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PLR 202306009

Religious, Charitable, etc., Institutions and Community Chest

Official textIRS Written Determinations (PLR · TAM · CCA)irs.gov
Summarize

# Issues

1. Whether ( ) continues to qualify for exemption under Section 501 (c)(3) of the Internal Revenue Code?
2. Whether revocation of exempt status under IRC §§ 501 (c)(3) and 170(b)(1 )(A)(vi) Facts: should be made retroactive to 1.
J L was incorporated in the state of signed the Articles of Incorporation as lncorporator.
2. Form 1023 was submitted on , signed the form as Admin. Assistant.
Administrator.
3. received its Initial Determination Letter on Final Determination Letter on on as ), wife of is listed as . It received its
4. On from amended its Articles of Incorporation to change its name to
5. On merged with with being the surviving organization.
6. signed the merger agreement as Secretary of J l
1. was incorporated in the state of on , as 1
2. received its determination as a 501 (c)(3) organization in
3. On amended its Articles of Incorporation to become
4. On changed its address from , to (same address as ).
5. On organization. merged with , with being the surviving
6. was the Executive Director of prior to the management Agreement with J l as
1. was incorporated in the state of on , wife of , was listed as the sole Director.
2. Form 1120-S, U.S. Income Tax Return for an S Corporation, returns filed for tax years through lists one Schedule K-1, Shareholder's Share of Income, Deductions, Credits, etc., recipient. That Schedule K-1 was issued to rand lists her as having % of Shareholder's percentage of stock ownership for tax year in I. (Part 1-F)
3. In Form 1120-S listed Schedule K-1 s for shareholders, , and (Parts 1-F)
4. Form 1120-S returns for through lists the same K-1 recipients with an equal Shareholder's percentage of stock ownership for tax year in Management and Administration Agreement (Agreement)
1. The Agreement between and , dated states:
• o ( ) is a management services company established by founder and former Executive Director to provide management consultation on an Agreement for services basis to and other organizations as appropriate opportunities arise. will provide executive, 2 fiscal. strategic and program development management for . The Agreement will be based upon industry standards and should be established at % initially and potentially grow, based on reaching program and fiscal goals, to % or whatever industry standard, fair market-fees are determined to be.
Due to the current challenges involved in assimilating into and other budgetary constraints, recommends an 'incremental transition' into the management services Agreement relationship. The Agreement will begin at a rate supported by fiscal ability and include executive management and as the budget allows, the other services listed above will be added as fiscally appropriate with corresponding increases in the Agreement fees to %. o The contractual Agreement between and will be presented to the board for review and approval upon its completion for retroactive initiation date of
• New Executive Director o ... As of , will assume the title of Executive Director and will continue to perform his duties under the authority and direction of per the management Agreement.
0 last day on the payroll of was to be ; the pay period ended on and was inadvertently paid extra days on the payroll.
2. The Agreement between and , dated states:
This Manaqement and Administrative Services Aqreement ("AQreement") is made on , , by and between , an Corporation (herein " " or Manager or Administrator) and (a not-for-profit corporation) (herein .. ). a. Administration and Management. i. hereby retains to provide management and administrative services to to facilitate in carrying out its various contractual Agreements and obligations to 3 provide stable and caring placements for youth in need of out-ofhome care according to the highest standards of professionalism as follows: ii. shall recruit, recommend for selection and provide oversight Executive Director who is responsible for the fulfillment of contractual obligations. iii. shall provide, supervise and administer a comprehensive program of quality standards and assurance in compliance with applicable state and referring agency regulations, standards and policies. iv. shall provide, supervise and administer appropriate budgeting processes for to assure fiscal responsibility in accordance with generally accepted accounting practice and shall insure satisfactory completion of an annual independent audit in compliance with state and agency regulatory standards. v. shall have responsibility for program development and strategic planning to accomplish program objectives and to provide for long term growth. b. Manner & Place of Performance. i. During the term of this Agreement shall have exclusive discretion to determine the means, manner, methods and place of its performance c. Intellectual Property. i. acknowledges that pursuant to the terms of this Agreement will use and further develop confidential means and methods and proprietary information that it has previously used and developed relating to the administration the programs and contractual obligations of and it is agreed that this confidential information is and shall be the property of ii. further agrees that all ideas, programs, software, works of authorship and other trade secrets developed or improved shall not be considered to be "works made for hire" and that shall be deemed the author thereof under the U.S.
Copyright Act.
4 signed the Agreement as Director of
3. A new Agreement was agreed to , with an effective date of . The differences between this Agreement and the Agreement are: a. Administration and Management.
- (d) shall have responsibility for program development and strategic planning to accomplish program objectives and to provide for long term growth.
- (d) shall provide, supervise administration for program development and strategic planning to accomplish program objectives and to provide for long term growth.
Added:

(e) shall provide data management tools, specifically the use of the for case management duties, quality assurance reporting and invoicing and payments. b. Term.
- This Agreement shall be in effect for a term of ( ) years commencing from the date of execution hereof and shall be automatically renewed for successive ( ) year periods thereafter unless either party shall give notice in writing of an intention to not-renew not less than days prior to any termination date.
- This Agreement shall be in effect for a term often ( ) years commencing and shall be automatically renewed for successive ( ) year period thereafter unless either party shall give notice in writing of an intention to not-renew not less than days prior to any termination date. c. Compensation.
- During an initial transition period, compensation paid to for the services it provides pursuant to the terms of this Agreement shall be paid pursuant to the following transition schedule:
% of receipts for the period from through % of receipts 5 for the period from through % of receipts for the period from through period from % of receipts for the and thereafter.
This transition schedule may be accelerated by mutual Agreement of the parties. In any event, after the phase-in period, the compensation to be paid to for the services it provides pursuant to the terms of this Agreement shall be paid monthly and adjusted annually to current market standard rate or is equal to percent ( % ) of gross receipts.
- Compensation rates are in accordance with general business standards as researched and verified through organization filings, ranging from % to %. Current rate is % of gross revenue as adjusted for corrections and refunds less bad debt with adjustments made for annual reconciliation. Compensation may be increased based on current market analysis and mutual Agreement between both parties during the life of the Agreement. d. General Terms.
Added-

(h) Assessment, Assessment and evaluation of the stated objectives will be performed by the board of directors at a regularly scheduled board meeting annually. Documentation of the periodic assessment and evaluation will be recorded in the meeting minutes. signed the Agreement as Director of
4. An addendum to the Agreement dated , dated , with an effective date of , states that the addendum was entered into by and between , an Corporation (herein 11 " or Manager or Administrator) and (a not-for-profit corporation) (herein 11 "). It states that this amendment is to adjust the Agreement entered between said parties dated , specifically the rate of compensation. a. The term of ( ) years remains in effect beginning with automatic renewal for successive years. b. The compensation will increase from % to % of gross revenue as 6 adjusted for corrections and refunds less bad debt with adjustments made for annual reconciliation. c. It was also discussed, since the rate of % is lower than the industry standard of % - %, the rate may be increased to % within the next quarter. d. This rate increase was discussed and voted into effect at the Board Meeting of the Directors signed the addendum as Asst. CEO of
5. An addendum to the Agreement dated , by and between (herein 11 11 or Manager or Administrator) and , was entered into on , an Corporation (a not-for-profit corporation) (herein 11 11 ). It states that this amendment is to adjust the Agreement entered between said parties dated , specifically the rate of compensation. a. The term of ( ) years remains in effect beginning with automatic renewal for successive years. b. The compensation will increase from % to % of gross revenue as adjusted for corrections and refunds less bad debt with adjustments made for annual reconciliation. c. The effective date for said increase is retroactive to d. This rate increase was discussed and voted into effect at the Board Meeting of the Directors signed the addendum as Asst. CEO of and
6. A new Agreement between and was signed on The differences between the Agreement and the Agreement dated with addendums effective
1. Administration and Management.
( effective ) , and are noted below.

(b) shall provide, supervise and administer a comprehensive program of quality standards and assurance in compliance with applicable state and referring agency regulations, standards and 7 Added: policies;

(c) shall provide, supervise and administer appropriate budgeting processes for to assure fiscal responsibility in accordance with generally accepted accounting practice and shall insure satisfactory completion of an annual independent audit in compliance with state and agency regulatory standards;

(d) shall provide, supervise administration for program development and strategic planning to accomplish program objectives and to provide for long term growth.

(b) shall provide evaluation of a comprehensive program of quality standards and assurance in compliance with applicable state and referring agency regulations, standards and policies;

(c) shall provide direction and evaluation of appropriate budgeting processes for to assure fiscal responsibility in accordance with generally accepted accounting practice and shall assist in the satisfactory completion of an annual independent audit in compliance with state and agency regulatory standards;

(d) shall provide direction and evaluation for program development and strategic planning to accomplish program objectives and to provide for long term growth.
10. Contractual Compliance is a provider to state and county agencies for child welfare services and is subject to audits for such program, fiscal and contractual performance. provides direction and evaluation to the Agreement but does not perform the duties outlined in the state Agreements, i.e., case management, licensing, foster parent training. is a vendor providing a service to as outlined in Section 1. Administration and Management. signed the Agreement as Director of Information Document Request (IDR) 8
1. An Information Document Request (IDR) dated , was issued to (IDR #2). Questions were asked concerning the Management and Administrative Agreements. answered those questions in a response dated Question #1 - Why did decide that it needed a management services company?
Answer - (hereafter referred to as ) retained (hereafter referred to as ) to provide management administrative services to to facilitate its mission of providing foster care. had grown into a larger more technologically complex organization. There was a growing need for more technological sophistication in the areas of support as well as a need to develop financial management, strategic planning, legal and Agreement management, audit support as well as the need to develop a more effective IT system. became aware of the trend among foster care providers to look to management companies that would bring specialized technical knowledge and expertise, allowing the core activities of child placement and family support to remain the primary focus and priority of the program staff, whose training and competency is in the area of social work.
The management services would bring technological support in an increasingly more complex administrative environment.
In addition, a management company could supervise and administer appropriate budgeting processes for to assure fiscal responsibility in accordance with generally accepted accounting practice.
Question #2 (a) Did have a different management services company in the years before was incorporated? If yes, what was the compensation rate paid to any other management services companies? Please provide a copy of any other management services Agreements before was hired.
Answer- N/A
Question #2 (b) If did not hire any other management services companies before it hired , who previously performed the services that are now being performed by ?
Answer - The key administrators of performed these duties.
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Question #3 - Did put the management services out for competitive bidding before awarding it to ?
Answer - board of directors did not see a need to solicit bidding as the team brought an extensive knowledge base in executive leadership and the challenges that would face in the everchallenging field of foster care. The board of directors was careful to ensure that the Agreement with was within fair market values. The Agreement was actually established at a lower than market standard fee structure, as evidenced by the reviewed and included in this report.
Question #8 - Please provide a narrative description of the typical services performs for in a given week including (c), Who performs those services Answer - is located in where a substantial amount of the services are provided and travels extensively to all the locations across states. o During these office visits, team provides on-site and inperson executive, financial, technology, legal, contract relationships and program quality support. works closely on a daily basis with executive management and top managers in the departments on administrative issues, progress, strategies, reports, upcoming projects, etc. works daily with staff on items including but not limited to: o Handling the weekly and monthly financial reporting along with ongoing assistance daily with accounting staff on accounting/coding related questions. o works closely with human resource staff on personnel issues, including hiring and any disciplinary actions that may need to address with personnel. o oversees the IT department and assists with networking and data integrity and availability. works daily with IT department to assist with any problems, offer solutions and help ensure the infrastructure is in place to support all of 10 0 current offices as well as planned growth. Included in the fee is the use of a database tracking system called which was developed to and the requirements necessary per individual state standards. Also, all required documentation for the foster youth cases and foster homes are stored in drives strategic quarterly goals including but not limited to recruitment of new foster homes, dashboards on financial data, dashboards on personnel data, quality program outcomes, and generates a host of reports that uses on a daily basis. The team works with staff on configurations/requirement issues that arise in various states. on behalf of the board of directors provides executive support and consultation to the executive director and management team. The primary focus of this is strategic planning around the achievement of economy of scale which is essential for organizational survival in an environment where small to medium sized programs are finding it increasingly difficult to compete with the larger, more technically astute, scale driven companies. The board looks to to guide management to leverage resources in the most forward-looking entrepreneurial way in order to compete successfully in this challenging and competitive environment. meets daily with management leading the process of metrics based decisionmaking, coordinating the development of strategic growth plans for each region. The process involves demographic analysis and tracking of recruitment metrics and foster parent training participation and progress. Daily discussion with managers revolves around the pressing constraint of remaining viable through continuous and effective strategic activity. executive support professionals are experienced social program providers with extensive training and experience in business and organizational management.
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Question #9 - Please provide a narrative description of the services performed occasionally or on a set schedule e.g., monthly, quarterly, or yearly and the services performed on an ad hoc/as needed basis, including: c.) Who performs these?
Answer - staff regularly travel to the sites in and staff plan and conduct at least all staff inservices a . These are conducted in various locations across the country. leads these day in-services and provides an array of training and leadership for the organization, following up training events with transfer of learning sessions. also leads quarterly director of strategy and development meetings. These meetings again move from state to state. Full office updates are presented for every office in leads and provides critical input on how to move each office forward with quality and strategic growth. administrative team attends bi-weekly department head meetings in . All departments discuss the challenges they are experiencing in their departments and receive support and technical assistance from o Recruitment activities, marketing, strategizing around demographicl? utilizing technology, and other analytical tools. Director of Development and Marketing is the coordinator of these activities, assisting program directors with ongoing marketing and recruitment strategy. o supports program staff in the utilization of the data management system, ( ) following up on help-desk requests and solving configuration problems as identified through our ongoing systems analysis process. I develops and maintains the internal IT infrastructure and consults with software program writers. supports and trains staff in the utilization of and other software applications for case management processes. develops and expands the utilization of the database features as the need for more information evolves. coordinates the installation and maintenance of low voltage hardware, networking systems in offices and troubleshoots system shutdowns. These and other support activities are performed by the operational support team of several IT systems specialists.
12 o provides fiscal oversight including accounts receivable, accounts payable, and payroll processes. produces monthly as well ad hoc financial reports for the executives and board. Financial reports are presented quarterly to the board by coordinates audit activities with state contract audits and leads the annual independent audit process with the independent auditing firm. ensures that all appropriate processes and procedures are being followed in accordance with GAAP and GAGAS and ensures all state specific regulations and policies are complied with. State specific cost reports are an ongoing process conducted by staff. The financial activities and processes of are directed by an professional with credentials and is assisted by an st ate cost report specialist. organizes the annual independent audit and works closely with staff and independent auditors to ensure all information is available and accurately report ed. works closely with staff and other LAW: outside auditors when is audited by other departments in the different contract regions in which they do business. produces annual budgets and reports quarterly results at board meetings.
Internal Revenue Code (IRC) §501 (a) provides that an organization described in §501 (c) (3) is exempt from income tax.
IRC §501 (c)(3) exempts from federal income tax corporations organized and operated exclusively for charitable, educational, and other purposes, provided that no part of the net earnings inure to the benefit of any private shareholder or individual.
Regulations §1.501 (a)-1 (c) defines "private shareholder or individual" in section 501 as persons having a personal and private interest in the activities of the organization.
An IRC §170(b)(1 )(A)(vi) organization is defined as an organization referred to in subsection (c)(2) which normally receives a substantial part of its support (exclusive of income received in the exercise or performance by such organization of its charitable, educational, or other purpose or function constituting the basis for its exemption under §501 (a)) from a governmental unit referred to in subsection (c)(1) or from direct or indirect contributions from the general public.
IRC §170(c)(2)(B) defines a charitable organization as a corporation, trust, or community 13 chest, fund, or foundation that is organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals;
Regulations §1.501 (a)-1 (c) states that the words private shareholder or individual in section 501 refer to persons having a personal and private interest in the activities of the organization.
Regulations §1.501 (c)(3)-1 (a)(1) provides that, in order to be exempt as an organization described in Code §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.
Regulations §1.501 (c)(3)-1 (b)(1) 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; (b) 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.
Regulations §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 that accomplish one or more of such exempt purposes specified in Code §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. The existence of a substantial nonexempt purpose, regardless of the number or importance of exempt purposes, will cause failure of the operational test. Better Business Bureau of Washington, D.C. v. U.S., 326 U.S. 279 (1945).
Regulations §1.501 (c)(3)-1 (c)(2) provides that the operational test is not satisfied where any part of the organization's earnings inure to the benefit of private shareholders or individuals, and where the organization serves a private benefit rather than public interests.
Regulations §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 private interest. Thus, 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. Prohibited private interests include those of unrelated third parties as well as insiders. Christian Stewardship Assistance, Inc. v. Commissioner. 70 T.C. 1037 (1978);
American Campaign Academy v. Commissioner, 92 T.C. 1053 (1989). Private benefits include an "advantage; profit; fruit; privilege; gain; [or] interest." Retired Teachers Legal Fund v.
Commissioner, 78 T.C. 280, 286 (1982).
Regulations §1.501 (c)(3)-1 (f)(ii) provides that In determining whether to continue to recognize the tax-exempt status of an applicable tax-exempt organization described in section 501 (c)(3) that engages in one or more excess benefit transactions that violate the prohibition on inurement under section 501 (c)(3), the Commissioner will consider all relevant facts and 14 circumstances, including, but not limited to, the following -

(A) The size and scope of the organization's regular and ongoing activities that further exempt purposes before and after the excess benefit transaction or transactions occurred;

(B) The size and scope of the excess benefit transaction or transactions (collectively, if more than one) in relation to the size and scope of the organization's regular and ongoing activities that further exempt purposes;

(C) Whether the organization has been involved in multiple excess benefit transactions with one or more persons;

(D) Whether the organization has implemented safeguards that are reasonably calculated to prevent excess benefit transactions; and

(E) Whether the excess benefit transaction has been corrected (within the meaning of section 4958(f)(6) and§ 53.4958-7). or the organization has made good faith efforts to seek correction from the disqualified person(s) who benefited from the excess benefit transaction.
The presence of a single substantial nonexempt purpose can destroy the exemption regardless of the number or importance of exempt purposes. Better Bus. Bureau v. United States, 326 U.S. 279. 238, 90 L. Ed. 67, 66 S. Ct. 112 (1945); Am. Campaign Acad. V.
Commissioner, 92 T.C. 1053, 1065 (1989). When an organization operates for the benefit of private interests, such as designated individuals, the creator or his family, or persons directly or indirectly controlled by such private interests, the organization by definition does not operate exclusively for exempt purposes. Am. Campaign Acad. V. Commissioner, supra at 1065-1066.
Rev. Proc. 2008-9, I.R.B. 2008-2 (January 14, 2008), Section 12, states that a determination letter or ruling recognizing exemption may be revoked or modified by a notice to the taxpayer to whom the determination letter or ruling was issued. It went on to say that the revocation or modification of a determination letter or ruling recognizing exemption may be retroactive if the organization omitted or misstated a material fact, operated in a manner materially different from that originally represented, or engaged in a prohibited transaction and where there is a material change, inconsistent with exemption, in the character, the purpose, or the method of operation of an organization, revocation or modification will ordinarily take effect as of the date of such material change.
People of God Community v. Commissioner, 75 T.C. 127 (1980) - "We hold here that paying over a portion of gross earnings to those vested with the control of a charitable organization constitutes private inurement as well. All in all, taking a slice off the top should be no less prohibited than a slice out of net".
United Cancer Council, Inc. v. Commissioner, 165 F.3d 1173, 1176 (1999). - "The term "any private shareholder or individual" in the inurement clause of section 501 (c)(3) of the Internal Revenue Code has been interpreted to mean an insider of the charity. A charity is not to siphon its earnings to its founder, or the members of its board, or their families, or anyone else fairly to be described as an insider, that is, as the equivalent of an owner or manager. The test is functional. It looks to the reality of control rather than to the insider's place in a formal 15 table of organization. The insider could be a "mere" employee-or even a nominal outsider, such as a physician with hospital privileges in a charitable hospital, a case involving a founder's siphoning of charitable donations, or for that matter a fundraiser. (Cites omitted) Church by Mail, Inc. v. Commissioner, 765 F.2d 1387, 1392 (9th Cir. 1985), aff'g T.C. 1984-349; - tax-exempt status was denied for Church by Mail (Church) on the grounds that Church operated for the non-exempt purpose of providing a market for the services of Twentieth Century Advertising Agency (Twentieth), a for-profit organization. The court found that "the critical inquiry is not whether the particular contractual payments to a related for-profit organization are reasonable or excessive, but instead whether the entire enterprise is carried on is such a manner that the for-profit entity benefits substantially" from the operation of the exempt organization, even if that organization is furthering some exempt purpose.
Government's Position:
It is the position of the Government that after ) entered into a Management and Administration Agreement (Agreement) with ) no longer continued to qualify for exemption under Section 501 (c)(3) of the Internal Revenue Code, as it no longer operated exclusively for one or more charitable purposes.
In order to be exempt as an organization described in Code §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. (Regulations §1.501 (c)(3)-1 (a)(1 )) An organization will be regarded as "operated exclusively" for one or more exempt purposes only if it engages primarily in activities that accomplish one or more of such exempt purposes specified in Code §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. (Regulations §1.501 (c)(3)-1 (c)(1 )) Organizational Test meets the part of qualifying for exempt status, the organizational test. is organized to provide placement of children in foster homes, to provide adoption services, and to provide counseling services and training to foster parents. The placement of children in foster homes and the providing of services and training of foster parents are some of the exempt purposes specified in Code §501 (c)(3).
Operational Test
The operational test is not satisfied where any part of the organization's earnings inure to the 16 benefit of private shareholders or individuals, and where the organization serves a private benefit rather than public interests. (Regulations §§1.501 (c)(3)-1 (c)(2) and 1.501 (c)(3)-1 (d)(1 )(ii)) Private Benefit
1. At the time of the negotiations for the management agreement between and , was the founder and Executive Director of . His wife, was the incorporator and sole shareholder of . They both meet the definition of "private individual or shareholder" in relation to and respectively, as they have a personal and private interest in the activities of the each organization (Treas. Reg. § 1.501 (a)-1 (c)). Typically, those covered under this regulation are referred to as "insiders," such as founders, directors, officers, or their families, or anyone else fairly to be described as an insider, that is, as equivalent of owner or manager (See Treas. Reg.§§ 1.501(a)-1(c), 1.501(c)(3)-1(d)(1)(i, ii); United Cancer Council, Inc. v. Commissioner, 165 F.3d 1173, 1176 (1999)).
2. Since its incorporation on has been controlled by and his wife, ( ). They are of the listed officers of and are % shareholders of the corporation. As an officer of has substantial control of the operations of as evidenced by his signing of the Agreements. also exercises control over as evidenced by her signing addendums to the Agreement as Asst. CEO of . Therefore, both and meet the definition of a private shareholder or individual with respect to . (Treas. Reg. §1.501 (a)-1 (c)).
3. The Management and Administration Agreement a. The , Executive Board Meeting minutes for , stated that:
( ) is a management services company established by founder and former Executive Director to provide management consultation on an Agreement for services basis to and other organizations as appropriate opportunities arise. will provide executive, fiscal. strategic and program development management for . The Agreement will be based upon industry standards and should be established at % initially and potentially grow, based on reaching program and fiscal goals, to % or whatever industry standard, fair market-fees are determined to be.
Due to the current challenges involved in assimilating into and other budgetary constraints, recommends an 'incremental transition' into the management services Agreement relationship. The Agreement will begin at a rate 17 supported by fiscal ability and include executive management and as the budget allows, the other services listed above will be added as fiscally appropriate with corresponding increases in the Agreement fees to %.
The minutes go on to state that:
The contractual Agreement between and will be presented to the board for review and approval upon its completion for retroactive initiation date of As of , will assume the title of Executive Director and will continue to perform his duties under the authority and direction of per the management Agreement. last day on the payroll of was to be ; the pay period ended on was inadvertently paid extra days on the payroll. and b. The minutes indicate that , while Executive Director of , had considerable input into the terms of the Agreement. This is evidenced by his recommendation of an 'incremental transition' into the management services Agreement relationship and his statement "The Agreement will begin at a rate supported by fiscal ability and include executive management and as the budget allows, the other services listed above will be added as fiscally appropriate with corresponding increases in the Agreement fees to %".
4. The Agreement was not an "arm's length" transaction. In Information Document Request #2, Form 4564, dated , the question was asked:
Question #3 - Did put the management services out for competitive bidding before awarding it to ?
Question #3 Answer - board of directors did not see a need to solicit bidding as the team brought an extensive knowledge base in executive leadership and the challenges that would face in the everchallenging field of foster care. The board of directors was careful to ensure that the Agreement with was within fair market values. The Agreement was actually established at a lower than market standard fee structure, as evidenced by the reviewed and included in this report.
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5. The terms of the Agreement give a substantial amount of control over the operations of including in recruiting, recommending for selection, and oversight of the Executive Director; budgeting; involvement in the annual independent audit of and program development and strategic planning to, among other things, provide for long-term growth. According to IDR #2, Q #8C, also works closely with human resource staff on personnel issues, including hiring and any disciplinary actions that may need to address with personnel. According to IDR #2, Q #9C, also produces financial reports and coordinates audit activities with state contract audits. According to IDR #2, Q 8C, the primary focus of executive support and consultation to the executive director and management team is "strategic planning around the achievement of economy of scale," and " meets daily with management leading the process of metrics based decision-making, coordinating the development of strategic growth plans for each region … "
6. focus on strategic planning and growth of operations has the effect of increasing revenues, which in turn increases the fee paid to , as it is based on a percentage of gross revenue.
7. pays a substantial amount of money for management services, the vast majority of which pays out to and in the form of salaries and distributions to themselves and their trusts. A review of Forms determined that approximately by was paid out to the , for the years under the current contract percent ( %) of the management fee paid and their trusts each year.
8. is the main client of A review of Forms , for the years under the current contract determined that approximately percent ( %) of the gross income reported by came from the management fee paid by
9. This case is similar to Church by Mail, Inc. v. Commissioner, 765 F.2d 1387, 1392 (9th
Cir. 1985), aff'g T.C. 1984-349. In this case tax-exempt status was denied for Church by Mail (Church) on the grounds that Church operated for the non-exempt purpose of providing a market for the services of Twentieth Century Advertising Agency (Twentieth), a for-profit organization.
The court found that "the critical inquiry is not whether the particular contractual payments to a related for-profit organization are reasonable or excessive, but instead whether the entire enterprise is carried on is such a manner that the for-profit entity benefits substantially" from the operation of the exempt organization, even if that organization is furthering some exempt purpose. benefits substantially from the operations of . According to the In this case, Agreement, receives a percentage of the gross income of . Over the course of the Agreement, received approximately % of its income from the management 19 fees produced by the Agreement. Without the fees generated by the Agreement, would not be a going concern. This indicates, as in Church, the entire enterprise is carried on in such a manner that the for-profit entity benefits substantially.
With these facts in mind, does not meet the requirements of Regulations §§1.501 (c)(3)-1 (c)(2), as earnings serve a private benefit to and the by their 'Insider'' status in , rather than public interests. lnurement Since its incorporation on has been controlled by and his wife, ( ). They are of the listed officers of and are % shareholders of the corporation. As an officer of , has substantial control of the operations of as evidenced by his signing of the Agreements. also exercises control over as evidenced by her signing addendums to the Agreement as Asst. CEO of . Therefore, both and meet the definition of a. private shareholder or individual with respect to . (Treas. Reg. §1.501 (a)-1 (c)).
Operation prior to the Agreement
1. Prior to the Agreement all management functions of were performed by administrators of . This is confirmed by answers to questions asked in Information Document Request #2, Form 4564, dated , the question was asked:
Question #2(b) - If did not hire any other management services companies before it hired , who previously performed the services that are now being performed by ? answered this question in a response dated Answer (b) - The key administrators of The Management and Administration Agreement performed these duties.
2. The , Executive Board Meeting minutes for , stated that:
( ) is a management services company established by founder and former Executive Director to provide management consultation on an Agreement for services basis to and other organizations as appropriate opportunities arise. will provide executive, fiscal. strategic and program development management for . The Agreement will be based upon industry standards and should be established at % initially and potentially grow, based on reaching program and fiscal goals, to % or whatever industry standard, fair market-fees are determined to be.
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Due to the current challenges involved in assimilating into and other budgetary constraints, recommends an 'incremental transition' into the management services Agreement relationship. The Agreement will begin at a rate supported by fiscal ability and include executive management and as the budget allows, the other services listed above will be added as fiscally appropriate with corresponding increases in the Agreement fees to % .
The minutes go on to state that:
The contractual Agreement between and will be presented to the board for review and approval upon its completion for retroactive initiation date of As of will assume the title of Executive Director and will continue to perform his duties under the authority and direction of per the management Agreement. last day on the payroll of to be ; the pay period ended on inadvertently paid extra days on the payroll. and was was
3. The minutes indicate that , while Executive Director of , had considerable input into the terms of the Agreement. This is evidenced by his recommendation of an 'incremental transition' into the management services Agreement relationship and his statement "The Agreement will begin at a rate supported by fiscal ability and include executive management and as the budget allows, the other services listed above will be added as fiscally appropriate with corresponding increases in the Agreement fees to %".
The Agreement was not an "arm's length" transaction. In Information Document Request #2, Form 4564, dated , the question was asked:
Question #3 - Did put the management services out for competitive bidding before awarding it to ?
Question #3 Answer - board of directors did not see a need to solicit bidding as the team brought an extensive knowledge base in executive leadership and the challenges that would face in the everchallenging field of foster care. The board of directors was careful to ensure that the Agreement with was within fair market 21 values. The Agreement was actually established at a lower than market standard fee structure, as evidenced by the reviewed and included in this report. operations to . The
4. The Agreement gave a substantial amount of control of Agreement states that for Agreement purposes to as , an Corporation (herein 11 is referred 11 or Manager or Administrator). The agreement states that: ii. shall recruit, recommend for selection and provide oversight Executive Director who is responsible for the fulfillment of contractual obligations. iii. shall provide, supervise and administer a comprehensive program of quality standards and assurance in compliance with applicable state and referring agency regulations, standards and policies. iv. shall provide, supervise and administer appropriate budgeting processes for to assure fiscal responsibility in accordance with generally accepted accounting practice and shall insure satisfactory completion of an annual independent audit in compliance with state and agency regulatory standards. v. shall provide, supervise administration for program development and strategic planning to accomplish program objectives and to provide for long term growth.
5. The terms of the Agreement give a substantial amount of control over the operations of including in recruiting, recommending for selection, and oversight of the Executive Director; budgeting; involvement in the annual independent audit of and program development and strategic planning to, among other things, provide for long-term growth.
According to answers received IDR #2, dated Question #8 - Please provide a narrative description of the typical services performs for in a given week including (c), Who performs those services Question #8C answers - a) also works closely with human resource staff on personnel issues, including hiring and any disciplinary actions that may need to address with personnel.
22
6. b) The primary focus of executive support and consultation to the executive director and management team is "strategic planning around the achievement of economy of scale," and" meets daily with management leading the process of metrics based decision-making, coordinating the development of strategic growth plans for each region … "
Question #9 - Please provide a narrative description of the services performed occasionally or on a set schedule e.g., monthly, quarterly, or yearly and the services performed on an ad hoc/as needed basis, including: c.) Who performs these?
Question #9C answer - also produces financial reports and coordinates audit activities with state contract audits. focus on strategic planning and growth of operations has the effect of increasing revenues, which in turn increases the fee paid to , as it is based on a percentage of gross revenue is the founder of He left when the Agreement was signed. He and his wife have control of and are % shareholders of . As such, & are "Insiders" in and by inference . The larger the fees collected from by , the larger the income to the shareholders of . Thus and meet the definition of private shareholders or individuals referred to in section 501 of the Regulations as persons having a personal and private interest in the activities of the (Regulation 1-501(a)-1(c)) pays a substantial amount of money for management services, the vast majority of which pays out to and in the form of salaries and distributions to themselves and their trusts. A review of Forms determined that approximately by was paid out to the , for the years under the current contract percent ( % ) of the management fee paid and their trusts each year.
This is a similar fact pattern to People of God Community v. Commissioner, 75 T.C. 127 (1980). In People of God, the salaries of the ministers of the Christian church were based on a predetermined percentage of the gross tithes and offerings received. The court held that part of the church's net earnings inured to the benefit of private individuals. This finding caused the court to determine that the church was not exempt as an organization described in IRC §501 (c)(3).
The major difference between People of God and this case is the insertion of 23
7. between and the . In People of God the ministers controlled the church directly. In this case the Agreement gave substantial control of to , with & controlling by being the CEO and Asst. CEO respectively.
As in the People of God case, the Agreement set management fees paid by to at a predetermined percentage of gross income.
In People of God, the court stated that:
"We hold here that paying over a portion of gross earnings to those vested with the control of a charitable organization constitutes private inurement as well. All in all, taking a slice off the top should be no less prohibited than a slice out of net".
The court continued:
What is prohibited is inurement "to the benefit of any private shareholder or individual." The term "private shareholder or individual" refers to persons who have a personal and private interest in the payer organization. The term does not refer to unrelated third parties. In other words, section 501 (c)(3) denies exempt status to an organization whose founders or controlling members have a personal stake in that organization's receipts. Such is the case here, where petitioner's ministers, and Donhowe, in particular, completely control its affairs. Petitioner therefore fails to qualify for exemption under section 501 (c)(3). (citations omitted) In this case the Agreement gives a substantial amount of control of operations. has a stake in gross receipts. The better performs, the higher the fees received by The operational test is not satisfied where any part of the organization's earnings inure to the benefit of private shareholders or individuals, and where the organization serves a private benefit rather than public interests. (Regulations §1.501 (c)(3)-1 (c)(2)) As in People of God, fails to qualify for exemption under section 501 (c)(3). is the main client of benefits substantially from the operation of The Agreement's fee structure provides that "Compensation rates are in accordance with general business standards as researched and verified through organization filings, ranging from % to %. Current rate is % of gross revenue as adjusted for corrections and refunds less bad debt with adjustments made for annual reconciliation. Compensation may be increased based on current market analysis and mutual Agreement between both parties during the life of the Agreement".
With these facts in mind, does not meet the requirements of Regulations §§1.501 (c)(3)-24 1 (c)(2) and 1.501 (c)(3)-1 (d)(1 )(ii) as interests.
Revocation earnings serves a private benefit rather than public Regulations §1.501 (c)(3)-1 (f)(ii) provides that In determining whether to continue to recognize the tax-exempt status of an applicable tax-exempt organization described in section 501 (c)(3) that engages in one or more excess benefit transactions that violate the prohibition on inurement under section 501 (c)(3), the Commissioner will consider all relevant facts and circumstances, including, but not limited to, the following -

(A) The size and scope of the organization's regular and ongoing activities that further exempt purposes before and after the excess benefit transaction or transactions occurred;

(B) The size and scope of the excess benefit transaction or transactions (collectively, if more than one) in relation to the size and scope of the organization's regular and ongoing activities that further exempt purposes;

(C) Whether the organization has been involved in multiple excess benefit transactions with one or more persons;

(D) Whether the organization has implemented safeguards that are reasonably calculated to prevent excess benefit transactions; and

(E) Whether the excess benefit transaction has been corrected (within the meaning of section 4958(f)(6) and§ 53.4958-7), or the organization has made good faith efforts to seek correction from the disqualified person(s) who benefited from the excess benefit transaction.
The most relevant considerations in this case are C, D, and E of the regulation. has been involved in the excess benefit transactions that violate the prohibition on inurement under section 501 (c)(3) since the adoption of the original agreement in of Since the original agreement was signed, and have been "Insiders" in relation to . They have both been officers of and only shareholders. The signing of the agreement did nothing to modify the agreement in any way that would prohibit the control and fee structure of the agreement from enabling and to receive funds that inured to their private benefit.
The agreement was not an "arms-length" transaction. The organization made no attempt to put the management services out for competitive bidding before awarding it to In IDR #2, Question #3, stated that: board of directors did not see a need to solicit bidding as the team brought an extensive knowledge base in executive leadership and the challenges that would face in the ever-challenging field of foster care. The board of directors was careful to ensure that the Agreement with was within fair market values. The Agreement was actually established at a lower than market standard fee 25 structure, as evidenced by the report. reviewed and included in this The Agreement gave substantial control of operations to and by inference, and . As discussed above, in People of God v. Commissioner, the court found that:
"We hold here that paying over a portion of gross earnings to those vested with the control of a charitable organization constitutes private inurement as well. All in all, taking a slice off the top should be no less prohibited than a slice out of net". and its Board have not made good faith efforts to seek correction from and who benefited from the excess benefit transactions. Amendments to the Agreement were made to increase the percentage of gross income paid by as management fee, but no control modification amendments were included.
Considering the above facts and circumstances, should not continue to be recognized as an organization having the tax-exempt status of an applicable tax-exempt organization described in section 501 (c)(3). (Regulations §1.501 (c)(3)-1 (f)(ii), example 3(iii))

# Conclusions

The Service has sufficient information / evidence to establish the Agreement between and exhibits a pattern of control over the operations of is the founder of He left when the Agreement was signed. and have control of and are % shareholders of As such, & have a personal and private interest in and by inference (Reg. §1.501 (c)(3)-1 (c)(2)). pays a substantial amount of money for management services, the vast majority of which pays out to and in the form of salaries and distributions to themselves and their trusts. A review of Forms for the years under the current contract determined that approximately ( %) of the management fee paid by was paid out to the year. percent and their trusts each We believe that paying the excise taxes and making corrections would not be sufficient to allow to retain its tax-exempt status since would continue to be controlled by the through the Agreement, thus continuing the practice of using substantial assets for the private benefit of the same individuals. As long as the Agreement is in place, it will continue to disqualify from exemption. should lose its tax-exempt status. In addition, given the fact pattern of abuse, nonprofit private foundation status should be terminated pursuant to IRC §507(a)(2) and Regulations §1.501 (c)(3)-1 (f)(ii}, example 3(iii)) 26 The revocation should be effective (the day of the audit period). will be , inclusive. required to file Form 1120 for all tax years since
Taxpayer Position
Page __
Catalog Number 20810W
Form 886-A (Rev. 5-2017) www.irs.gov 27

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