Exemption revoked for uncontrolled grants and unexplained officer spending

Plain-English summary

A public charity said it would make grants to institutions and individuals using board approval, reports on the use of funds, and records showing that recipients and purposes were charitable. During an examination, it could not produce contemporaneous records supporting substantial grants to individuals and organizations. It also could not establish an exempt use for substantial checks to cash, cash withdrawals, and debit or credit card purchases made by its controlling officer and the officer's spouse. The IRS found that the organization had not implemented the controls described in its application, amended bylaws, and determination letter, and that its funds inured to private individuals. The IRS revoked section 501(c)(3) status effective January 1 of the redacted year.

Ruling snapshot

• Question: Could the organization retain section 501(c)(3) status without records showing charitable selection, approval, and use of grants and officer-controlled expenditures?
• Outcome: revocation
• Key authorities: IRC § 501(c)(3); Treas. Reg. § 1.501(c)(3)-1; Rev. Ruls. 56-304 and 68-489; Church in Boston v. Commissioner, 71 T.C. 102 (1978)

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE

TEGE EO Examinations Mail Stop 4920 DAL

1100 Commerce St.

Dallas, Texas 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Date: April 17, 2017

Number: 201749012 Taxpayer Identification Number:
Release Date: 12/8/2017
Person to Contact:

Employee Identification Number:

Employee Telephone Number:

UIL: 501.03-00
CERTIFIED MAIL — RETURN RECEIPT
Dear

This is a final adverse determination regarding your exempt status under section 501(c)(3) of the
Internal Revenue Code. Our favorable determination letter to you dated December 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 described in IRC 501(c)(3) and exempt under section 501(a) must be both organized
and operated exclusively for exempt purposes. You have failed to demonstrate that you are
operating for charitable, educational or other exempt purposes and that no part of your net
earnings inures to the benefit of private shareholders or individuals. You have not implemented
the controls as described within your application for tax exempt status, the Form 1023, as stated
within your bylaws, as amended on September 18, 19xx, and as advised within our determination
letter, dated December 12, 19xx.

You were not able to produce contemporaneous records to substantiate solicitation of grant
funds, the intended use of the funds solicited and the approval process. Additionally, you were
not able to demonstrate an exempt purpose use of funds drawn from your bank accounts or for
debit and credit card purchases made by your controlling officer and his spouse.

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


You are required to file income tax returns on Form 1120. These returns should be filed with the
appropriate Service Center for the tax year ending 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 the United States Tax Court at the following address:

United States Tax Court
400 Second Street, NW
Washington, DC 20217

You also have the right to contact the Office of the Taxpayer Advocate. 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 prefer, you may contact your local Taxpayer Advocate at:

Internal Revenue Service
Office of the Taxpayer Advocate

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

Sincerely,

Maria Hooke
Director, EO Examinations

Enclosures:
Publication 892


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

Date: May 23, 2016
Taxpayer Identification Number:

Form:

Tax Year(s) Ended:

Person to Contact/ID Number:

Contact Numbers:
Telephone:
Fax:

Manager’s name/ID number:

Manager’s contact number:

Response due date:

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

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


standing to seek a declaratory judgment because you failed to exhaust your administrative
remedies.

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 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
12/31/20xx
12/31/20xx
12/31/20xx
Issue:
Should the tax exempt status of under Internal

Revenue Code (IRC) Section 501(c)(3) be revoked because:

1) It is not operating in the manner as described within its application for recognition of tax
exempt status failure to exercise expenditure responsibility over grant disbursements;

2) Its funds inure to the benefit of its controlling officer and spouse.

Facts:

was incorporated under the Not-For-Profit Corporation Law of the State of
on February 6, 19xx. The organization was granted tax exempt status under IRC
section 501(c)(3), as a public charity described in sections 509(a)(1) & 170(b)(1)(A)(vi) of Code,
by our letter dated December 12,19xx.

The organization's purposes, as stated within its certificate of incorporation, are to award grants
to 501(c)(3) type of institutions and to help the poor, needy, sick and disabled.

Form 1023, Application for Recognition of Exemption Under Section
501(c)(3) of the Internal Revenue Code, was received on May 22, 19xx. The application was
submitted by founder and current officer, . The 1023 application
bears his signature as the organization's President, and includes his name as the contact
person during the application process. The organization describes its activities within Part Il of
the application, as follows:

• The organization would award grants and or loans to educational
institutions, upon receipt of an application or request for funds for a specific purpose.

• Control will be exercised by requiring a report of the use of the award or loan from the
institution. Reports concerning use of past grants or loans will be considered when
evaluating future requests.

• The organization would award grants and or loans to the sick, needy and disabled
people, and to such organizations that support and help such. Proof from individuals will
be required as to the use of funds and or loans, and if they qualify, will be examined and
approved by the board of directors.

During the application process, the bylaws were amended on September 18, 19xx, to include
the following language: "The Board of Directors shall review all requests for funds from other
organizations. The Board shall require that such requests specify the use to which the funds will
be put, and ifthe Board approves the request, it shall authorize payment of such funds to the
approved grantee. The Board of Directors shall require that the grantees furnish a periodic
accounting to show that the funds were expended for the purposes which were approved by the

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -1-


Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
12/31/20xx
12/31/20xx
12/31/20xx
Board ...." The article of amendment to the bylaws was signed by , as the
organization's President.
Our examination determined that failed to implement the grant making controls it

described within Part II of the application Form 1023, as stated within its amended bylaws and
as advised within our determination letter, dated December 12, 19xx.

Form 990 returns filed for periods ending December 31, 20xx through December 31, 20xx,
report total support revenue from contributions of $xxx,xxx, $xxx,xxx and $xxx,xxx,
respectively. Total grant distributions during these same years are reported as $xxx,xxx,
$xxx,xxx, and $xxx,xxx, respectively. was not able to produce records to
substantiate grants it made to individuals and organizations were used for exempt purposes.
The amounts involved are substantial: $xxx,xxx in 20xx, $xxx,xxx in 20xx and $xxx,xxx in
20xx, representing xx%, xx% and xx% of total grant distributions reported in each of the years
under examination (see attached Schedule 1).

Although the application for tax exempt status, Form 1023, and the bylaws indicate that there
shall be three board officers, President, Secretary and Treasurer. is the sole
controlling officer of the organization. He is the signing official of the filed Forms 990 and is
listed as the organization's only officer. It was noted that the organization filed an amended
Form 990 for calendar year ending 20xx, adding two trustees. and his spouse,
, draw employee compensation. During the years under examination,

executed substantially all of the checks on behalf of the organization. Those not executed by

were executed by . Their combined salaries as reported on the 990
returns for the calendar years ending 20xx through 20xx are $xx,xxx, $xx,xxx and $xx,xxx,

respectively.

Our examination also determined that total grant distributions, as reported in return years 20xx
through 20xx and as referenced in the paragraph above, included the following transactions
executed by and : checks written to cash totaling $xx,xxx, ATM/debit/teller cash
withdrawals totaling $xx,xxx, and debit/credit card purchases totaling $xx,xxx. The sum total of
these transactions is $xxx,xxx (see attached Schedule 2). and were unable to
provide records in order to substantiate an exempt purpose for these transactions.

Law:

Section 501(c)(3) of the Internal Revenue 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.

In order to qualify under IRC 501(c)(3), an organization must be both "organized" and
“operated” exclusively for one or more purposes specified in that section. If the organization
fails to meet either the organizational test or operational test, it is not exempt (Regs.1.501 (c)(3)
-1(a)(1)). The organizational test relates to the rules for governing an organization and the

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -2-


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

12/31/20xx
12/31/20xx
12/31/20xx

purposes stated in its articles of organization. The operational test relates to the organization's
activities.

Treasury Regulation 1.501(c)(3)-1(c)(1) provides that an organization will be regarded as
operated exclusively for exempt purposes only if it engages primarily in activities which
accomplish one or more exempt purposes. An organization will not be so regarded if more than
an insubstantial part of its activities is not in furtherance of an exempt purpose.

Treasury Regulation 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 demonstrate 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." Thus, if an organization is operated to benefit private interests rather than for public
purposes, or is operated so that there is prohibited inurement of earnings to the benefit of
private shareholders or individuals, it may not retain its exempt status.

In Better Business Bureau v. U.S., 326 U.S. 279 (1945), the Supreme Court stated that the
presence of even a single, non-exempt purpose, if more than insubstantial in nature, will defeat
exemption under Section 501(c)(3) of the Code, regardless of the manner or importance of the
truly exempt purposes.

In Church in Boston v. Commissioner, 71 T.C. 102 (1978), the court upheld the denial of
exemption on an organization that made grants to individuals. The organization asserted that its
grants were made in furtherance of a charitable purpose: to assist the poor. The organization
was unable to furnish any documented criteria which would demonstrate the selection process
of a deserving recipient, the reason for specific amounts given, or the purpose of the grant. The
court held that this information was insufficient in determining whether the grants were made in
furtherance of an exempt purpose.

Revenue Ruling 56-304, 1956-2 C.B. 306, provides that an organization is not precluded from
Section 501(c)(3) exemption when it makes grants to individuals, provided the distributions are
made on a true charitable basis and in furtherance of its exempt purposes. Such organizations
should keep adequate records and case histories to show:

1) The name and address of the recipients;
2) The amount distributed to each;
3) The purpose for which the aid was given;
4) The manner in which the recipient was selected; and,
5) The relationship, if any, between the recipient and
(i) Members, officers, or trustees of the organization;
(ii) A granter or substantial contributor to the organization or a member of the family
of either; and
(iii) A corporation controlled by a granter or substantial contributor

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


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

12/31/20xx
12/31/20xx
12/31/20xx

Rev. Rul. 68-489, 1968-2 C.B. 210 states that an organization will not jeopardize its exemption
under Code section 501(c)(3), even though it distributes funds to nonexempt organizations,
provided it retains control and discretion over use of the funds for section 501(c)(3) purposes.

Government's Position:

has failed to demonstrate that it is operating for charitable, educational or other
exempt purposes. It has not implemented the controls as described within its application for tax
exempt status, the Form 1023, as stated within its bylaws, as amended on September 18,
19xx, and as advised within our determination letter, dated December 12, 19xx.

A review of the Form 1023 application, submitted by and signed by founder and
controlling officer, , indicate, within Part Il of the application, that he had
knowledge and was aware of the recordkeeping requirements of organizations having grant
making programs. This knowledge is further indicated by an amendment to the bylaws,
effected on September 19, 19xx and signed by , incorporating specific procedures
that will be followed by the organization in considering, reviewing and approving grants.

was not able to produce contemporaneous records to substantiate solicitation of
grant funds, the intended use of the funds solicited and the approval process. Additionally, the
organization was not able to demonstrate an exempt purpose use of funds drawn from its bank
accounts or for debit and credit card purchases made by its controlling officer and his spouse.

Similar to Church in Boston v. Commissioner, where the court upheld the denial of exemption of
an organization that made grants to individuals, was unable to furnish documented
criteria which would demonstrate the selection process of a deserving recipient, the reason for
specific amounts given, or the purpose of the grant. The court held that this information was
insufficient in determining whether the grants were made in furtherance of an exempt purpose.

failed to put into place recordkeeping requirements similar to the ones described in
Revenue Rulings 56-304 and 68-489, with respect to grant distributions to individuals and
nonexempt organizations, as it stated it would do within its application for tax exempt status, as
stated within its amended bylaws, and as was specifically advised within our determination letter
granting tax exempt status.

Conclusion:

is not operating as an organization described in Section 501(c)(3) of the Internal
Revenue Code. Accordingly, we propose to revoke the organization's exempt status effective
as of January 1, 20xx.

As an organization that is no longer tax exempt, you are required to file income tax returns on
Form 1120. These returns should be filed with the appropriate Service Center beginning with
the tax year ending December 31, 20xx, and for all tax years thereafter in accordance with the
instructions of the return.

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


Grant Payments

To individuals
Amount
12/31/20xx $XX,XXX.XX
12/31/20xx XX, XXX.XX
12/31/20xx XX, XXX.XX
Total to individuals $XX,XXX.XX
To organizations
Amount
12/31/20xx $XXX,XXX.XX
12/31/20xx XXX, XXX.XX
12/31/20xx XXX, XXX. XX
Total to organizations $XXX,XXX.XX
Total to individuals & organizations
Amount
12/31/20xx $XXX,XXX.XX
12/31/20xx XXX, XXX. XX
12/31/20xx XXX, XXX. XX
Total disbursements $XXX,XXX.XX

Schedule 1


Transactions by Principal Officer and Spouse

Calendar Years Ending

Transactions 12/31/20xx 12/31/20xx 12/31/20xx Total
Debit Card ATM Withdrawals $XX,XXX.XX $XX,XXX.XX $XX,XXX.XX $XX,XXX.XX
Cash Teller Withdrawals XX,XXX.XX X,XXX.XX XX,XXX.XX
Checks Drawn to Cash XX,XXX.XX XX,XXX.XX X,XXX.XX XX,XXX.XX
Debit/Credit & Check Purchases XX,XXX.XX XX,XXX.XX XX,XXX.XX XX,XXX.XX
Total $XX,XXX.XX $XX,XXX.XX $XX,XXX.XX $XXX,XXX.XX

$XX,XXX.XX

Schedule 2