Commingled funds and private benefit end exemption

Plain-English summary

A charity provided donated goods and social services, but its activities had declined substantially. Its president used a personal checking account as the organization's bank account, mixing charitable contributions with personal rental and pension income. The examination found personal or unexplained expenditures, out-of-state and foreign ATM withdrawals, casino transactions, missing documentation, and no independent financial oversight. The IRS concluded that more than an insubstantial part of the organization's activities served nonexempt purposes and the private interests of its founder and president. It revoked exemption under IRC § 501(c)(3), ended deductibility of contributions after the effective date, and required federal income tax returns.

Ruling snapshot

• Question: Did the organization continue to qualify under IRC § 501(c)(3) despite commingled funds, weak oversight, and private benefit to its president?
• Outcome: revocation
• Key authorities: IRC §§ 170, 501(a), 501(c)(3), and 7428; Treas. Reg. § 1.501(c)(3)-1(c) and (d)

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

August 22, 2016

Release Number: 201647008
Release Date: 11/18/2016
UIL Code: 501.03-00

Taxpayer Identification Number:

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 July 7, 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):

You are not operating exclusively for any charitable purpose, educational purpose, or
any other exempt purpose. Our examination reveals that you are not engaged primarily
in activities which accomplish charitable, educational or other exempt purposes as
required by Treas. Reg. 1.501(c)(3)-1(c)(1). Your activities, including your financial
transactions, more than insubstantially furthered non-exempt purposes. Moreover, you
failed to establish that you were not operated for the benefit of private interest of your
founder and president as required for continued recognition of exemption pursuant to
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. The return
should be filed with the appropriate Service Center for tax years ended December 31,
20XX and December 31, 20XX and for all tax 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,
Margaret Von Lienen
Director, EO Examinations

Enclosure:
Publication 892


Department of the Treasury
Internal Revenue Service
Tax Exempt and Government Entities
IRS Exempt Organizations Examinations
1100 Commerce Street MS 4900 DAL
Dallas, TX 75242-1100

Date:
April 20, 2016

Taxpayer Identification Number:

Form:

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

Person to Contact/ID Number:

Contact Numbers:
Telephone:
Fax:

Manager’s Name/ID Number:

Manager’s Contact Number:

Response due date:
May 20, 20XX

CERTIFIED MAIL - RETURN RECEIPT REQUESTED

Dear

We propose to revoke our recognition of your exempt status as an organization
described in section 501(c)(3) of the Internal Revenue Code (the Code). We enclose
our report of examination explaining why we are proposing this action.

If you accept our proposal, please sign and return the enclosed Form 6018, Consent to
Proposed Action - Section 7428, unless you have already provided us a signed Form
6018. We will issue a final revocation letter determining you are not an organization
described in section 501(c)(3). After the issuance of the final revocation letter we will
publish an announcement that you have been deleted from the cumulative list of
organizations contributions to which are deductible under section 170 of the Code. If
you do not respond to this proposal, we will similarly issue a final revocation letter.
Failing to respond to this proposal may adversely impact your legal standing to seek a
declaratory judgment because you may be deemed to have failed to exhaust
administrative remedies.

If you do not agree with our proposed revocation and wish to protest our proposed
revocation to the Appeals Office of the Internal Revenue Service, then you must submit
to us a written request for Appeals Office consideration within 30 days from the date of
this letter to protest our decision. This written request is called a protest. For your
protest to be valid it needs to contain certain specific information which generally
includes a statement of the facts, the applicable law, and arguments in support of your

Mod. Letter 3618

position. For the specific information needed for a valid protest, please refer to page 6 of
the enclosed Publication 3498, The Examination Process, and page 1 of the enclosed
Publication 892, How to Appeal an IRS Decision on Tax-Exempt Status.

If you do submit a valid protest, then an Appeals officer will review your case. The
Appeals Office is independent of the Director, EO Examinations. The Appeals Office
resolves most disputes informally and promptly. The enclosed Publication 3498 and
Publication 892 explain how to appeal an Internal Revenue Service (IRS) decision.
Publication 3498 also includes information on your rights as a taxpayer and the IRS
collection process. Please note that Fast Track Mediation Services referred to in
Publication 3498, generally do not apply after issuance of this letter.

You may also request that we refer this matter for Technical Advice as explained in
Publication 892 and an annual revenue procedure. 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 EO Rulings and Agreements function, then no further
administrative appeal will be available to you within the IRS on the matter.

If you receive a final revocation letter, you will be required to file Federal income tax
returns for the tax period(s) shown above as well as for subsequent years.

You have the right to contact the office of the Taxpayer Advocate. Taxpayer Advocate
assistance is not a substitute for established IRS procedures, such as the formal
appeals process. The Taxpayer Advocate cannot reverse a legally correct tax
determination, or extend the time fixed by law that you have to file a petition in a United
States court. The Taxpayer Advocate can, however, see that a tax matter that may not
have been resolved through normal channels gets prompt and proper handling. 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

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.

Mod. Letter 3618

Thank you for your cooperation.

Sincerely,

Paul A. Marmolejo
Acting Director, Exempt Organizations
Examinations

Enclosure:

Publication 892,
Publication 3498,
Form 6018,

Report of Examination

3
Mod. Letter 3618

Form 886-A
EXPLANATION OF ITEMS
Schedule or Exhibit No.
Page 1 of 6
Name of Taxpayer
Year Ended
20XX12 & 20XX12
Issue

Should the Organization’s 501(c)(3) status be revoked on the grounds that it is not operating within the scope of
Internal Revenue Code Section 501(c)(3)?

Facts

Per the Organization’s filed Form 990 for tax year ending December 31, 20XX, their mission is to:

“ ”

Per the Organization’s Articles of Incorporation, filed August 5, 19XX, their purpose is:

“

”

The President, , advised that the Organization is no longer affiliated with the
in

On July 28, 19XX, the Organization’s Articles of Incorporation were amended to include the following
paragraph, which states, in part:

“

.”

Per the President, the Organization performs: and they
perform social services for individuals and families. At the time of the tour of the facilities, they were not
providing any housing. They identify individuals and families in need and they network with different
organizations and businesses in the community to find the resources to meet that need. The President advised
that their activities have greatly been reduced since governmental agencies now provide the majority of the
services they used to offer.

During 20XX, the Organization reported that they received a total of $XXX,XXX in Fair Market Value from a
combination of donated furniture, food and toys. The President advised that the majority of these items are
donated to those in need throughout the year.

On the Filed Form 990 and calendar years ending 20XX and 20XX, the Organization reported that they own
properties. The Organization reported “gross rents” (Part VIII of Form 990) related to this property, totaling
$XX,XXX. For tax year 20XX, the amount reported totaled $XX,XXX. When asked about this property and the
related rental income, the President , advised that this property and rental income was actually

Department of the Treasury - Internal Revenue Service Form 886-A


Schedule or
Form 886-A EXPLANATION OF ITEMS Exhibit No.
Page 2 of 6
Name of Taxpayer Year Ended
20XX12 & 20XX12

hers, and it should not have been reported on the Forms 990 because the Organization does not own the property
nor do they directly receive the rental income. She advised that she reports this rental income on her personal tax
return. She advised that it was a mistake to have included it on the Forms 990.

Due to this, the President advised that the Forms 990 are incorrect and that most of the income and expenses
reported on the returns are actually related to her and not the Organization. Therefore, the Forms 990 filed for
20XX and 20XX are materially incorrect.

The President advised that her personal checking account is also used as the Organization’s bank account. The
President advised that she makes all deposits into this account, which includes the rental income, her retirement
pension, which is unrelated to the Organization, and all charitable contributions the Organization receives. Since
the Organization's bank account is commingled with the President’s personal funds, it is impossible to discern any
purported Organization expense from the President’s personal expenditures. The Organization's assets, i.e. its
bank account, are readily available for the President’s immediate and personal use. The majority of the
expenditures were personal in nature or unexplained.

An Information Document Request (IDR) dated August 21, 20XX was provided to the Organization. This IDR
requested source documentation pertaining to questionable transactions identified in the checking account, such as
out of state and out of country ATM withdrawals and debit card transactions at casinos. A follow up IDR was
provided to the Organization on September 14, 20XX. No response was provided by the organization to either
IDRs.

The President is in complete control over the Organization's financial activities. The President does not have to
substantiate or provide accounting for any expenditure made from the Organization's bank account. The audit
reveals that the President never relinquishes control over the funds. There is a Board of Directors listed on the
filed Forms 990 but there is no indication that they act as an independent body responsible for reviewing,
approving, co-signing financial transactions, or, preventing Organizational assets (bank account) from inuring to
its founder. Transactions are not recorded, there is no segregation of duties, there are no outside parties overseeing
the Organization, there is no annual independent audit. The President is the sole controller of the Organization.

Law

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. The existence of a substantial nonexempt purpose,
regardless of the number or importance of exempt purposes, will cause failure of the operational test. Better
Business Bureau of Washington, D.C., Inc. v. United States , 326 U.S. 279 (1945).

Department of the Treasury - Internal Revenue Service Form 886-A

Schedule or
Form 886-A EXPLANATION OF ITEMS Exhibit No.
Page 3 of 6
Name of Taxpayer Year Ended
20XX12 & 20XX12

Regulation Section 1.501(c)(3)-1(c) defines the "Operational test". Regulation Section 1.501(c)(3)-1(c)(1)
"Primary activities" provides, in part "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 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.”

Regulation Section 1.501(c)(3)-1(c)(2) "Distribution of earnings" expands on the definition of an activity that is
not in furtherance of an exempt purpose. It states: "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.
For the definition of the words ‘private shareholder or individual’, see paragraph (c) of Sec. 1.501(a)-1."

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. Prohibited private interests include those of unrelated third parties
as well as insiders. Christian Stewardship Assistance, Inc. v. Commissioner , 70 T.C. 1037 (1978); American
Campaign Academy v. Commissioner , 92 T.C. 1053 (1989). Private benefits include an "advantage; profit;
privilege; gain; [or] interest." Retired Teachers Legal Fund v. Commissioner , 78 T.C. 280, 286 (1982).

Better Business Bureau v. United States , 316 U.S. 279 (1945), holds that the existence of a single non-exempt
purpose, if substantial in nature, will destroy the exemption under section 501(c)(3). An organization will be
regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities that
accomplish one or more of such purposes.

In Basic Bible Church v. Commissioner, 74 T.C. 846 (1980), the court found that although the organization did
serve charitable purposes, it existed to serve the private benefit of its founders, and thus failed the operational test
of section 501(c)(3). Control over financial affairs by the founder created an opportunity for abuse and the need to
be open and candid about financial matters; the applicant failed to provide information concerning financial
affairs.

Taxpayer's Position

The organization’s President advised that she disagrees with certain portions of this report. She stated that she has
never misused the organization’s funds. She stated that she has never personally benefited from her involvement
with the organization and that the organization would not have existed without her financial support. She is very
proud of the work the organization has done on the behalf of the community over the roughly XX years they have
been in existence. She advised that any errors they might have made by not properly abiding by the laws
governing charitable organizations were done in ignorance and were not intentional.

With a letter dated April 11, 20XX, the organization’s President, , further explained her position
concerning this report. See attached, Exhibit 1. Accompanying this letter was Form 6018 signed by her, also
attached.

Department of the Treasury - Internal Revenue Service Form 886-A

Schedule or
Form 886-A EXPLANATION OF ITEMS Exhibit No.
Page 4 of 6
Name of Taxpayer Year Ended
20XX12 & 20XX12

Government's Position

Though some exempt purpose activity has occurred, the Organization does not appear to operate exclusively
exempt purposes as required by section 501(c)(3) and Section 1.501(c)(3)-1(c)(1). Similar to the Organization in
Basic Bible Church v. Commissioner , 74 T.C. 846 (1980), the Foundation appears to exist to serve the private
benefit of its founder, and thus fails the operational test of section 501(c)(3) even though it may operate for some
exempt purposes. As in that case, control over financial affairs by the founders creates an opportunity for abuse.
More than an insubstantial part of the President's activities appear to benefit the President rather than the general
public.

Since the Organization does not operate exclusively for exempt purposes and operates to the private benefit of the
President to a more than insubstantial extent, the Organization is not described by section 501(c)(3).

Conclusion

The above facts demonstrate that the Foundation is not operated exclusively for exempt purposes described within
Internal Revenue Code section 501(c)(3):

a. The Organization is not engaged primarily in activities that accomplish an exempt purpose.

b. More than an insubstantial part of the Organization's activities are in furtherance of a non-exempt

purpose.

c. The Organization was operated for the purpose of serving a private benefit rather than public interests.
Based on our audit, and in light of the applicable law, we have determined that you are not operated for exempt
purposes. Rather, you are, primarily, operated for the non-exempt purpose, operating in furtherance of private
interests, of the President. Accordingly, you do not qualify for exemption as an Organization described in section
501(c)(3) of the Code and you must file federal income tax returns. Contributions to you are not deductible under
section 170 of the Code.

Department of the Treasury - Internal Revenue Service Form 886-A

Form 886-A
EXPLANATION OF ITEMS
Schedule or Exhibit No.
Page 5 of 6
Name of Taxpayer
Year Ended
20XX12 & 20XX12
Department of the Treasury - Internal Revenue Service

Form 886-A
EXPLANATION OF ITEMS
Schedule or Exhibit No.
Page 6 of 6
Name of Taxpayer
Year Ended
20XX12 & 20XX12
Department of the Treasury - Internal Revenue Service Form 886-A