IRS denies 501(c)(3) status to a fund that gives college scholarships to all children of a cooperative's employees, with no need or merit test

Plain-English summary

An organization applied to be recognized as a tax-exempt charity under section 501(c)(3). Its only activity was giving college scholarships to the children of employees of a particular cooperative, in memory of a former employee's daughter. There was no selection committee and no need-based or merit-based criteria: every child of an employee who graduated high school and enrolled in college or technical school automatically received a scholarship. The IRS denied exemption for two reasons. First, scholarships awarded without any need or merit standard look more like extra employee compensation than charity, so the group operates for the private interests of the employer and its workers rather than a public interest, failing the operational test. Second, an employer-related scholarship program must meet all seven conditions plus a percentage test of Revenue Procedure 76-47, and this one did not (for example, it had no independent selection committee), so its grants are "taxable expenditures." Because the applicant did not protest the proposed denial within 30 days, this became the IRS's final adverse determination, meaning donors cannot deduct contributions under section 170.

Ruling snapshot

• Question: Does an organization whose sole activity is giving scholarships to all children of a specific employer's employees, with no need or merit criteria, qualify for exemption under section 501(c)(3)?
• Outcome: Denied (final adverse determination; fails the operational/private-benefit test and the Rev. Proc. 76-47 employer-related grant conditions).
• Key authorities: IRC § 501(c)(3); Treas. Reg. § 1.501(c)(3)-1(a), (c), (d); Rev. Proc. 76-47; IRC §§ 170, 4945(g)(1).

Full text (IRS public release)

Department of the Treasury                          Date: November 23, 2021
Internal Revenue Service
Tax Exempt and Government Entities                  Employer ID number:

IRS P.O. Box 2508                                   Form you must file:
Cincinnati, OH 45201

                                                    Tax years:

                                                    Person to contact:
                                                    Name:
                                                    ID number:
                                                    Telephone:

Release Number: 202207010
Release Date: 2/18/2022
UIL: 501.03-22, 501.33-00

Dear

This letter is our final determination that you don't qualify for exemption from federal income tax
under Internal Revenue Code (IRC) Section 501(a) as an organization described in IRC Section
501(c)(3). 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 IRC Section 501(c)(3), donors
generally can't deduct contributions to you under IRC Section 170.

We may notify the appropriate state officials of our determination, as required by IRC Section 6104(c),
by sending them a copy of this final letter along with the proposed determination letter.

You must file the federal income tax forms for the tax years shown above within 30 days from
the date of this letter unless you request an extension of time to file. For further instructions,
forms, and information, visit www.irs.gov.

We'll make this final adverse determination letter and the proposed adverse determination letter
available for public inspection after deleting certain identifying information, as required by IRC
Section 6110. Read the enclosed Letter 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 Letter 437 on how to notify us. If you agree with our deletions, you
don't need to take any further action.

If you have questions about this letter, you can call the contact person shown above. If you have
questions about your federal income tax status and responsibilities, call our customer service

Letter 4038 (Rev. 1-2021)
Catalog Number 47632S

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

Sincerely,

Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements

Enclosures:

Letter 437

Redacted Letter 4034
Redacted Letter 4038

Letter 4038 (Rev. 1-2021)
Catalog Number 47632S

Department of the Treasury
Internal Revenue Service
IRS P.O. Box 2508

Cincinnati, OH 45201
Date: October 5, 2021
Employer ID number:
Contact person/ID number:
Contact telephone number:

Contact fax number:

Legend:

D    Date                          UIL:

X = State                          501.03-22
Y = Cooperative                    501.33-00

Z = Individual

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 IRC Section 501(c)(3)? No, for the reasons stated below.

Facts

You were formed in the state of X. According to your Articles of Incorporation, you were formed exclusively
for charitable, religious, educational, or scientific purposes, including, for such purposes, the making of
distributions to organizations that qualify as exempt organizations under IRC Section 501(c)(3), or the
corresponding section of any future federal tax code. You filed your Form 1023 application on D with the
purpose of providing college scholarships to children of employees of Y. The scholarship program is your sole
purpose.

In your response to our additional information request you state you have no scholarship criteria or
requirements for your scholarship other than (1) being the child of Y employee, (2) graduating from high school
and (3) registering for college or technical school. You also indicated that you agreed to change your foundation
status to private foundation since you requested advance approval of your grant-making program under IRC
Section 4945(g)(1).

The purpose of the scholarship is to honor the memory of Z, who was the daughter of a retired employee of Y,
by assisting with the higher educational expenses of children of employees of Y. Y currently employs -
full-time and part-time employee.

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

You state there is no selection process, all children of employees of Y are awarded scholarships. The -
member Board of Directors consist of elected board members of Y, plus the Y General Manager/CEO and
Human Resources Director. The Bylaws of Y prohibit employees from being board members of that
organization, therefore only two board members might indirectly benefit from scholarship funds would be the
children of the Y General Manager and the children of the Y Human Resources Director. This is a moot point
since all children of Y employees are awarded a scholarship upon graduation from High School and registration
for college or technical school (the required criteria).

Law

Section 501(c)(3) of the Internal Revenue Code exempts from federal income tax: corporations, and any
community chest, fund, or foundation, 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 (but only if no part of its activities involves the provision of athletic facilities or equipment), or
for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of
any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or
otherwise attempting to influence legislation (except as otherwise provided in subsection (h)), and which does
not participate in, or intervene in (including the publishing or distributing of statements), any political campaign
on behalf of any candidate for public office."

Treasury Regulation Section 1.501(c)(3)-1(a)(1) states 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 that section. If an organization fails to meet either the organizational test or the
operational test, it is not exempt.

Treas. Reg. Sec. 1.501(c)(3)-1(c)(1) provides an organization is operated exclusively for exempt purposes only
if it engages primarily in activities which accomplish one or more exempt purposes specified in section
501(c)(3). It is not so operated if more than an insubstantial part of its activities does not further those purposes.

Treas. Reg. Sec. 1.501(c)(3)-1(d)(1)(ii) of the regulations provides that an organization is not organized or
operated exclusively for exempt purposes unless it serves a public rather than a private interest. To meet this
requirement, it is necessary for an organization to establish that it is not organized or operated for the benefit of
private interests

Rev. Proc. 76-47, 1976-2 C.B. 670, discusses an employer-related grant or loan program that treats some or all of
the employees, or children of employees, of particular employer as a group from which grantees of some or all of
the foundation grants or loans will be selected. The Rev. Proc. states the grant program must satisfy seven
conditions and meet a percentage test. If it does not satisfy all seven conditions plus the percentage test, the
Service will not issue a favorable letter in regard to the grant or loan program.

Application of law

You are not described in IRC Section 501(c)(3) and Treas. Reg. Section 1.501(c)(3)-1(a)(1). You fail the
operational test for exemption under Section 501(c)(3) because your scholarship program is not based on need
or merit which is required for scholarship programs to be exempt. Your sole activity is to provide
scholarships for individuals of a certain company.

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

Your activities are to benefit children of employees of Y, which indirectly benefits the employees. Student aid
does not further exclusively educational purposes if it is provided as compensation. Allowing all children of
employees to qualify for your grants without some objective criteria such as need or merit indicates your grants
are more compensatory than need or merit-based grants. This indicates a substantially non-exempt purpose
inconsistent with IRC Section 501(c)(3) and Treas. Reg. Sec. 1.501(c)(3)-1(c)(1).

You operate for the private interests of Y's employees and the children of Y's employees. Therefore, you are
not organized or operated exclusively as described in Treas. Reg. Sec. 1.501(c)(3)-1(d)(1)(ii).

You do not satisfy the guidelines of Rev. Proc 76-47 because you must meet all seven conditions stated in the
Rev. Proc., plus a percentage test. Of the seven conditions, one is that the selection committee must consist of
individuals totally independent and separate from the private foundation. Since you do not have any type of
selection committee, among other reasons, you do not meet the requirements of the Rev. Proc. Because your
employer-related grants do not meet the criteria of Rev. Proc. 76-47, they are considered to be taxable
expenditures. Because your only activity consists of taxable expenditures, your scholarship program is
inconsistent with IRC 501(c)(3) purposes.

Your position
You state that the scholarship program is separate from Y and Y is only involved because it's the employees of
the company whose children will receive the scholarship.

Our response to your position

Providing scholarships for the purpose of serving a private interest of Y and providing extra compensation, an
employment incentive, or an employee fringe benefit does not qualify you for exemption under section
501(c)(3) of the Internal Revenue Code. If your scholarship program would have been otherwise acceptable,
you still will not meet the requirements of section 501(c)(3) of the Internal Revenue Code because the program
is not based on need or merit.

Conclusion

Your scholarship program does not meet the requirements for exemption under IRC Section 501(c)(3) because
your scholarships are not for need or merit. Further, even if your scholarship program was generally acceptable,
it will not meet the requirements for exemption because it is an employer related program, which has additional
requirements to qualify for exemption as outlined in Rev. Proc 76-47, which you have not met.

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.

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

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

* 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:

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.

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

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