Charity-controlled medical professional corporation fails the organizational test

Plain-English summary

To be exempt under section 501(c)(3), an organization must pass the "organizational test": its founding document (for a corporation, the articles of incorporation) must limit its purposes to exempt ones and must dedicate its assets to an exempt purpose on dissolution. This applicant was a professional medical corporation formed and controlled by a section 501(c)(3) public charity, with a single shareholder who held the shares solely for the charity's benefit under a control agreement. Its articles of incorporation, however, stated a business purpose (practicing medicine), did not limit its purposes to exempt ones, and had no dissolution clause. The applicant explained that its state's licensing authority for medical professional corporations refused to accept the required 501(c)(3) language in the articles, so it put that language in its bylaws instead. The IRS held that bylaws are not the formation document for a corporation, so the applicant failed the organizational test regardless of the charity's control, and it issued this final adverse determination: no exemption, and contributions are not deductible under section 170. The letter shows that exempt-purpose and dissolution language must appear in the articles themselves, and a state-law barrier to putting it there does not excuse the requirement.

Ruling snapshot

• Question: Does the charity-controlled professional medical corporation qualify for exemption under section 501(c)(3) when its articles of incorporation lack the required purpose and dissolution provisions?
• Outcome: Denied (final adverse determination; failed the organizational test)
• Key authorities: IRC § 501(c)(3); Treas. Reg. §§ 1.501(c)(3)-1(a)(1), (b)(1)(i), (b)(4); IRC §§ 170, 6110, 7428

Full text (IRS public release)

[illegible] Department of the Treasury Date: October 31, 2018
y Internal Revenue Service

Appeals Office Person to contact:
IRS 300 N. Los Angeles Street Name:
Los Angeles, CA 90018 Employee ID number:
Telephone:
Fax:
. Hours:
Release Number: 201904016 Employer ID number:

Release Date: 1/25/2019
Uniform issue list (UIL):
501.03-06
501.03-05
501.03-30
501.29-00

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.

We made the adverse determination for the following reasons:
You are not organized for one or more exempt purposes as required for tax-exempt organizations described
under section 501(c)(3) of the Internal Revenue Code.

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
rm's instructions. You can get forms and

your form to the appropriate Internal Revenue Service Center per the fo
instructions by visiting our website at www. irs.gov/forms-pubs or by calling 800-TAX-FORM ( 800-829-3676).

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 decide to contest this determination, you can file an action for declaratory judgment under the provisions
of Section 7428 of the Code in either:

• The United States Tax Court.

» The United States Court of Federal Claims, or

• The United States District Court for the District of Columbia

Letter 1371 (Rev. 12-2017)
Catalog Number 40683R

You must file a petition or complaint in one of these three courts within 90 days from the date we mailed this
determination letter to you. Contact the clerk of the appropriate court for rules and the appropriate forms for
filing petitions for declaratory judgment. You can write to the courts at the following addresses:

United States Tax Court US Court of Federal Claims US District Court for the District of Columbia
400 Second Street, NW 717 Madison Place, NW 333 Constitution Avenue. NW
Washington, DC 20217 Washington, DC 20005 Washington, DC 20001

Note: We will not delay processing income tax returns and assessing any taxes due even if you file a petition for
declaratory judgment under Section 7428 of the Code.

Please refer to the enclosed Publication 892, How to Appeal an IRS Determination on Tax-Exempt Status, for
more information about the Appeals process.

You also have the right to contact the Taxpayer Advocate Service (TAS). 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 www.taxpayeradvocate.irs.
gov or call 877-777-4778.

TAS assistance is not a substitute for established IRS procedures, such as the formal appeals process. TAS
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.

If you have questions, contact the person at the top of this letter.

Sincerely,
Appeals Team Manager

Enclosures:
Publication 892

CC:

Letter 1371 (Rev. 12-2017)
Catalog Number 40683R

Department of the Treasury
Internal Revenue Service

Cincinnati, OH 45201

Date: January 30,2018 -

Employer ID number:

Contact person/ID number:
Contact telephone number:

Contact fax number:

Legend: UIL:

B = Date of formation 501.00-00

C = State 501.03-05

D = Organization 501.03-30
501.29-00

Dear

We considered your application for recognition of exemption from federal income tax under Section 501(a) of
the Internal Revenue Code (the Code). Based on the information provided, we determined that you don’t qualify
for exemption under Section 501(c)(3) of the Code. This letter explains the basis for our conclusion. Please

keep it for your records.

Issues

Do you qualify for exemption under Section 501(c)(3) of the Code? No, for the reasons stated below.

Facts

You were formed on B in the State of C as a Professional Corporation. You were formed and are controlled by
D, a Section 501(c)(3) public charity.

You have a sole shareholder, an individual employed and selected by D. The relationship between you, the sole
shareholder, and D is subject to a Shareholder Control Agreement. The Agreement provides that the sole
shareholder shall hold the shares solely for the benefit of D and exclusively in furtherance of the charitable
purposes of D. D shall retain ultimate control over your activities and finances and shall retain sole power and

discretion.

Your incorporation document states that your purpose is, in pertinent part, to carry on and conduct the business
of practicing medicine and related services pursuant to the laws of the State of C through individuals authorized
by law to render such services. It further states that you have the authority to issue shares of stock. Your
incorporation document is silent regarding the disposition of your assets upon your dissolution.

2

You indicated that the State of C would not permit the required Section 501(c)(3) purpose and dissolution
language in your incorporation document, so you included the required language in your By-Laws. There is a
specific department in the State of C which is the licensing authority for all professional corporations that
engage in the practice of medicine. You later provided a printed email and an official rejection letter issued by
the State of C’s licensing authority showing that the Section 501(c)(3) purpose and dissolution language would
not be accepted in your incorporation document because it violates the State of C’s business law.

Law

Section 501(c)(3) of the Code provides for the recognition of exemption of organizations that are organized and
operated exclusively for religious, charitable or other purposes as specified in the statute. No part of the net
earnings may inure to the benefit of any private shareholder or individual.

Treasury Regulation Section 1.501(c)(3)-1(a)(1) states that, in order to be exempt as an organization described
in Section 501(c)(3) of the Code, 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.

Treas. Reg. Section 1.501(c)(3)-1(b)(1)(i) 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 engage, otherwise than as an insubstantial part of its
activities, in activities that in themselves are not in furtherance of one or more exempt purposes.

Treas. Reg. Section 1.501(c)(3)-1(b)(4) holds that an organization is not organized exclusively for one or more
exempt purposes unless its assets are dedicated to an exempt purpose. An organization’s assets will be
considered dedicated to an exempt purpose, for example, if, upon dissolution, such assets would, by reason of a
provision in the organization’s articles or operation of law, be distributed for one or more exempt purposes.

Application of law

As stated in Treas. Reg. 1.501(c)(3)-1(a)(1), to qualify for exemption under Section 501(c)(3) of the Code an
organization must be both organized and operated exclusively for purposes described in Section 501(c)(3). Your
incorporation document states that you were formed for the business purpose of practicing medicine. Your
formation document does not limit your purposes to one or more exempt purposes, as required by Treas. Reg.
Section 1.501(c)(3)-1(b)(1)(i), causing you to fail the organizational test. Additionally, your incorporation
document does not have a dissolution provision as required by Treas. Reg. Section 1.501(c)(3)-1(b)(4), which
also causes you to fail the organizational test.

Although your By-laws contain proper Section 501(c)(3) language, your By-laws are not your formation
document because you are a corporation. As a result, you have not satisfied the organizational test and are not

exempt under Section 501(c)(3) of the Code.
|

Letter 4036 (Rev. 7-2014)
Catalog Number 47630W

Conclusion
Based on the information submitted, you fail the organizational test. Therefore, you do not qualify for

exemption under Section 501(c)(3) of the Code.

If you don’t agree
You have a right to file a protest if you don’t agree with our proposed adverse determination. To do so, you

must send a statement to us within 30 days of the date of this letter. The statement must include:

• Your name, address, employer identification number (EIN), and a daytime phone
number

• Acopy of this letter highlighting the findings you disagree with
• Anexplanation of why you disagree, including any supporting documents

• The law or authority, if any, you are relying on

• The signature of an officer, director, trustee, or other official who is authorized to sign for the
organization, or your authorized representative

• One of the following declarations:

For an officer, director, trustee, or other official who is authorized to sign for the organization:
Under penalties of perjury, I declare that I examined this protest statement, including

accompanying documents, and to the best of my knowledge and belief, the statement contains all
relevant facts and such facts are true, correct, and complete.

For authorized representatives:
Under penalties of perjury, I declare that I prepared this protest statement, including
accompanying documents, and to the best of my knowledge and belief, the statement contains all

relevant facts and such facts are true, correct, and complete.

Your representative (attorney, certified public accountant, or other individual enrolled to practice before the
IRS) must file a Form 2848, Power of Attorney and Declaration of Representative, with us if he or she hasn’t

already done so. You can find more information about representation in Publication 947, Practice Before the
IRS and Power of Attorney.

We'll review your protest statement and decide if you provided a basis for us to reconsider our determination. If
so, we'll continue to process your case considering the information you provided. If you haven't provided a
basis for reconsideration, we'll forward your case to the Office of Appeals and notify you. You can find more
information about the role of the Appeals Office in Publication 892, How to Appeal an IRS Decision on Tax-

Exempt Status.

If you don’t file a protest within 30 days, you can’t seek a declaratory judgment in court at a later date because
the law requires that you use the IRS administrative process first (Section 7428(b)(2) of the Code).

Letter 4036 (Rev. 7-2014)
Catalog Number 47630W

Where to send your protest
Please send your protest statement, Form 2848, if needed, and any supporting

documents to the applicable

address:
U.S. mail: Street address for delivery service:
Internal Revenue Service Internal Revenue Service
EO Determinations Quality Assurance EO Determinations Quality Assurance
Room 7-008 550 Main Street, Room 7-008
P.O. Box 2508 Cincinnati, OH 45202

Cincinnati, OH 45201

You can also fax your statement and supporting documents to the fax number listed at the top of this letter. If
you fax your statement, please contact the person listed at the top of this letter to confirm that he or she received

it.

If you agree
If you agree with our proposed adverse determination, you don’t need to do anything. If we don’t hear from you

within 30 days, we’ll issue a final adverse determination letter. That letter will provide information on your
income tax filing requirements.

You can find all forms and publications mentioned in this letter on our website at www.irs.gov/formspubs. If
you have questions, you can contact the person listed at the top of this letter.

We sent a copy of this letter to your representative as indicated in your power of attorney.

Sincerely,

Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements

Enclosure:
Publication 892

Letter 4036 (Rev. 7-2014)
Catalog Number 47630W