Software licensing organization denied section 501(c)(3) status

Plain-English summary

An organization owned proprietary training materials and application software intended to help communities and institutions conduct structured discussions. It planned to provide a noncommercial online version and free training to certain government and exempt users, while licensing a customizable commercial version for substantial fees and training third-party service providers who would support commercial customers. The IRS found that the organization's stated purposes were broader than section 501(c)(3) purposes and that neither version of the program primarily accomplished an exempt purpose. It also concluded that free training for commercial service providers created a substantial private benefit. The IRS therefore denied exemption because the organization failed both the organizational and operational tests.

Ruling snapshot

• Question: Does the software and training organization qualify for exemption under section 501(c)(3)?
• Outcome: denied, because it was neither organized nor operated exclusively for exempt purposes
• Key authorities: IRC § 501(c)(3); Treas. Reg. § 1.501(c)(3)-1; Rev. Rul. 65-1; Rev. Rul. 85-1; Rev. Rul. 85-2

Full text (IRS public release)

Department of the Treasury
Internal Revenue Service
P.O. Box 2508
Cincinnati, OH 45201
Date:
August 6, 2019

Employer ID number:

Release Number: 201944016 Contact person/ID number:
Release Date: 11/1/2019

UIL: 501.35-00, 501.36-01, 501.33-00

Contact telephone number:
Form you must file:

Tax years:

Dear

This letter is our final determination that you don’t qualify for tax-exempt status under Section 501(c)(3) of the
Internal Revenue Code (the Code). Recently, we sent you a proposed adverse determination in response to your
application. The proposed adverse determination explained the facts, law, and basis for our conclusion, and it
gave you 30 days to file a protest. Because we didn’t receive a protest within the required 30 days, the proposed
determination is now final.

Because you don’t qualify as a tax-exempt organization under Section 501(c)(3) of the Code, donors can’t
deduct contributions to you under Section 170 of the Code. You must file federal income tax returns for the tax
years listed at the top of this letter using the required form (also listed at the top of this letter) within 30 days of
this letter unless you request an extension of time to file.

We’ll make this final adverse determination letter and the proposed adverse determination letter available for
public inspection (as required under Section 6110 of the Code) after deleting certain identifying information.
Please read the enclosed Notice 437, Notice of Intention to Disclose, and review the two attached letters that
show our proposed deletions. If you disagree with our proposed deletions, follow the instructions in the Notice
437 on how to notify us. If you agree with our deletions, you don’t need to take any further action.

We'll also notify the appropriate state officials of our determination by sending them a copy of this final letter
and the proposed determination letter (under Section 6104(c) of the Code). You should contact your state
officials if you have questions about how this determination will affect your state responsibilities and
requirements.

Letter 4038 (Rev. 7-2014)
Catalog Number 47632S

If you have questions about this letter, you can contact the person listed at the top of this letter. If you have
questions about your federal income tax status and responsibilities, call our customer service number at

1-800-829-1040 (TTY 1-800-829-4933 for deaf or hard of hearing) or customer service for businesses at
1-800-829-4933.

Sincerely,

Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements

Enclosures:

Notice 437

Redacted Letter 4036, Proposed Adverse Determination Under IRC Section 501(c)(3)
Redacted Letter 4038, Final Adverse Determination Under IRC Section 501(c)(3) - No Protest

Letter 4038 (Rev. 7-2014)
Catalog Number 47632S

Department of the Treasury
Internal Revenue Service

Cincinnati, OH 45201

Date:
June 4, 2019

Employer ID number:
Contact person/ID number:
Contact telephone number:

Contact fax number:

Legend: UIL:

B = Incorporation date 501.35-00
C = State 501.36-01
D = Proprietary training materials 501.33-00

E = Proprietary application software

Dear

We considered your application for recognition of exemption from federal income tax under Internal Revenue
Code (IRC) Section 501(a). We determined that you don’t qualify for exemption under IRC Section 501(c)(3).
This letter explains the reasons 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 incorporated on B in the state of C. The specific purpose for which were formed is to “promote the
development of, public access to, and adoption of D and E within the meaning of Internal Revenue Code section
501(c)(3).”

You own the intellectual property rights to D and E. D and E will facilitate creative engagement of people with
diverse cultures, ideologies, experiences and expertise in decision-making for the benefit of their communities.
You will make D and E available to the public in a non-commercial version and a commercial version.

You will charge no fee for non-commercial, non-derivative works licenses to organizations recognized by the
Internal Revenue Service as a state/local/Indian tribal government agency or as a public instrumentality or
exempt under Section 501(c)(3). You will also provide free training in utilizing the licensed application
software and free support services to these non-commercial users. The non-commercial version (NCV) is
available only on-line as a Software-as-a-Service solution and cannot be customized.

Commercial, derivative works licensees will pay you fees based on current commercial standards and practices.
The CV is available only as downloadable form; is available to anyone for a licensing fee; and can be
customized. The licensees will use the solution for their own internal or commercial purposes. You will teach

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and engage third party service providers in the use of E so they can download, install and deploy the CV on
their customers’ computing infrastructure as well as provide support services to their customers. These service
providers will normally be professional community engagement facilitators. You have not provided a
description of the support the service providers will furnish, but the implication is that it will include facilitation
services. You have not indicated that any portion of your gross receipts will consist of payments for such
training, mentioning only revenue from licensing fees.

An organization that is not eligible to use the NCV or needs to customize the software can purchase the license
from you. Your estimated revenue comes primarily from gifts, grants and contributions but estimated gross
receipts from CV licensing are also substantial, exceeding [redacted] percent of your total revenue. You aver that you
do not intend to promote the CV but you have not provided the percentages of your resources and time that will
be spent on the CV. The annual licensing fee for the sale of your CV ranges from [redacted] to [redacted] percent of annual
gross receipts. Expenses include compensation, occupancy and professional fees.

You provided examples illustrating how an organization might use the NCV and the CV. In the NCV example,
a school district could reach out to various community stakeholders (parents, students, teachers, volunteers,
school employees, community members) to secure their input in an upcoming budget cycle. An on-line
community discussion would be initiated through invitations which is hosted by your software. A video or other
presentation could be made part of the online discussion which may go on for weeks or even months. The
software gathers and analyzes all comments. The software also includes discussion mechanisms which respond
to vitriolic tones or assertions of suspicious facts. The comments are not censored, but the software invites
participants to rephrase their comment or provide support for their assertion. The software uses artificial
intelligence to cluster on-line comments into groups by common topics/perspectives. Discussion participants
can see what clusters have emerged and see the comments/summary. Experts could be asked to join the
discussion by summarizing relevant research findings or posing more sophisticated questions to participants.
The software may automatically contact participants during the discussion period for various reasons which
enhance the conversation and feedback. When the online conversation is closed, the school district can invite
interested contributors to meet in person to continue the discussion. You provide a half- to full-day training to
participants comfortable in leading groups who act as facilitators of small discussion groups. The software
captures the online discussion as well as the results of the group meetings.

You maintain a website that contains basic information about your programs. The website did not contain
advertising or promotional materials.

Law

Section 501(c)(3) of the Code exempts from taxation any corporation organized and operated exclusively for
religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or
international amateur sports competition, or for the prevention of cruelty to children or animals, provided no
part of the net earnings of which inures to the benefit of any private shareholder or individual.

Section 1.501(c)(3)-1(a)(1) of the Income Tax Regulations provides that, to be exempt as an organization
described in Sec. 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 or operational
test, it is not exempt.

Letter 4034 (Rev. 11-2018)
Catalog Number 47628K

3

Treas. Reg. Sec. 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 limit the purposes of such organization to one or more
exempt purposes; and 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. Sec. 1.501(c)(3)—1(b)(1)(ii) provides that, to meet the organizational test, the organization’s
purposes must be specified in its articles. They may be as broad as, or more specific than, the purposes stated in
Section 501(c)(3).

Treas. Reg. Sec. 1.501(c)(3)—1(b)(1)(iv) provides that in no case an organization shall be considered to be
organized exclusively for one or more exempt purposes, if, by the terms of its articles, the purposes for which
such organization is created are broader than the purposes specified in Section 501(c)(3).

Treas. Reg. Sec. 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 Sec. 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.

Treas. Reg. Sec.1.501(c)(3)-1(d)(1)(ii) 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, to meet the
requirement of this subdivision, 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.

Treas. Reg. Sec. 1.501(c)(3)-1(d)(2) includes "lessening of the burdens of government" in the definition of the
term "charitable."

Treas. Reg. Sec. 1.501(c)(3)-1(d)(3)(i) defines the term educational as relating to instruction of the individual
for the purpose of improving or developing his capabilities, or instruction of the public on subjects useful to the
individual and beneficial to the community.

Treas. Reg. Sec. 1.501(c)(3)-1(e)(1) provides that an organization may meet the requirements of Section
501(c)(3) even though it operates a trade or business as a substantial part of its activities, unless its primary
purpose is carrying on of a trade or business that does not further charitable purposes.

Rev. Rul. 65-1, 1965-1 C.B. 226, determined that an organization which promotes and fosters the development
and design of machinery in connection with a commercial operation and which has the power to sell, assign,
and grant licenses with respect to its copyrights, trademarks, trade names, or patent rights was not exempt under
§ 501(c)(3). Specifically, the development of a new machine, the patents of which may be licensed on a
restrictive basis to selected manufacturers, is directed toward benefiting those particular manufacturers and any
benefit to the public must be considered indirect. Under these circumstances the organization cannot be
considered as operating for a public purpose.

Rev. Rul. 70-79, 1970—1 C.B. 127describes an organization that assisted local governments of a metropolitan
area by researching solutions for common regional problems, such as water and air pollution, waste disposal,
water supply, and transportation, that was operated exclusively for the charitable purpose of relieving the

Letter 4034 (Rev. 11-2018)
Catalog Number 47628K

4

burden of government. The chief elected officers of the local jurisdictions constituted the membership of the
organization. Receipts included assessments on the local jurisdictions. The interrelationship between the local
governments and the organization indicates the existence of a burden of government in that the organization’s
membership was composed totally of government officials; persons appointed by the local governments
involved. The funding of the organization from the government assessments indicates a burden of government.
Developing regional plans and policies for regional problems is an activity normally conducted by
governmental units and indicates a burden of the government.

A Rev. Rul. 85—1, 1985—1 C.B. 177, states that an activity is a burden of government only if there is an
objective manifestation by a governmental unit that it considers the activities of the organization to be its
burden.

Rev. Rul. 85-2, 1985-2 C.B. 178, states that an organization is lessening the burdens of government if

its activities are activities that a governmental unit considers to be its burdens, and the activities actually lessen
such governmental burden. The organization must demonstrate that a governmental unit considers the
organization to be acting on the government’s behalf, thereby actually freeing up government assets — human,
material, and fiscal — that would otherwise have to be devoted to the particular activity. This determination is
based on facts and circumstances.

In Forest Press Inc. v. Commissioner, 22 T.C. 265 (1954), the Tax Court determined that an organization
devoted to developing and propagating the use of the Dewey Decimal Classification System and Related Index
was a charitable organization. The system is a method for indexing any collection of books. Forest Press’
primary activity was the ongoing development of the system, which required continuous revision. By the time
the organization was formed, the System had been adopted by more than 90 per cent of the libraries in the
United States to classify and index their collections and was in use in 42 countries. Thus, the court concluded
that the System was an important aid to education and research and not a commercial enterprise.

Application of law
You meet neither the organizational not the operational test as required by Section 501(c)(3) of the Code and
Treas. Reg. Sec. 1.501(c)(3)-1(a)(1).

You do not meet the organizational test of Treas. Reg. Sec. 1.501(c)(3)—-1(b)(1)(i) and (ii), because you cannot
be considered to be organized exclusively for one or more exempt purposes, the purposes stated in your articles
of incorporation -- promoting the development of, public access to, and adoption of D and E -- being of the kind
expressly addressed by Treas. Reg. Sec. 1.501(c)(3)-1(b)(1)(iv), namely, broader than the purposes specified in
section 501(c)(3). Adding the words “within the meaning of Section 501(c)(3)” cannot cure this unacceptable
statement of purpose, since the specific purposes named are inherently incompatible with Section 501(c)(3)
purposes.

You do not meet the operational test of Treas. Reg. Sec. 1.501(c)(3)-1(c)(1), because you do not engage
primarily in activities which accomplish one or more of such exempt purposes specified in Sec. 501(c)(3).

You do not meet the operational test as required by Treas. Reg. Sec. 1.501(c)(3)-1(a)(1), because you cannot be
regarded as "operated exclusively" for such purposes as stipulated by Treas. Reg. Sec. 1.501(c)(3)-1(c)(1).

Based on the information you have provided we are unable to establish whether the CV or the NCV is your
primary activity. However, the CV clearly of a commercial nature — you yourself having characterized it as as

Letter 4034 (Rev. 11-2018)
Catalog Number 47628K

5

such — that is, a business described in Treas. Reg. Sec.1.501(c)(3)-1(e)(1) that does not further any charitable
purpose. If it is your primary activity, for that reason alone you do not meet the operational test.

The NCV, however, also accomplishes no exempt purposes specified in Sec. 501(c)(3). The provision of free
services to other organizations, whether for profit, exempt or governmental is not per se in furtherance of any
exempt purpose within the meaning of Section 501(c)(3). The NCV does not further charitable purposes within
the meaning of Treas. Reg. Sec. 1.501(c)(3)-1(d)(2) by relieving the burdens of government because it does not
meet the requirements of Rev. Rulings 85-1 and 85-2 that its facilitation services should be activities that a
governmental unit considers to be its burdens, there being no objective manifestation by a governmental unit
that it considers your facilitation activities to be its burden, and actually lessens such governmental burdens.
Although you and the organization described in Rev. Rul. 70—79 are superficially similar in that both focus on
problem-solving, you otherwise bear little resemblance to the organization in the Revenue Ruling.

Your facilitation services to organizations exempt under Section 501(c)(3) are also not necessarily charitable as
indirectly supporting them in carrying out their charitable purposes. Nor are they educational, as Section
1.501(c)(3)-1(d)(3)(i) defines the term, because they neither instruct the individual for the purpose of improving
or developing his capabilities, nor instruct the public on subjects useful to the individual and beneficial to the
community.

You also cannot be regarded as "operated exclusively" for such purposes because you do not meet the
requirement of Treas. Reg. Sec.1.501(c)(3)-1(d)(1)(ii) that you serve a public rather than a private interest
because you confer a substantial, non-incidental benefit on private interests.

The NCV and CV programs are tools to facilitate discussion of problems which affect the entities that use them.
The entities to which you license the CV require the services of third-party service providers whom you train to
download, install and deploy the CV on their customers’ computing infrastructure and provide support services.
You provide this training to them gratis, thereby conferring on them a substantial nonincidental private benefit.

Like the organization in Rev. Rul. 65-1, which restricted licensing of its patents to selected manufacturers, your
training of third-party service providers to render necessary services and support to the for-profit licensees’
commercial clients or the licensees themselves is directed toward benefiting these particular private businesses
rather than the public.

You are distinguishable from the organization in Forest Press Inc. That organization developed and
disseminated licenses to use its intellectual property, as you do, but the dissemination of the Dewey Decimal
system served the public interest exclusively, all benefits to private persons being incidental.

Conclusion

Based on the above, we have determined that you do not meet the requirements for exemption under Section
501(c)(3) because you are neither organized nor operated exclusively for one or more exempt purposes within
the meaning of Section 501(c)(3).

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.

Letter 4034 (Rev. 11-2018)
Catalog Number 47628K

If you don't agree
You have a right to protest if you don’t agree with our proposed adverse determination. To do so, send us a
protest within 30 days of the date of this letter. You must include:

• Your name, address, employer identification number (EIN), and a daytime phone number
• A statement of the facts, law, and arguments supporting your position
• A statement indicating whether you are requesting an Appeals Office conference

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

The following declaration:

For an officer, director, trustee, or other official who is authorized to sign for the organization:
Under penalties of perjury, I declare that I have examined this request, or this modification to the
request, including accompanying documents, and to the best of my knowledge and belief, the request
or the modification contains all relevant facts relating to the request, 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 they haven’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 gave us a basis to reconsider our determination. If so,
we’ll continue to process your case considering the information you provided. If you haven’t given us a basis
for reconsideration, we’ll send your case to the Appeals Office and notify you. You can find more information
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 later because the
law requires that you use the IRC administrative process first (IRC Section 7428(b)(2)).

Where to send your protest
Send your protest, Form 2848, if applicable, and any supporting documents to the applicable address:

Letter 4034 (Rev. 11-2018)
Catalog Number 47628K

U.S. mail: Street address for delivery service:

Internal Revenue Service Internal Revenue Service

EO Determinations Quality Assurance EO Determinations Quality Assurance
Mail Stop 6403 550 Main Street, Mail Stop 6403

P.O. Box 2508 Cincinnati, OH 45202

Cincinnati, OH 45201

You can also fax your protest 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 they received it.

You can get the forms and publications mentioned in this letter by visiting our website at www.irs.gov/forms-
pubs or by calling 800-TAX-FORM (800-829-3676). If you have questions, you can contact the person listed at
the top of this letter.

Contacting the Taxpayer Advocate Service

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 if 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.

Sincerely,

Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements

Letter 4034 (Rev. 11-2018)
Catalog Number 47628K