Foundation loses exemption for private use of charitable assets

Plain-English summary

A foundation had been created to promote scientific research in physics and cosmology. After its founder died, his wife became president, and the IRS found no ongoing charitable activity, unexplained short-term rental income, and payments for personal expenses from foundation accounts. The president controlled the bank account and credit card, while the board was not involved in daily decisions or financial oversight. The IRS concluded that foundation income paid for home repairs, furnishings, groceries, travel, clothing, and other personal costs without substantiation of an exempt purpose. It revoked the Section 501(c)(3) exemption because the organization failed the operational test and its assets inured to the benefit of a private individual.

Ruling snapshot

• Question: Did the foundation continue to operate exclusively for exempt purposes without private inurement?
• Outcome: Revocation.
• Key authorities: IRC §§ 501(c)(3), 4958; Treas. Reg. §§ 1.501(c)(3)-1, 1.501(a)-1(c)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury

Date: APR 26 2018

Number: 201829023
Release Date: 7/20/2018

UIL: 7428.00-00

Person to Contact:
Tel:
Fax:
Refer Reply to:
In Re:
Tax Period(s) Ended:
Form Number
Employer Identification Number

CERTIFIED MAIL

Dear

This is a final adverse determination as to your exempt status under section 501(c)(3) of the
Internal Revenue Code. It is determined that you are no longer recognized as exempt from
Federal income tax under Section 501(c)(3) of the Internal Revenue Code, effective
December 1, 20 .
Our adverse determination was made for the following reason(s):
Your activities are not exclusively charitable and the assets of the organization
have inured to the benefit of private individuals (i.e., your founders and/or
officers) through the payment of their private expenses, private benefits, and cash.
Therefore, you are not operated exclusively for exempt purposes pursuant to
section 501(c)(3) of the Internal Revenue Code.

Contributions to your organization are not deductible under code section 170 of the
Internal Revenue Code.

You are required to file Federal income tax returns on Form 1120 for any years that are
still open under the statute of limitations.

By executing Form 906-c, Closing Agreement on Final Determination Covering Specific
Matters, you have waived your right to contest this determination under the declaratory judgment
provisions of section 7428 of the Internal Revenue Code.

We will make this letter and the proposed adverse determination letter available for public

inspection under Code section 6110 after deleting certain identifying information. We have
provided to you, in a separate mailing, Notice 437, Notice of Intention to Disclose. Please
review the Notice 437 and the documents attached that show our proposed deletions. If you
disagree with our proposed deletions, follow the instructions in Notice 437.

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

You also have the right to contact the office of the Taxpayer Advocate. Taxpayer Advocate
assistance is not a substitute for established IRS procedures, formal appeals process, etc. The
Taxpayer Advocate is not able to reverse legally correct tax determinations, nor extend the time
fixed by law that you have to file a petition in 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. If you want Taxpayer Advocate assistance, please contact the Taxpayer
Advocate for the IRS office that issued this letter. See the enclosed Notice 1214, Helpful
Contacts for Your “Notice of Deficiency”, for Taxpayer Advocate telephone numbers and

addresses.

Thank you for your cooperation.

Sincerely,

Timothy D. Jarvis
Appeals Team Manager

Enclosures:
Notice 1214 Helpful Contacts for Your Deficiency Notice
Notice 437, Notice of Intention to Disclose

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

Date: May 01, 2017

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,

Maria Hooke
Director, EO Examinations

Enclosures:

Report of Examination
Form 6018
Publication 892
Publication 3498

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

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
November 30, 20XX
November 30, 20XX
ISSUES:

1. Whether is operated exclusively for exempt purposes described within
   Internal Revenue Code section 501(c)(3)?
2. Whether is engaged primarily in activities that accomplish an exempt
   purpose?
3. Whether any part of the net earnings of inured to the benefit of any

private shareholder or individual?

4. Whether revocation of the Foundation’s exempt status is appropriate given that the
   Foundation engaged in substantial excess benefit with its officer? If revocation is upheld the

Date would be October 1, 20XX.

FACTS:

( ) was incorporated on February 19XX in as a not-for-profit
corporation and was recognized by the Internal Revenue Service as a tax-exempt organization as
described in section 501(c)(3) by letter dated July 19XX. The Foundation was created in 19XX by
, engineer and physicist. The purpose of the foundation was to promote scientific research in

physics and cosmology; to propagate theories of physics. lectured and
wrote and published research materials on physics. supported other scientific
organizations. In December 20XX, passed away.

After his passing, his wife assumed the position of President of , and has

served in that position until the present. The board of trustees meets annually to discuss future
plans and activities. During the interview and examination, the president was unable to describe

any ongoing from 20XX when passed, to the present.

does not have any employees and is operated solely by from her home
in , . During the interview, the president stated that receives income
from contributions and rental income. provides short-term rental to travelers. The president
did not explain how the rental income was related to exempt purpose.
During the review of books and records multiple payments for clothes, travel and
household repairs and maintenance charges were noted. When asked for substantiation to
support how the noted payments were related to exempt purpose known was provided.

maintains one checking account at . has sole signature authority
and control over the account.

Form 886-A (1-1994) Catalog Number 20810W Page 1 publish.no.irs.gov Department of the Treasury-Internal Revenue Service

Form 886-A
(Rev. January 1994)

EXPLANATIONS OF ITEMS

Schedule number or exhibit

Name of taxpayer

Tax identification Number

Year/Period ended
November 30, 20XX
November 30, 20XX

The income is used to pay the day to day personal expenses, pay for clothes and travel and the
household repairs and maintenance bills of

at

files Forms 990-N. The

. The foundation has a checking account

account shows the following transactions:

Revenue Sources

November 30, 20XX

November 30 20XX

Deposits 0 0
Withdrawals 0 0
Totals

[illegible]

has an credit card whereas is the only authorized user.
During the tax years that ended November 30, 20XX & 20XX charges were analyzed in detail.
When asked for substantiation to support how the noted charges were related to exempt
purpose none was provided. The following is a summary of noted charges:

[illegible]

did not provided any documentation that supports an exempt purpose for charges.

did not provide any receipts or other documentation to show a business purpose for the
expenditures that made up the balance of the credit card charges.

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).

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).

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.

Treas. Reg. Section 1.501(c)(3)-1(a)(1) states: “In order to be exempt as an organization
described in Section 501(c)(3), an organization must be both organized and operated exclusively
for one or more of the purposes specified in such Code section.”

Section 1.501(c)(3)-1(c)(1) of the regulations provides that 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 exempt purposes specified in section 501(c)(3). An

Form 886-A (1-1994) Catalog Number 20810W Page 5 publish.no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Year/Period ended
November 30, 20XX
November 30, 20XX

Name of taxpayer Tax Identification Number

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

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

furtherance of one or more exempt purposes.

Treas. Reg. § 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 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.

In Better Business Bureau of Washington, D.C., Inc. v. U.S., 326 U.S. 279 (1945), the Supreme
Court stated that an organization is not operated exclusively for charitable purposes if it has a
single non charitable purpose that is substantial in nature.

The words “private shareholder or individual” in section 501 refer to persons having a personal
and private interest in the activities of the organization. Treas. Reg. § 1.501(a)-1(c). The
inurement prohibition provision “is designed to prevent the siphoning of charitable receipts to
insiders of the charity... .” United Cancer Council v. Commissioner, 165 F.3d 1173 (7th Cir.
1999). A “private shareholder or individual” for purposes of a private inurement analysis has been
interpreted to mean an insider of the organization. See Orange County Agricultural Society, Inc. v.
Commissioner, 893 F.2d 529, 534 (2d Cir. 1990). The prohibited private inurement involves using
the assets of the exempt organization for the benefit of the insider; examples include payment of a
percentage of revenue, lending money, and payment of personal expenses. Founding Church of
Scientology v. United States, 412 F.2d 1197 (Ct. Cl. 1969).

Prohibited inurement is strongly suggested where an individual or small group has exclusive
control over the management of the organization's funds. The Church of Eternal Life and Liberty,

Inc. v. Commissioner, 86 T.C. 916, 927 (1986); Basic Bible Church v. Commissioner, 74 T.C. 846,
857 (1980); Church of the Transfiguring Spirit v. Commissioner, 76 T.C. 1, 7 (1981).

Section 4958(c)(1)(A) of the Code, in part, defines an "excess benefit transaction" as “any

transaction in which an economic benefit is provided by an applicable tax-exempt organization
Department of the Treasury-Internal Revenue Service

Form 886-A (1-1994) Catalog Number 20810W Page 6 publish.no.irs.gov

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax identification Number Year/Period ended
November 30, 20XX

November 30, 20XX

directly or indirectly to or for the use of any disqualified person if the value of the economic benefit
provided exceeds the value of the consideration (including the performance of services) received
for providing such benefit.” In addition, section 4958(c)(1)(A). also provides that “an economic
benefit shall not be treated as the consideration for the performance of services unless such
organization clearly indicated its intent to so treat such benefit.” IRC § 4958(c)(1)(A).

Section 4958(e) of the Code defines an "applicable tax-exempt organization" as an organization
described in either section 501(c)(3) or section 501(c)(4) of the Code or an organization which was
so described at any time during the five-year period ending on the date of the excess benefit
transaction. “Such term shall not include a private foundation as defined in section 509(a).” I.R.C.

§ 4958(e).

Section 4958(f)(1) of the Code defines "disqualified person" as “(A) (A) any person who was, at
any time during the five-year period ending on the date of such transaction, in a position to
exercise substantial influence over the affairs of the organization, (B) a member of the family of a
disqualified person, [and] (C) a 35 percent controlled entity.

The expenses listed above appear to be excess benefit transactions because the economic
benefits provided by an applicable tax-exempt organization directly or indirectly exceeds the value
of any consideration received by the Foundation. I.R.C. § 4958(c)(1)(A)

GOVERNMENT’S POSITION:

The 501(c)(3) tax exempt status of should be revoked because it is not
operated exclusively for tax exempt purposes. An organization described in section 501(c)(3) must
establish that no more than an insubstantial part of its activities is not in furtherance of an exempt

purpose. Treas. Regs. 1.501(c)(3)-1(c)(1).

Section 1.501(c)(3)-1(d)(1)(ii) of the regulations states that an organization is not organized
exclusively for any of the purposes specified in section 501(c)(3) of the Code unless it serves
public, rather than private interests. Since the founder’s death, the organization has not engaged
in any activities that provide a charitable benefit to the public.

is an officer and she has sole control over bank account, disbursements, and
assets. It is the position of the Government that assets inured to the benefit of

There were multiple and repetitive transactions during the years under examination that were

not substantiated as being related to exempt purpose. Hence it is our position that a
significant portion of income was in fact used to pay for personal expenses.
From our review of the expenses as noted above, it clearly shows that the charges

were personal in nature and conferred a private benefit to . Source documents support
that income was used to make home repairs and maintenance; to purchase home

Department of the Treasury-Internal Revenue Service

Form 886-A (1-1994) Catalog Number 20810W Page 7 publish.no.irs.gov

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Year/Period ended
November 30, 20XX
November 30, 20XX

Name of taxpayer Tax Identification Number

furnishings, groceries, alcohol, gasoline, restaurant visits, clothes, pet supplies, eye examination
and glasses, travel expenses; and other unrelated charges. Although does not have a
vehicle, charges for car related expenses were noted.

Although has a board of trustees they are not involved in the decisions and daily
operations. They do not have internal controls to ensure that funds are used for exempt purposes.
There are no safeguards in place to prevent the reoccurrence of assets inuring to the benefit of
any private individual. The President has free reign over the foundation’s bank
account and the credit card. There are no indications that other board members have any

involvement with the finances of the organization.

Based on the facts of this examination, does not qualify for exemption under IRC Section
501(c)(3) as a charitable organization. The foundation is not operated exclusively for exempt
purposes. Inurement and private benefit to the president outweighs any and all public interest

served.

TAXPAYER’S POSITION:

Taxpayer's position with respect to the issues, facts, applicable law and conclusions is unknown.
The organization will be allowed 30 days to review this report and respond with a protest if
desired.

CONCLUSION

is not operating exclusively for section 501(c)(3) exempt purposes. They
failed the operational test because they no longer are operating as an organization exempt under
section 501(c)(3) of the code. Hence it is our recommendation that their exempt status should be
revoked effective December 01, 20XX the beginning of the tax year whereas we became aware
that they no longer are operating as an organization exempt section 501(c)(3) of the code.

If revocation is upheld, will be required to file Form 1120 for the tax periods ending
November 31, 20XX and all subsequent tax years.

Form 886-A (1-1994) Catalog Number 20810W Page 8 publish.no.irs.gov Department of the Treasury-Internal Revenue Service