Virtual-reality entertainment platform did not qualify under section 501(c)(3)

Plain-English summary

A nonprofit corporation proposed to build and maintain an open virtual-reality platform where users could socialize, play games, enter tournaments, and connect with proprietary platforms. Its articles described an entertainment purpose rather than limiting the organization to charitable or educational purposes. The IRS also found that operating the platform primarily served substantial social and recreational purposes, even if much of it was free and some activities could be instructive. Possible market-based fees for games and tournaments reinforced the platform's entertainment focus. Because the organization failed both the organizational and operational tests, the IRS denied section 501(c)(3) status, and the denial became final after no protest was filed.

Ruling snapshot

• Question: Did an organization building a social and gaming virtual-reality platform qualify for exemption under section 501(c)(3)?
• Outcome: Denied
• Key authorities: IRC § 501(c)(3); Treas. Reg. § 1.501(c)(3)-1; Rev. Rul. 66-179; Rev. Rul. 77-366; Better Business Bureau v. United States

Full text (IRS public release)

Department of the Treasury Date:

Internal Revenue Service 01/17/2023
Tax Exempt and Government Entities

IRS PO Box 2508

Cincinnati, OH 45201

Employer ID number:

Person to contact:

Release Number: 202315012
Release Date 4/14/2023

UIL Code: 501.03-00,
501.35-00

Dear [redacted]:

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

Letter 4038 (Rev. 11-2021)
Catalog Number 47632S

Sincerely,

Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements

Enclosures:

Letter 437

Redacted Letter 4034
Redacted Letter 4038

Letter 4038 (Rev. 11-2021)
Catalog Number 47632S

Department of the Treasury
Internal Revenue Service
IRS PO Box 2508
Cincinnati, OH 45201
Date:

November 21, 2022
Employer ID number:

Person to contact:

Name:
ID number:
Telephone:
Fax:
Legend: UIL:
B = state 501.03-00
C = date 501.35-00
D = entity
E = platform
Dear [redacted]:

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 as a corporation in the state of B on C. According to your Articles of Incorporation, your
purpose is to explore, develop, support, and administer an Internet “world” where users are able to interact in
multiple forms or “venues” for the purposes of entertainment.

According to your application, you will operate a virtual reality (VR) software platform to allow all VR users to
equally participate, without being tied to a specific hardware platform. You will provide a place where everyone
is able to participate in VR and interact with multiple proprietary platforms. The platform is intended to
function all day, every day. Users will be able to experience and use the platform with no expectation of
payment. Anyone with proper equipment and access can connect/participate. Your initial operations will be
platform development and implementation (which may include distributed hardware). Ongoing activities would
be system maintenance, system expansion, and platform upgrades.

You did not list an exempt purpose in your application. When asked how your activities further an exempt
purpose, you stated that developing the platform is the entire basis for your founding but did not specify how
the platform would further an exempt purpose.

Letter 4034 (Rev. 01-2021)
Catalog Number 47628K

2

No fee structure is currently anticipated. You hope to receive funds through donations, however, some of the
activities within the platform may be fee-based. For example, you may charge to play some, or all, of the games
you develop. Once the platform is active there are ideas for a digital arcade. You plan on charging fees for some
of these games. There may also be tournaments for a particular game where an entry fee is required. You may
collect a portion of these fees as income. Fees for games will be based on what the market will support, with
monitoring and adjustment as needed. Fees for tournaments will be based on what users are willing to pay.

Currently you have no connections with for profit entities. And although you intend on maintaining the area as
your own, you will look to work with outside companies and acquire needed commands to design an open
platform allowing users to connect to other existing platforms. Any for profit companies you work with will be
selected for their willingness to provide outside platform connections and their commitment to allow your
project to remain a neutral platform. For example, you indicated a relationship with D, which promoted itself as
a new way to log into VR devices and make the greatest experiences in VR even better by sharing them with the
people you love spending time with. E makes it simple to meet up with friends-to play some ping pong, get in a
group workout, build entirely new worlds and so much more.

Law

IRC Section 501(c)(3) 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 IRC 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.

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)(1)(iv) provides that in no case shall an organization 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 IRC Section 501(c)(3).

Treas. Reg. Section 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 IRC 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.

Revenue Ruling 66-179, 1966-1 C.B. 139, describes situations under which garden clubs may qualify for
exemption under IRC Section 501. Situation 1 describes an organization that is incorporated as a nonprofit
organization to instruct the public on horticultural subjects and stimulating interest in the beautification of the
geographic area. In furtherance of these purposes, the organization (1) maintains and operates a free library of
materials on horticulture and allied subjects; (2) instructs the public on correct gardening procedures and

Letter 4034 (Rev. 01-2021)
Catalog Number 47628K

3

conservation of trees and plant by means of radio, television, and lecture programs, (3) holds public flower
shows of a noncommercial nature at which new varieties of plants and flowers are exhibited; (4) makes awards
to children for achievements in gardening; (5) encourages roadside beautification and civic planting; and (6)
makes awards for civic achievement in conservation and horticulture. Situation 2 describes an organization with
the same facts as described in Situation 1 except that a substantial part of the organization's activities, but not its
primary activity, consists of social functions for the benefit, pleasure, and recreation of its members. The
organization in Situation 1 is organized and operated exclusively for charitable and educational purposes and
qualifies for exemption under Section 501(c)(3) of the Code. The facts in Situation 2 are distinguishable from
those in Situation 1 in that the organization in Situation 2 conducts substantial social functions not in
furtherance of any of the purposes specified in Section 501(c)(3). Accordingly, the organization does not
qualify for exemption under Section 501(c)(3).

Revenue Ruling 77-366, 1977-2 C.B. 192, states that a nonprofit organization that arranges and conducts
wintertime ocean cruises during which activities to further religious and educational purposes are provided in
addition to extensive social and recreational activities is not operated exclusively for exempt purposes and does
not qualify for exemption under IRC Section 501(c)(3).

In Better Business Bureau of Washington, D.C., Inc. v. United States, 326 U.S. 179 (1945), the Supreme Court
held that the presence of a single non-exempt purpose, if substantial in nature, will destroy a claim for
exemption regardless of the number or importance of truly exempt purposes.

In St. Louis Science Fiction Limited v. Commissioner, 49 TCM 1126 , 1985-162, the Tax Court held that a
science fiction society failed to qualify for tax-exempt status under IRC Section 501(c)(3). Although many of
the organization's functions at its annual conventions (the organization's principal activity) were educational, its
overall agenda was not exclusively educational. A substantial portion of convention affairs were social and
recreational in nature.

Application of law

IRC Section 501(c)(3) and Treas. Reg. Section 1.501(c)(3)-1(a)(1) set forth two main tests for an organization
to be recognized as exempt. An organization must be both organized and operated exclusively for purposes
described in Section 501(c)(3).

Based on the information you provided in your application and supporting documentation, we conclude that you
fail both tests. Your Articles of Incorporation do not include language that limits your purposes to one or more
exempt purposes. The purposes for which you were created are broader than the purposes specified in IRC
Section 501(c)(3). Accordingly, you do not satisfy the organizational test required by Treas. Reg. Section
1.501(c)(3)-1(b)(1)(i) and 1.501(c)(3)-1(b)(1)(iv), and you are not organized exclusively for purposes described
in Section 501(c)(3).

You are also not described in IRC Section 501(c)(3) because you fail the operational test. Specifically, you are
not operated exclusively for an exempt purpose as described in Treas. Reg. Section 1.501(c)(3)-1(c)(1). The
facts show you are not operated exclusively for charitable purposes, but for the purpose of providing a virtual
reality platform where users gather for entertainment purposes. These activities show more than an insubstantial
part of your activities are furthering recreational and social purposes.

Letter 4034 (Rev. 01-2021)
Catalog Number 47628K

4

Although an organization may carry on activities that further one or more tax-exempt purposes, it will not be
treated as operated exclusively for an exempt purpose if it has a single non-exempt purpose that is substantial in
nature. You are formed primarily for social and recreational purposes in providing a virtual reality platform for
users to share personal interactive and gaming experiences. Your everyday activities are aimed at development
and maintenance of this platform. Even though you are providing this mostly free of charge you are not serving
exclusive charitable or educational purposes. Social and recreational purposes which are more than insubstantial
will defeat exemption under IRC Section 501(c)(3). (See St. Louis Science Fiction Limited and Better Business
Bureau.)

Similar to the organizations described in Revenue Rulings 66-179 and 77-366, even though your activities may
be instructive to participants, it is the overall purpose for which the activities are conducted that is considered.
Your platforms primarily serve the social interests of your users, enabling them to gather virtually for social
interaction and gaming. The organizations in these rulings offered activities instructing the public and furthering
religion, but the primary purposes were social and recreational in nature. Any activities serving exclusive IRC
Section 501(c)(3) purposes were outweighed by those serving extensive social and recreational purposes.

Conclusion

To be described in IRC Section 501(c)(3), your activities must exclusively further those exempt purposes.
Based on the information in your application, you are organized and operated primarily for social and
recreational purposes. You have not satisfied the organizational and operational test. Therefore, you fail to
qualify for exemption under 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.

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

Letter 4034 (Rev. 01-2021)
Catalog Number 47628K

5

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 Determination 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

PO 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. 01-2021)
Catalog Number 47628K