Shareholder water company denied charitable exemption

Plain-English summary

A nonprofit water distribution company sought recognition as a charity under IRC § 501(c)(3). Property owners in its service area contributed water rights, received proportional shares, and paid charges based on their water use and the company's operating expenses. The company provided water services only to its shareholders. The IRS concluded that this cooperative arrangement primarily served the shareholders' private interests rather than a public charitable interest and constituted a substantial nonexempt purpose. It denied exemption, and the denial became final after the company did not protest within 30 days.

Ruling snapshot

• Question: Does a water company that provides at-cost service exclusively to its shareholders qualify under IRC § 501(c)(3)?
• Outcome: Denied, because the company serves private shareholder interests rather than a public charitable interest
• Key authorities: IRC §§ 501(a), 501(c)(3); Treas. Reg. § 1.501(c)(3)-1; Rev. Rul. 61-170; Rev. Rul. 69-175

Full text (IRS public release)

Department of the Treasury Date:
Internal Revenue Service 05/08/2025

Tax Exempt and Government Entities Employer ID number:
PO Box 2508
Cincinnati, OH 45201 Form you must file:
Tax years:
Release Number: 202531013
Release Date: 8/1/2025
UIL Code: 501.03-05, 501.36-01

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 - 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:
02/27/2025

Employer ID number:

Person to contact:
Name:
ID number:
Telephone:
Fax:

Legend: UIL:

B = Date 501.03-05
C = State 501.36-01
D = County

x acre-feet = Amount

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

Facts
You were formed on B in the state of C as a nonprofit corporation.

You are a water distribution company. Your primary and only activity is to provide water service to your
shareholders located in a water service area in C through the upkeep and maintenance of the infrastructure and
land necessary to accomplish this activity. You did not define your service area in your application, but you did
say you will conduct your activities in D County in the state of C.

Your shareholders are property owners in your service area. You exclusively provide your services to your
shareholders, who collectively donated x acre-feet of water rights to you. Each shareholder is allocated shares
proportional to the water rights they donate to you.

You charge at-cost to your shareholders for providing your services, proportional to each shareholder’s water
use divided by your total operational expenses. The entirety of your revenues comes from charges paid by
shareholders. You did not provide an itemized breakdown of your expenses.

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

Law

Internal Revenue Code (IRC) Section 501(c)(3) 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, or for the prevention of cruelty to children or animals.” 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) state 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 said section. If an organization fails to meet either the organizational or operational test, it
is not exempt.

Treas. Reg. Section 1.501(c)(3)-1(c)(1) provides that an organization will be regarded as operating 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.

Treas. Reg. Section 1.501(c)(3)-1(d)(1)(ii) states that an organization is not operated exclusively for one or
more exempt purposes unless it serves a public rather than a private interest.

Revenue Ruling 61-170, 1961-1 C.B. 112, held that an organization which is primarily engaged in the
performance of personal services by operating an employment service principally for the benefit of its members
serves the private interest of its members rather than a public interest. Therefore, the organization is not exempt
under IRC Section 501(c)(3).

Rev. Rul. 69-175, 1969-1 C.B. 149, held that when a group of individuals associate to provide a cooperative
service for themselves, they are serving a private rather than a public interest. Accordingly, the organization
was not exempt under IRC Section 501(c)(3).

In Better Business Bureau of Washington D.C., Inc. v. United States, 326 U.S. 279 (1945), the Supreme Court
held that the presence of a single non-exempt purposes, if substantial in nature, will destroy the exemption

regardless of the number or importance of truly exempt purposes.

Application of law
You are not described in IRC Section 501(c)(3) nor comply with Treas. Reg. Section 1.501(c)(3)-1(a)(1)
because you are not operated exclusively for exempt purposes.

Treas. Reg. Section 1.501(c)(3)-1(d)(1)(ii) states that an organization is not operated exclusively for one or
more exempt purposes unless it serves a public rather than a private interest. Your primary and only activity is
to provide water service to your shareholders. You provide your services exclusively to your shareholders and
substantially further their private interests rather than a public interest. Therefore, you do not operate
exclusively for one or more exempt purposes as required by Treas. Reg. Section 1.501(c)(3)-1(c)(1).
Accordingly, you do not conduct an activity which furthers one or more exempt purposes specified in IRC
Section 501(c)(3).

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

You are similar to the organization in Rev. Rul. 61-170 and Rev. Rul. 69-175 because more than an
insubstantial amount of your resources and activities are used to offer your shareholders a service exclusively
for their use. Your shareholders collectively pool together their water rights in order to provide a cooperative
service for themselves. You have a limited membership. Your members pay a fee. Your members receive a
benefit. Accordingly, you serve the private interests of your shareholders.

You are similar to the organization described in Better Business Bureau of Washington, D.C., Inc., because
your water service activity serves a substantial non-exempt purpose precluding exemption under IRC Section
501(c)(3). The main beneficiaries of your operation are your shareholders rather than the general public and
your activities constitute an unrelated trade or business.

Conclusion

Based on the above, you are not operated exclusively for exempt purposes. You serve the private interests of
your members rather than public interests and your activities constitute an unrelated trade or business. Thus,
you do not qualify for exemption as an organization described in IRC 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
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.

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

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:
Christopher Mak Christopher Mak

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