Gymnastics organization's exemption revoked for private inurement and benefit

Plain-English summary

The IRS revoked the Section 501(c)(3) exemption of an organization that provided gymnastics instruction. The organization had replaced a related for-profit business in the same space while retaining its staff, equipment, customers, and founder control, and its board was not independent. The examination found that organization funds paid unsubstantiated personal charge-card expenses for insiders and that customer payments were deposited into an insider's personal bank account, with part of the money retained there. The IRS concluded that net earnings inured to insiders and that the organization operated substantially for private rather than public interests. The revocation applies from the organization's original exemption date, contributions are no longer deductible, and the organization must file corporate income tax returns. The organization agreed to waive its right to contest the determination under IRC § 7428.

Ruling snapshot

• Question: Did the organization continue to qualify for exemption as an educational organization under Section 501(c)(3)?
• Outcome: Revocation
• Key authorities: IRC §§ 170, 501(a), 501(c)(3), 509(a)(2), 7428; Treas. Reg. § 1.501(c)(3)-1

Full text (IRS public release)

Department of the Treasury

Internal Revenue Service
Appeals Office

4330 Watt Avenue SA 7890
Sacramento, CA 95821-7012

Employer Identification Number:

Release Number: 201902032 Person to Contact:
Release Date: 1/11/2019
Date: October 18, 2018
Employee ID Number:
Tel:
Fax:

UIL: 0501.03-08

Certified Mail

Dear .

This is a final adverse determination that you do not qualify for exemption from federal income tax under
Internal Revenue Code (the “Code”) section 501(a) as an organization described in section 501(c)(3) of
the Code.

The favorable determination letter to you dated January 17, 2014 is hereby revoked, and you are no
longer exempt under section 501(a) of the Code effective January 15,

We made the adverse determination for the following reasons:

You were not operated exclusively for charitable or other exempt purposes as required by section
501(c)(3) of the Code. Your net earnings inured to the benefit of private shareholders or individuals, such
as your officers or founders. In addition, you operated in substantial part for the benefit of private rather
than public interests, such as for the benefit of your officers and founders, an activity which does not

further charitable or other exempt purposes.
Contributions to your organization are not deductible under section 170 of the Code.

You're required to file federal income tax returns on Forms 1120, U.S. Corporation Income Tax Return.
Mail your form to the appropriate Internal Revenue Service Center per the form's instructions. You can
get forms and instructions by visiting our website at www.irs.gov/forms-pubs or by calling 800-TAX-FORM

(800-829-3676).

You've agreed to waive your right to contest this determination under the declaratory judgment provisions
of Section 7428 of the Code.

We'll make this letter and the proposed adverse determination letter available for public inspection under
Section 6110 of the Code after deleting certain identifying information. We 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 questions, contact the person at the top of this letter.

Sincerely Yours,

Appeals Team Manager

Enclosure: Publication 892

cc:

Date: August 1, 2007

Department of the Treasury
Internal Revenue Service
IRS Tax Exempt and Government Entities Division Taxpayer Identification Number:

Form:
Tax year(s) ended:

Person to contact / ID number:

Contact numbers:
Phone Number:

Fax Number:
Manager's name / ID number:

Manager's contact number:

Phone 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 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
1222 Spruce Street Stop 1005 STL
St. Louis, Mo. 63103

314-612-4610

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.

Thank you for your cooperation.

Director, EO Examinations

Enclosures:
Report of Examination
Form 6018
Publication 892
Publication 3498

ISSUE(S):

Whether (“ ”) continues to qualify for exemption under Section 501(c)(3)
of the Internal Revenue Code.

FACTS:
The was granted exemption under 501(c)(3) and 509(a)(2) of the Internal Revenue Code per a

determination letter issued January 17, 20XX with effective date of January 15, 20XX. The
organization’s purpose per its bylaws is to “Provide and promote quality, affordable, gymnastics
instruction, education, and development.” president is ( is her spouse).

operates in the space formerly occupied by . was a for-profit entity
controlled by and . The building from which operates is also owned by and

through a Limited Liability Company called . On December 22, 20XX

suddenly shut down and opened in its place. started with funds which came from a check
written from bank account, and deposited into the account ($0 of the $0).

maintains the same staff, equipment, and customers. Of the staff, and her daughter
continue to receive wages from , and were reported on a W-2. continued to accept checks
made out to . maintains control of , as all financial decisions were made
by her or her spouse. The board of was comprised of , her daughter, and two former
employees of ; thus the board is not independent.

The agent reviewed the organization’s financial records for 20XX, and noticed numerous payments made
to an charge card for a total of $0 that were paid from bank account. The

charge card was listed under the name and and . There were no other
cards issued to any other person. The agent requested detail from the Power-of-Attorney regarding

which transactions were for exempt purposes made on the Card. The agent
received the statements, and the agent made determinations of which transactions were

for. The agent also received journal entries relating to the charges. The agent was unable to match
the entries to the statements. Some of the entries were sums of the transactions for the month, debit into
expense accounts and credit liability. Others entries did not add up to what was on the

statements.

The agent went through the statements and summed up all the transactions the agent
determined were for use; those transactions totaled $0. The agent went through those and was able
to identify $0 of the transactions that were for purposes, and $0 that appeared to be personal. The
agent requested additional detail regarding the $0, and from that, was able to establish an additional $0

for purposes. In summary:

Expenditures made by or on card: $0
Amounts identified for exempt operating purposes: $0
Amounts unsubstantiated and deemed personal: $0
$0
While examining the financial records for 20XX, the agent discovered that the customer credit card
payment transactions were no longer being deposited into the organization’s checking account. The
agent requested further information on where these deposits were going, and the organization’s Power-
of-Attorney presented the agent with bank statements from . These statements were for
personal checking account. The agent analyzed the bank statements and identified the credit card
deposits from customers. The credit card deposits totaled $0. There were also processing charges
for the credit card transactions, which amounted to $0. There were transfers made back to the
organization’s bank account, which totaled $0. The balance of $0 remained in personal
bank account. In summary:

Customer credit card deposits into personal bank account: $0
Credit card processing fees: 0
Net deposits: $0

Less: Amounts transferred back to : $0
Amount retained by : $0

LAW:

§ 1.501(c)(3)-1 Organizations organized and operated for religious, charitable, scientific, testing for
public safety, literary, or educational purposes, or for the prevention of cruelty to children or animals. 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 section. If an
organization fails to meet either the organizational test or the operational test, it is not exempt.

Operational Test:

1) Primary activities. 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.

2) Distribution of earnings. 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.

Treasury Regulations section 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.

Treasury Regulations section 1.62-2(c)(2) (c) Reimbursement or other expense allowance
arrangement— (1) Defined. For purposes of §§ 1.62-1, 1.62-1T, and 1.62-2, the phrase “reimbursement
or other expense allowance arrangement” means an arrangement that meets the requirements of
paragraphs (d) (business connection), (e) (substantiation), and (f) (returning amounts in excess of
expenses) of this section. A payor may have more than one arrangement with respect to a particular
employee, depending on the facts and circumstances. See paragraph (d)(2) of this section (payor treated
as having two arrangements under certain circumstances). (2) Accountable plans— (i) In general. Except
as provided in paragraph (c)(2)(ii) of this section, if an arrangement meets the requirements of
paragraphs (d), (e), and (f) of this section, all amounts paid under the arrangement are treated as paid

under an “accountable plan.”

Treasury Regulations section 1.274-5T(2)(c)(i) In general. —To meet the “adequate records”
requirements of section 274(d), a taxpayer shall maintain an account book, diary, log, statement of
expense, trip sheets, or similar record, and documentary evidence which, in combination, are sufficient to
establish each element of an expenditure or use specified in paragraph (b) of this section. It is not
necessary to record information in an account book, diary, log, statement of expense, trip sheet, or similar
record which duplicates information reflected on a receipt so long as the account book, etc., and receipt
complement each other in an orderly manner.

Founding Church of Scientology v. United States, 412 F.2d 1197 (Ct. Cl. 1969), cert. den., 397 U.S.
1009 (1970), an organization argued that it had paid its founder for expenses incurred in connection with
his services, made reimbursements to him for expenditures on its behalf, and made some payments to him
as repayments on a loan. The organization could produce no evidence of contractual agreements for
services, documents evidencing indebtedness, or any explanation regarding the purposes for which
expenses had been incurred.

Better Business Bureau of Washington, D.C., Inc. v. United States, 326 U.S. 279 (1945), the presence
of private benefit, if substantial in nature, will destroy the exemption regardless of an organization’s
other charitable purpose or activities.

John Marshall Law School and John Marshall University v. United States, 82-2 USTC 9514(Ct. Cl.
1981), the Service revoked the exemption of both organization on the ground that part of the net earnings
of the organization inured to the benefit of private shareholders or individuals.

GOVERNMENT POSITION:
In accordance with the above-cited provisions of the Code and Regulations under 501(c)(3), Treasury

Regulation §1.501(c)(3), and court cases listed above, the is not the type of an organization for
which an exemption from tax was intended. Although the activities of were within the definition of
the Regulations, the conduct of the organization was for the benefit of the owners.

Distribution of earnings — An organization is not operated exclusively for exempt purpose if it
provides either benefits to insiders, known as inurement, or substantial, non-incidental benefits to
any private individual. 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. In this case, the agent

identified questionable transactions on the account that were not substantiated
as being for an exempt purpose. These transactions were personal in nature, and for the benefit of

and . These payments totaled $0 for 20XX. The agent also identified

credit card transactions that were deposited into personal checking account. The
net deposits after subtracting charges and transfers are $0. These payments were not reported as

wages or other compensation.

TAXPAYER POSITION:
The organization wishes to continue as an 501(c)(3) exempt organization. The organization stated it is

willing to make the necessary changes to retain exemption.

CONCLUSION:
In accordance with the above-cited provisions of the Code and Regulations under 501(c)(3), Treasury

Regulation §1.501(c)(3), and court cases listed above, is not the type of an
organization for which an exemption from tax was intended. When began its existence in January of
20XX, it didn’t change its nature as a private enterprise, or ownership, from the prior entity of

. The Board of Directors is the same as the prior business. is being operated for the benefit of, and
under the control of the . The organization provided significant private benefits to the founder,

, and her spouse, , by the fact that paid for and

card purchases, and organization funds were diverted into personal checking account. The
organization currently leases the building and equipment from the . continues to
teach lessons at the organization, and still has access to the organization’s checking account. Due to this
relationship, and private benefits uncovered, the agent recommends revocation of the organization’s

exempt status as of January 15, 20XX.

Form 1120, U. S. Corporation Income Tax Return, should be filed for 20XX and 20XX, and each year
thereafter as long as the organization remains subject to federal income tax. If the proposed revocation
becomes final, appropriate state officials will be notified of such action in accordance with section
6104(c) of the Internal Revenue Code.