 437
Redacted Letter 4034
Letter 4038

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

Department of the Treasury
Internal Revenue Service

Date: 02/26/2026

Employer ID number:

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

Legend:
C = Location
D = Date
v percent = Percentage
w percent = Percentage
x percent = Percentage
y percent = Percentage
z dollars = Amount

UIL:
501.03-00
501.03-30
501.35-00

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 are an unincorporated association formed by the government of C as a "semi-autonomous agency" on D. Your Bylaws state that you are formed for "development, charitable, religious, educational, and scientific purposes" under IRC Section 501(c)(3). Your board members are appointed by the governor of C.

You represent that all your time is dedicated to providing banking services other than deposits and you refer to yourself as a "lender of last resort." You seek to provide affordable lending opportunities to the people of C, however, you do not provide charitable loans. You stated that the loans you provide further your exempt purpose as the loans allow more homeowners to build or repair their homes. You state that the borrower's income determines the interest rate but you did not provide details. You didn't describe how the rate is calculated or the range of interest rates you offer.

You said that one hundred percent of your time and revenue is from traditional banking services such as providing mortgage and commercial loans to the underserved communities of C. You said all loan programs you offer have "a program income that is considered revenue to the bank to ensure that operations are sustained throughout the years."

We asked how much of your time you spend on charitable loan programs you said that you do "not offer charitable loans, however, we do have grant programs that were 100% grant, provided for those underserved homeowners in the most isolated areas in C." You said that the "grant funding afforded rehabilitations for 12 households" in one year. You were also awarded another grant to "further rehabilitate homes for the special needs community mainly elderly and disability [sic]."

When asked whether or not borrowers have been denied by commercial lenders before applying to you, you said that it was "not applicable." We also asked for an itemized list of investment income, but you said that is "not applicable."

You provided a sample installment note with an x percent interest rate. The note states that upon default the entire balance becomes due (acceleration clause), and an extra two percent is added to the interest rate. You said you offer new construction and repair home loans for the low and moderate low-income people of C. The terms of the loans are dependent on the loan amount and loan program for which the borrower is approved and vary from 15 years to 30 years. Other loans you offer are commercial loans for business capital startups varying from 4 to 30-year loan terms. You said the interest rates for your loans are based on the borrower's household income bracket.

You said there is one other bank in your area. You said your interest rates are lower than the other bank, which has rates from w percent. However, you did not disclose your range of rates. The sample note you provided also provides for the rate going from x percent to y percent upon default, bringing the rate close to the other lender in the area when the borrower experiences financial difficulty.

In addition, you represent that you facilitate loan guarantee programs, but you did not specify to what extent. You stated that you "had the opportunity to rehabilitate homes for elderly and low-income individual [sic] hundred percent grant funding." It is unclear whether you directly paid for these renovations or whether the individuals obtained loans to complete the renovations. You provided no further details about these activities.

You said you applied for exemption for the opportunity to expand your funding search to be able to apply for more grants. Your financial data shows most of your revenue coming from investment income, with only z dollars in gifts, grants, and contributions. Most of your expenses are for compensation, salaries and wages, fees depreciation, and occupancy costs.

Law

IRC Section 501(c)(3) requires an organization to be organized and operated exclusively for exempt purposes, no part of the net earnings of which inures to a private shareholder or individual, no substantial part of the activities is lobbying, and no political campaign intervention.

Treasury Regulation Section 1.501(c)(3)-1(a)(1) states 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 test or the operational test, it is not exempt.

Treas. Reg. Section 1.501(c)(3)-1(b)(1)(i) provides that an organization is organized exclusively for one or more exempt purposes only if its articles of organization limit the purposes of such organization to one or more exempt purposes; and do not expressly empower the organization engage, otherwise than as an insubstantial part of its activities, in activities that in themselves are not in furtherance of one or more exempt purposes.

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(d)(1)(i) sets forth the core requirement for an organization to qualify for exemption under IRC Section 501(c)(3). Specifically, it provides that an organization may be exempt as described in Section 501(c)(3) if it is organized and operated exclusively for one or more of the following purposes: religious, charitable, scientific, testing for public safety, literary, educational, or prevention of cruelty to children or animals.

Revenue Ruling 61-87, 1961-1 C.B. 191, holds that an organization whose primary purpose and activity is to extend unsecured loans to needy students, at a comparatively low rate of interest to enable them to finance their education, is exempt from federal income tax under IRC Section 501(a) as a charitable and educational organization described in Section 501(c)(3).

Rev. Rul. 63-220, 1963-2 C.B. 208, amplifies Rev. Rul. 61-87 and describes a corporation organized primarily for the purpose of extending loans to needy students of a college to enable them to complete their educational programs. Certain loans are granted on an unsecured basis, while others require a type of security. Both types of loans are made at the same nominal rate of interest which is substantially lower than commercial interest rates, thereby representing a substantial saving to the students. Held, the organization qualifies for exemption from Federal income tax as an organization described in IRC Section 501(c)(3) as one which is organized and operated exclusively for charitable and educational purposes.

Rev. Rul. 71-259, 1971-2 C.B. 234, held that an organization managing university endowment and investment funds at a below cost rate was exempt under IRC Section 501(c)(3).

Rev. Rul. 74-587, 1974-2 C.B. 162, held that an organization exclusively providing below cost loans to businesses in an economically depressed area and giving preference to businesses that will provide employment opportunities for residents is operated exclusively for charitable purposes.

Rev. Rul. 76-408, 1976-2 C.B. 145, held that providing interest free home repair loans to low income homeowners in deteriorated areas, who do not qualify for traditional loans, is a charitable purpose under IRC Section 501(c)(3).

Rev. Rul. 81-284, 1981-2 C.B. 130, held that an organization that issues loans below commercial rates to businesses that cannot obtain regular loans and employ unemployed residents was exempt under IRC Section 501(c)(3).

In Better Business Bureau of Washington, D.C., Inc. v. United States, 326 U.S. 179 (1945), the Supreme Court found that a single, substantial, non-exempt purpose will bar a claim for exemption, regardless of whether there are other exempt purposes.

In B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978), the court found that a corporation formed to provide consulting services was not exempt under Section 501(c)(3) because its activities constituted the conduct of a trade or business that is ordinarily carried on by commercial ventures organized for profit. Its primary purpose was not charitable, educational, nor scientific, but rather commercial. In addition, the court found that the organization's financing did not resemble that of the typical Section 501(c)(3) organizations. It had not solicited, nor had it received, voluntary contributions from the public. Its only source of income was from fees from services, and those fees were set high enough to recoup all projected costs and to produce a profit. Moreover, it did not appear that the corporation ever planned to charge a fee less than "cost." And finally, the corporation did not limit its clientele to organizations that were Section 501(c)(3) exempt organizations.

In Share Network Foundation v. Commissioner, 78 T.C.M. (CCH) 6 (1999), the court held that the organization has the burden of providing sufficient documentation or other substantive information regarding its activities and operations, which would establish entitlement to tax exempt status. Information that is vague or nonspecific is not sufficient to meet the requirements under IRC Section 501(c)(3).

Application of law

IRC Section 501(c)(3) sets forth two main tests for qualification of exempt status. Per Treas. Reg. Section 1.501(c)(3)-1(a)(1), an organization must be both organized and operated exclusively for purposes described in Section 501(c)(3).

Organizational Test

Your bylaws include as one of your purposes "development." Your purposes aren't limited to those which are exempt, as required by Treas. Reg. Section 1.501(c)(3)-1(b)(1)(i). Additionally, "development" isn't listed as one of the exempt purposes in Treas. Reg. Section 1.501(c)(3)-1(d)(1)(i). For these reasons, you fail the organizational test.

Operational Test
You also do not meet the operational test. You are operating a bank in a manner similar to a for-profit bank. You are not operating "exclusively" for exempt purposes as required by Treas. Reg. Section 1.501(c)(3)-1(c)(1).

There is no evidence that you charge substantially lower rates than commercial banks or provide loans to those who cannot obtain traditional loans, which were key factors for granting exemption for loan activities discussed in Rev. Rul. 63-220, Rev. Rul. 76-408, and Rev. Rul. 81-284. When asked for details regarding these factors, you responded that the questions do not apply to you.

You also penalize defaulted borrowers by increasing interest rates and accelerating the entire loan balance. This is sharply contrasted with the organization granted exemption in Rev. Rul. 61-87, which guaranteed loans for students when they default on commercial loans.

Your situation is also distinct from Rev. Rul. 71-259 because you do not provide your banking services below cost. Your sample loan agreement contains an x percent interest rate and a clause that increases the rate to y percent upon default. The y percent interest rate is only half a percentage lower than loans offered by your competitor. You state that the interest rate depends on the borrower's income but you did not describe how the rate is calculated or the range of rates.

You state that some of your customers are low income, but not all, and you didn't provide a demographic breakdown. You also state that your loans are low interest, and the rate depends upon the borrower's income but you failed to provide more details. Unlike the organization described in Rev. Rul. 74-587, in which the court found that providing below-cost loans to businesses operating in deteriorated areas and training residents is an exempt purpose, you provide loans to any resident and you have failed to demonstrate that the loans are below cost. Providing loans to low-income individuals, without more, is insufficient to qualify for exemption.

You represent that you spend all of your time providing banking services, other than deposits. Like the organization denied exemption in B.S.W. Group, Inc., you are operating a regular business in a non-exempt manner. Like the organization described in Better Business Bureau of Washington, D.C., Inc., any charitable purpose you may have is incidental to your substantial non-exempt purpose of operating a bank. As stated in this ruling, 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.

In addition, when asked specific questions about any exempt activities you may conduct, such as your range of interest rates, or proportion of loans going towards helping the poor, you said these questions didn't apply. You have the burden of establishing that your activities qualify for exemption, as described in Share Network Foundation. You failed to demonstrate that your sole activity of providing loans to residents of C fulfills an exempt purpose.

Conclusion

Based on the information submitted, you have not established that you are operating exclusively for one or more exempt purposes described in IRC Section 501(c)(3). Your Bylaws included purposes that are outside of IRC Section 501(c)(3) purposes. You fail the operational test because you are operating for the substantial non-exempt purpose of operating a banking institution in a manner similar to a commercial lender. Also, you failed to provide the detail needed to determine to what extent, if any, your activities serve a charitable purpose. Accordingly, you do not qualify for exemption under 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:
Internal Revenue Service
EO Determinations Quality Assurance
Mail Stop 6403
PO Box 2508
Cincinnati, OH 45201

Street address for delivery service:
Internal Revenue Service
EO Determinations Quality Assurance
550 Main Street, Mail Stop 6403
Cincinnati, OH 45202

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