IRS revokes charity status after personal expenses benefited its founder

Plain-English summary

The IRS revoked a charity's section 501(c)(3) status after an examination found repeated payments of personal expenses and other disbursements benefiting its founder. The organization used cash withdrawals and debit-card purchases, lacked an accountable plan, and did not provide records that tied meals, cable and internet service, vehicle costs, and other spending to exempt activities. It also characterized deposits as loans from an officer, but the IRS found no contemporaneous notes, repayment schedules, maturity dates, interest terms, or other evidence of bona fide debt. The IRS concluded that the payments created prohibited private inurement and private benefit, and that the organization did not operate exclusively for exempt purposes. Its exemption was revoked retroactively to a redacted date, contributions ceased to be deductible after that date, and it was required to file corporate income tax returns.

Ruling snapshot

• Question: Should the organization's section 501(c)(3) exemption be revoked because its funds benefited its founder and other private interests?
• Outcome: Revocation
• Key authorities: IRC §§ 170, 501(c)(3), 4958, and 7428; Treas. Reg. §§ 1.501(c)(3)-1(c) and 1.501(c)(3)-1(d)(1)(ii); Better Business Bureau v. United States; American Campaign Academy v. Commissioner; John Marshall Law School v. United States; United Cancer Council, Inc. v. Commissioner

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
TE/GE: EO Examinations
1100 Commerce Street, MC 4920 DAL
Dallas, TX 75242

TAX EXEMPT AND

GOVERNMENT ENTITIES
DIVISION March 31, 2016
Release Number: 201627002 Taxpayer Identification Number:
Release Date: 7/1/2016
UIL Code: 501.03-00 Person to Contact:

Identification Number:
Contact Telephone Number:
CERTIFIED MAIL — RETURN RECEIPT REQUESTED
Dear

This is a final adverse determination regarding your exempt status under section
501(c)(3) of the Internal Revenue Code (the Code). Our favorable determination letter
to you dated February 19XX is hereby revoked and you are no longer exempt under
section 501(a) of the Code effective January 1, 20XX.

The revocation of your exempt status was made for the following reason(s):

Organizations exempt from Federal income tax under section 501(c)(3) of the Internal
Revenue Code are required to operate exclusively for charitable, education, or other
exempt purposes. Organizations are not operated exclusively for exempt purposes if
the net earnings of the organization inure in whole or in part to the benefit of private
shareholders or individuals. See Treas. Reg. section 1.501(c)(3)-1(c)(2).

During 20XX, 20XX, and 20XX, we have determined that your net earnings inured to
the benefit of private individuals because you regularly paid personal expenses for and
made other disbursements to your founder without contemporaneously recording these
expenditures as salary or compensation. The transactions were frequent and were
significant in relation to your exempt activities in each year. No efforts were made by
the board to seek correction of these transactions, no safeguards were implemented to
prevent future divisions and Organization ceased operating in 20XX. You have
operated for the benefit of private interests of individuals in contravention of the
requirements of Treas. Reg. 1.501(c)(3)-1(d)(1)(ii).

Contributions to your organization are no longer deductible under IRC §170 after
January 1, 20XX.


You are required to file Form 1120 U. S. Corporation Income Tax Return. These
returns should be filed with the appropriate Service Center for tax years ended
December 31, 20XX, December 31, 20XX, December 31, 20XX and for all years
thereafter in accordance with the instructions of the return.

Processing of income tax returns and assessments of any taxes due will not be delayed
should a petition for declaratory judgment be filed under section 7428 of the Internal
Revenue Code.

If you decide to contest this determination under the declaratory judgment provisions of
section 7428 of the Code, a petition to the United States Tax Court, the United States
Claims Court, or the district court of the United States for the District of Columbia must
be filed before the 91st Day after the date this determination was mailed to you. Please
contact the clerk of the appropriate court for rules regarding filing petitions for
declaratory judgments by referring to the enclosed Publication 892. You may write to
these courts at the following addresses:

United States Tax Court United States Court of Federal Claims
400 Second Street, NW 717 Madison Place, NW
Washington, D.C. 20217 Washington, D.C. 20005

United States District Court for the District of Columbia
333 Constitution Avenue, NW
Washington, D.C. 20001

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 taxpayeradvocate.irs.gov
or call 1-877-777-4778.

If you have any questions, please contact the person whose name and telephone
number are shown in the heading of this letter.

Sincerely,
Paul A. Marmolejo
Acting Director, EO Examinations

Enclosure:
Publication 892


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

Exempt Organizations: Examinations

1100 Commerce Street, MS: 4920

Dallas, TX 75242

Date:
July 7, 20XX
Taxpayer Identification Number:

Form:
990

Tax Year(s) Ended:
December 31, 20XX
December 31, 20XX
December 31, 20XX

Person to Contact/ID Number:

Contact Numbers:
Manager’s name/ID number:

Manager’s contact number:

Response due date:
August 3, 20XX

Certified Mail — Return Receipt Requested
Dear

Why you are receiving this letter

We propose to revoke your status as an organization described in section 501(c)(3) of the
Internal Revenue Code (Code). Enclosed is our report of examination explaining the proposed
action.

What you need to do if you agree

If you agree with our proposal, please sign the enclosed Form 6018, Consent to Proposed
Action — Section 7428, and return it to the contact person at the address listed above (unless
you have already provided us a signed Form 6018). We'll issue a final revocation letter
determining that you aren't an organization described in section 501(c)(3).

After we issue the final revocation letter, we'll announce that your organization is no longer
eligible for contributions deductible under section 170 of the Code.

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 revocation letter. Failing to respond to this proposal will adversely impact your legal
standing to seek a declaratory judgment because you failed to exhaust your administrative
remedies.

Letter 3618 (Rev. 6-2012)
Catalog Number 34809F

Effect of revocation status
If you receive a final revocation letter, you'll be required to file federal income tax returns for the
tax year(s) shown above as well as for subsequent tax years.

What you need to do if you disagree with the proposed revocation

If you disagree with our proposed revocation, you may request a meeting or telephone
conference with the supervisor of the IRS contact identified in the heading of this letter. You also
may file a protest with the IRS Appeals office by submitting a written request to the contact
person at the address listed above within 30 calendar days from the date of this letter.

The Appeals office is independent of the Exempt Organizations division and resolves most
disputes informally.

For your protest to be valid, it must contain certain specific information including a statement of
the facts, the applicable law, and arguments in support of your position. For specific information
needed for a valid protest, please refer to page one of the enclosed Publication 892, How to
Appeal an IRS Decision on Tax-Exempt Status, and page six of the enclosed Publication 3498,
The Examination Process. Publication 3498 also includes information on your rights as a
taxpayer and the IRS collection process. Please note that Fast Track Mediation referred to in
Publication 3498 generally doesn’t apply after we issue this letter.

You also may request that we refer this matter for technical advice as explained in Publication

892. Please contact the individual identified on the first page of this letter if you are considering
requesting technical advice. If we issue a determination letter to you based on a technical
advice memorandum issued by the Exempt Organizations Rulings and Agreements office, no
further IRS administrative appeal will be available to you.

Contacting the Taxpayer Advocate Office is a taxpayer right

You have the right to contact the office of the Taxpayer Advocate. Their assistance isn't a
substitute for established IRS procedures, such as the formal appeals process. The Taxpayer
Advocate can't reverse a legally correct tax determination or extend the time you have (fixed by
law) to file a petition in a United States court. They can, however, see that a tax matter that
hasn't been resolved through normal channels gets prompt and proper handling. You may call
toll-free 1-877-777-4778 and ask for Taxpayer Advocate assistance. If you prefer, you may
contact your local Taxpayer Advocate at:

Internal Revenue Service
Office of the Taxpayer Advocate

For additional information

If you have any questions, please call the contact person at the telephone number shown in the
heading of this letter. If you write, please provide a telephone number and the most convenient
time to call if we need to contact you.

2 Letter 3618 (Rev. 6-2012)
Catalog Number 34809F


Thank you for your cooperation.

Sincerely,

Margaret Von Lienen
Director, EO Examinations

Enclosures:

Report of Examination
Form 6018
Publication 892
Publication 3498

3 Letter 3618 (Rev. 6-2012)
Catalog Number 34809F


Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit

Name of Taxpayer Year/Period Ended
DECEMBER 31,

20XX
DECEMBER 31
20XX
DECEMBER 31,
20XX

ISSUES

Whether should have their exemption revoked for creating private benefit
and inurement to a disqualified person of the exempt organization?

FACTS

is an applicable 501(c)(3) established in ; in
October 20 of 19XX. was granted their exemption on October of 19XX.
The purpose of is to provide assistance to various municipalities
around that have that are home to an endangered species list
that lives only in in the area. protects and

inventories the

paid for items that benefited
has failed to substantiate the exempt purpose of these expenditures as requested in the
issued to on March 13 20XX. A listing of the largest items noted is as follows.

Meals: In 20XX food was purchased times for a total of $ . These
purchases occurred evenly throughout the year. In 20XX food was purchased

times for a total of $ . provided bank statements showing these
expenditures, but was issued several on requesting substantiation for
the business and tax exempt purpose of said purchases, but to date has failed to
provide the requested information therefore these purchases are deemed to be
personal in nature benefiting personally.

Cable: purchased cable and internet for personal residence in the
years 20XX and 20XX. The total expense for each year was $ for 20XX and $
for 20XX. was issued requesting substantiation for the
business and tax exempt nature of these expenses, however to date this information
has not been provided. Therefore due to the personal nature of these expenses it is

deemed to be benefiting personally.

Vehicle expenses: In 20XX paid $ for fees, $ in gas,
and $ in vehicle repairs. In 20XX purchased $ in gas and
$ in vehicle repair. has no vehicle listed in the asset log that it
provided from sent on December 5, 20XX.

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service

Page: -1-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit

Name of Taxpayer Year/Period Ended
DECEMBER 31,

20XX
DECEMBER 31
20XX
DECEMBER 31,
20XX

All transactions provided by were either cash withdraws or debit card
purchases. This agent did not observe any transactions that were checks in the
records for the three years under exam.

was issued on March19, 20XX requesting explanation and source of the
deposits. stated that the amounts deposited were personal loans made to
the EO from him. Agent noted that no contemporaneous loan documents were
available to substantiate the terms of the loan. The loan from the officer was
determined to not be a bona fide debt. The organization did not maintain proper
substantiation to support and verify the expenses and advances that made up the total
balance due to the officer (such as a written promissory note, repayment schedule,
maturity date for the loan, or an interest rate for the loan.

All disbursements in the bank statements provided by are debit card
transactions or cash transactions.

provided the Service with bank statements and envelopes with
receipts in them. The receipts did not match the dollar amounts of the envelopes.
The receipts inside the envelopes were not always from the immediate period that the
cash withdraw was made. The receipts were from as much as a year before and half
a year later in the same envelope. There was no accountable plan in place at
Most transactions were cash transactions or reimbursements of purchases.

The Bylaws of state in Prohibition against Private
Inurement: No part of the net earnings of this corporation shall inure to the benefit of,
or be distributable to, its members, directors, or trustees, officers, or other private
persons, except that the corporation shall be authorized and empowered to pay
reasonable compensation for services rendered and to make payments and
distributions in furtherance of the purposes of this corporation.

The of provides monitoring on the side and is paid directly
for services.

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service

Page: -2-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit

Name of Taxpayer , Year/Period Ended
DECEMBER 31,

20XX

DECEMBER 31
20XX
DECEMBER 31,
20XX

Section 501(c)(3) of the Code exempts from federal income tax organizations organized
and operated exclusively for charitable, educational, and other exempt purposes,
provided that no part of the organization's net earnings inures to the benefit of any
private shareholder or individual.

Section 1.501(c)(3)-1(a)(1) of the regulations provides that in order to be exempt as an
organization described in section 501(c)(3) of the Code, the organization must be one
that is both organized and operated exclusively for one or more of the purposes
specified in that section.

Section 1.501(c)(3)-1(c)(1) of the regulations provides that an organization will not be
regarded as operated exclusively for exempt purposes if more than an insubstantial part
of its activities is not in furtherance of exempt purposes.

Section 1.501(c)(3)-1(d)(ii) of the regulations provides that an organization is not
organized or operated exclusively for one or more exempt purposes unless it serves a
public rather than a private interest. Thus, it is necessary for an organization to
establish that it is not organized or operated for the benefit of 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.

Section 1.501(c)(3)-1(d)(1)(ii) of the regulations states that an organization is not
organized or operated exclusively for exempt purposes unless it serves a public rather
than a private interest. The regulation places the burden of proof on the organization to
demonstrate that it is not organized or operated for the benefit of 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.

Section 1.501(c)(3)-1(d)(2) of the regulations provides that the term "charitable" is used
in section 501(c)(3) of the Code in its generally accepted legal sense, and includes the
promotion of education.

The presence of a single substantial nonexempt purpose can destroy the exemption
regardless of the number or importance of exempt purposes. Better Bus. Bureau v.
United States, 326 U.S. 279. 283, 90 L. Ed. 67, 66 S. Ct. 112 (1945); Am. Campaign
Acad. v. Commissioner, 92 T.C. 1053, 1065 (1989); see also Old Dominion Box Co.,
Inc. v. United States, 477 F2d. 340 (4th Cir. 1973), cert. denied, 413 US 910 (1973)
(“operating for the benefit of private parties who are not members of a charitable class
constitutes a substantial nonexempt purpose”). When an organization operates for the

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service
Page: -3-


Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
DECEMBER 31,
20XX
DECEMBER 31
20XX
DECEMBER 31,
20XX

benefit of private interests, such as designated individuals, the creator or his family, or
persons directly or indirectly controlled by such private interests, the organization by
definition does not operate exclusively for exempt purposes. Am. Campaign Acad. v.
Commissioner, supra at 1065-1066.

In B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978), the courts ruled
the organization did not qualify for exemption under IRC section 501(c)(3)
because it was not operated exclusively for charitable, educational, or scientific
purposes.

In order to be recognized as exempt under IRC section 501(c)(3), the organization is
prohibited from:

1) Permitting its net earnings to inure to the benefit of private individuals or operating in
a way where more than an insubstantial part of its activities further private versus public
purposes

2) Engaging substantially in legislative activity

3) Participating or intervening in any political activity

Treas. Reg. section 1.501(c)(3)-1(c)(2) states that an organization is not exclusively
operated for one or more exempt purposes if its net earnings inure in whole or in part to
the benefit of private shareholders or individuals.

Treas. Reg. section 1.501(a)-1(c) defines a “private shareholder or individual” as
“persons having a personal and private interest in the activities of an organization.”

If the private benefit to an individual or a group of individuals is greater than the public
benefit, the private benefit is considered substantial. A substantial private benefit can
result in revocation of exempt status.

Even a small amount of private inurement is fatal to exemption. In Spokane Motorcycle
Club v. U.S., 222 F. Supp. 151 (E.D. Wash. 1963), net profits were found to inure to
private individuals where refreshments, goods and services amounting to $825
(representing some 8% of gross revenues) were furnished to members

Regs. 1.501(c)(3)-1(d)(1)(ii) states that the burden of proof is upon the organization to
establish that it is not organized or operated for the benefit of private interests. This
requirement applies equally to inurement and private benefit issues. While it is difficult
to prove a negative, the organization is certainly in a better position than the Service to
know the detailed facts surrounding its formation and operation. Therefore, in an

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service
Page: -4-


Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit

Name of Taxpayer Year/Period Ended
DECEMBER 31,

20XX
DECEMBER 31
20XX
DECEMBER 31,
20XX

exemption application case the organization is required to furnish the Service with the
documents setting forth its purposes and rules of operation as well as a detailed
explanation of its operations. See Rev. Proc. 84-46, 1984-1 C.B. 541.

Baird v. Commissioner, 25 T.C. 387 (1955) provides that the extent to which the
borrower controls the corporation is a factor that can indicate whether a loan is a bona
fide debt.

United States v. Title Guarantee & Trust Co., 133 F. 2d 990 (6th Cir. 1943) provides
that the maturity date of the loan can indicate whether a loan is a bona fide debt.

Thielking v. Commissioner, T.C.M. 1987-227 provides that whether the note provides
for interest or not can indicate whether a loan is a bona fide debt.

In John Marshall Law School and John Marshall University v. United States, 228 Ct. Cl.
902 (1981), 81-2 U.S.T.C. 9514 involve classic channeling of an organization's net
earnings to those in control. The court sustained the Service’s revocation of the
school’s exempt status based on inurement. The court found inurement existed when
the school provided the following to family members who were its officers:

* Interest free loans

* Unsecured loans

* Payments for non-business travel

* Payments for non-business entertainment

* Personal health spa membership

In United Cancer Council, Inc. v. Commissioner, 165 F.3d 1173 (1999), the appeals
court stated the inurement clause of IRC section 501(c)(3) interprets the phrase “private
individual or shareholder’ as an insider of the charity.

The court further said a charity must not improperly pass its earnings to its founder,
board members, their families, or anyone else described as an insider who is the
equivalent of an owner or manager. The insider could be an employee such as an office
manager.

GOVERNMENT’S POSITION

An organization recognized as tax exempt under IRC section 501(c)(3) is prohibited
from permitting any of its net earnings to inure to the benefit of any private shareholder

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service
Page: -5-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
, Explanation of Items Exhibit

Name of Taxpayer Year/Period Ended
DECEMBER 31,

20XX

DECEMBER 31
20XX
DECEMBER 31,
20XX

or individual. records show several expenses that are inurement
just like in John Marshall Law School and John Marshall University v. United States,
228 Ct. Cl. 902 (1981), 81-2 U.S.T.C. 9514. These expenses meals, cable bills,
payments and other expenses are for the betterment of a disqualified person and not
for general public.

Regs. 1.501(c)(3)-1(d)(1)(ii) states that the burden of proof is upon the organization to
establish that it is not organized or operated for the benefit of private interests. This
requirement applies equally to inurement and private benefit issues. While it is difficult
to prove a negative, the organization is certainly in a better position than the Service to
know the detailed facts surrounding its formation and operation. Therefore, in an
exemption application case the organization is required to furnish the Service with the
documents setting forth its purposes and rules of operation as well as a detailed
explanation of its operations. See Rev. Proc. 84-46, 1984-1 C.B. 541.

It is the Government's position that the has not provided any consistency
in the information provided in this examination. In response to the Information
Document Requests, furnished several envelopes with receipts, total of

which never reconciled to the amounts withdrawn from the bank account.. The
receipts were from 8 months before the cash withdraw and up to 8 months after the
cash withdraw. The receipts contained in the envelopes were for various expenses that
were never proven to be for a business/tax exempt purpose and were dated for periods
outside of the audit years. See the examples attached to this report. This is
inconsistent with the meaning of an accountable plan and not proof of factual events for
an ongoing concern. The receipts provided in envelopes were not labeled with
information to discern their exempt purpose. To not have an accountable plan is to
have a taxable event and that is what this agent sees in . Not only
do we have a taxable event but we have inurement which is not allowed in Section
501(c)(3) organizations. Therefore it is the Governments position that

should lose its exemption due to inurement and private benefit created on behalf of the

of Disqualified Person who controls the exempt organization. All
purchases and decisions are made by the of
Excess benefit transactions would not occur without approval.

The amount of the benefit is not clear due to the intermingling of personal expenses
and exempt organizations functional expenses. What was determinable was that there
is a comingling of these expenses and that there were no controls or accountable plans

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service
Page: -6-


Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or

Explanation of Items Exhibit

Name of Taxpayer Year/Period Ended
DECEMBER 31,
20XX
DECEMBER 31
20XX
DECEMBER 31,
20XX

to separate personal expenses from the exempt organizations business. The exempt
organization did not report these amounts as compensation on an original or amended
Form 990, Form W-2, or Form 1099 for the year ending December 31, 20XX, before
the start of this examination; nor did any of the corporate officers report these amounts
as compensation on an original or amended Form 1040 before the start of this
examination. Furthermore, the EO did not establish that its failure to report these
amounts as compensation was due to reasonable cause within the meaning of section
301.6724-1 of the regulations, nor did it provide any other written documentation
demonstrating that it approved these payments in accordance with established
procedures set forth in section 53-4958-4(c)(3)(ii) of the regulations. The payments are
described in detail below and on the attached documents.

The claims that certain payments received by the exempt organization were
loans. As per United States v. Title Guarantee & Trust Co., 133 F. 2d 990 (6th Cir.
1943), Thielking v. Commissioner, T.C.M. 1987-227, and Baird v. Commissioner, 25
T.C. 387 (1955) the Government has a framework that must be followed to be bona fide
as a true loan and not a contribution to an organization. These steps to disclose a
bona fide debt such as including in the Form 990 that loans were created or a physical
document signed contemporaneously that would state terms conditions and implied

payback schedule were not provided. did not document the
transactions contemporaneously. The of did not even leave a
paper trail to proof that the moneys were from the of . The
of states that withdrew the cash from personal
account and deposited said cash into account. It is the

Government's position that there are no loans properly disclosed to the Government,
nor any contemporaneous documentation to proof the origins of the funds that were
received. The corresponding cash payments made to the of will be
considered unreported income therefore, as per definition Section 4958 excess benefit
transactions.

CONCLUSION

Regs. 1.501(c)(3)-1(d)(1)(ii) states that an organization is not organized or operated
exclusively for exempt purposes unless it serves a public rather than a private interest.
The regulation places the burden of proof on the organization to demonstrate that it is
not organized or operated for the benefit of private interests such as designated
individuals, the creator or family, shareholders of the organization, or persons

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service
Page: -7-

Form 886A

Department of the Treasury - Internal Revenue Service

Explanation of Items

Schedule No. or
Exhibit

Name of Taxpayer

Year/Period Ended
DECEMBER 31,
20XX
DECEMBER 31
20XX
DECEMBER 31,
20XX

controlled directly or indirectly by such private interests.
reasons, does not qualify for exemption under section 501(c)(3) and its tax
exempt status should be revoked as of January 1 20XX.

Based on the foregoing

should have their exempt status revoked due to lack of exempt purposes.

TAXPAYER’S POSITION

has indicated that it will agree with to revocation of its exemption.

Form 886-A (Rev. 4-68)

Department of the Treasury - Internal Revenue Service

Page: -8-