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PLR 202319018

Religious, Charitable, etc., Institutions and Community Chest

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

# LAW

Code §501 (c)(3) exempts from federal income tax organizations organized and operated exclusively for charitable, educational, and other purposes, provided that no part of the organization's net earnings inures to the benefit of any private shareholder or individual.
Code §6033(a)(1) requires, in part, that organizations exempt from taxation under §501 (a) to file an annual return stating specifically the items of gross income, receipts, and disbursements, and such other information for the purpose of carrying out the internal revenue laws as the Secretary may by forms or regulations prescribe.
Code §6652(c) imposes a penalty for failure to file a return required under §6033(a)(1) on the date and in the manner prescribed, failure to include any of the information required to be shown on a return, or failure to show the correct information. The penalty is $20 for each day during which such failure continues. For returns required to be filed in 2019, the maximum penalty for failure to timely file the required return with all required information with respect to any one return shall not exceed the lesser of $10,000 or 5 percent of the gross receipts of the organization for the year.
Treas. Reg. §1.501 (c)(3)-1 (a) of the Income Tax Regulations (Treas. Reg.) 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.
Treas. Reg. §1.501(c)(3)-1(b)(4) states that an organization is not organized exclusively for one or more exempt purposes unless its assets are dedicated to an exempt purpose. An organization's assets will be considered dedicated to an exempt purpose, for example, if, upon dissolution, such assets would, by reason of a provision in the organization's articles or operation of law, be distributed for one or more exempt purposes.
Treas. Reg. §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 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.
Treas. Reg. § 1.501 ( c)(3)-1 ( d)( 1 )(ii) provides that an organization is not organized or operated exclusively for one or more of the purposes specified in subdivision (i) of this subparagraph unless it serves a public rather than a private interest. Thus, to meet the requirement of this subdivision, it is necessary for an organization to establish that it is not organized or operated for the benefit of private interests such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests.
Treas. Reg. §1.501(c)(3)-1(d)(1)(iii), Example 3, describes an organization that is deemed to violate the restriction on private benefit due to their arrangement with a related for-profit entity, regardless of whether the payments to the related for-profit entity are reasonable.
Treas. Reg. §1.501(c)(3)-1(d)(2) defines "Charitable" to include; relief of the poor and distressed or of the underprivileged; advancement of religion; advancement of education or science; erection or maintenance of public buildings, monuments, or works; lessening of the burdens of government; and promotion of social welfare by organizations designed to accomplish any of the above purposes, or (i) to lessen neighborhood tensions; (ii) to eliminate prejudice and discrimination; (iii) to defend human and civil rights secured by law; or (iv) to combat community deterioration and juvenile delinquency.
Revenue Procedure (Rev. Proc.) 82-2, 1982-1 C.B.367 identifies the states and circumstances in which the Service will not require an express provision for the distribution of assets upon dissolution in an exempt organization's articles of incorporation, trust instrument, or other organizing document to satisfy the "organizational" test in Treas. Reg. §1.501 (c)(3)-1 (b)(4).
In Better Business Bureau of Washington, D.C. v. U.S., 326 U.S. 279 (1945), the Supreme Court held that "the presence of a single non-exempt purpose, if substantial in nature, will destroy the exemption regardless of the number or importance of truly exempt purposes."
In est of Hawaii v. Commissioner, 71 T.C. 1067 (1979), several for-profit est organizations exerted significant indirect control over est of Hawaii, a nonprofit entity, through contractual arrangements. The Tax Court concluded that the for-profits were able to use the nonprofit as an "instrument" to further their for-profit purposes. The question for the Tax Court was not whether petitioner's payments to the for-profits were excessive but whether the for-profits benefited substantially from petitioner's operations. The Tax Court noted that petitioner provided a substantial private benefit to the for-profit corporations. Petitioner "was simply the instrument to subsidize the for-profit corporations and not vice versa and had no life independent of those corporations." Accordingly, the Tax Court held that est of Hawaii did not qualify for exemption under §501 (c)(3).
In American Campaign Academy v. Commissioner, 92 T.C. 1053 (1989), the Tax Court determined that the American Campaign Academy, a training program for political campaign professionals, operated for the private benefit of the Republican party because its curriculum was tailored to Republican interests, its graduates worked for Republican candidates and incumbents, and it was financed by Republican sources. The Tax Court defined private benefit as "nonincidental benefits conferred on disinterested persons that serve private interests." Private benefits included "advantage; profit; privilege; gain; [or] interest."
ISSUE #1 - Did fail to timely file the required Information Return , fail to establish reasonable cause, and therefore is liable for penalties under §6652 of the Code?
TAXPAYER'S POSITION
On , the provided an unsigned written penalty relief request for the period ending . On the provided a signed written penalty relief request for the period ending The requests stated, in part, the following:
"Our was filed late because was the first time we were required to file a . There was a misunderstanding of the filing requirement because of how a bargain sale was handled by the company managing the bargain sale ( ). We fully believed that since the transaction and all funds were handled through , we were only required to report the net profit of the property when the was sold."
"Our was filed late because was audited and was the first time we were required to file a . Due to poor knowledge of the filing requirement because of how a bargain sale was handled by , managing the bargain sale . We fully believed that since the transaction and all funds were handled through , we were only required to report the net profit of the property when the was sold. The net profit from the bargain sale was well below the filing requirement and a was timely filed for . All future will be filed timely."
GOVERNMENT'S POSITION
It has been determined that the failed to timely file the required information return, , failed to establish reasonable cause, and this therefore liable for penalties under §6652(c) of the Code. The is liable for penalties of $ and $ for the periods ending and respectively.
Under Code §6033(c)(1), all organizations exempt from taxation under Code §501(c) are required to file an annual return, which correctly and completely states gross income, receipts, disbursements, and assets held for the period. This return must be filed on the proper form by the due date or extended due date for the period in question.
The filing requirements, as detailed in the Form 990 Series Instructions booklets, and posted on www.irs.gov is as follows:
Gross receipts normally s $50,000
Gross receipts< $200,000, and Total assets< $500,000 Gross receipts~ $200,000, or Total assets~ $500,000 990-N 990-EZ or 990 990 For the periods ending and , the submitted instead of a , when their income and/or assets surpassed the minimum filing requirement thresholds for the periods. As the gross receipts for the period ending included the non-cash contribution of , which was appraised at $ when received, the was required to file to report the gross receipt. As the retained the asset throughout the period ending , it was required to file to report the total assets, which surpassed $ based on their accepted valuation. By filing an electronic notice instead of an annual information return, the failed to provide the Service with the necessary information required for the purposes of carrying out the internal revenue laws, as prescribed by the Secretary.
The failed to establish reasonable cause, as it did not exercise ordinary care and prudence. The Service finds that the should have had knowledge sufficient to determine the correct filing requirements under the law for the periods under examination. To make this determination, the Service considered the facts and circumstances against the argument of 'ignorance of the law' and a 'mistake being made.' Information regarding filing requirements is widely available, as can be obtained online at www.irs.gov, including on the ( ) landing page, as well as the and booklets. The Chief Executive Officer (CEO) and Treasurer both hold bachelor's in business administration degrees, the latter having a concentration in Accounting. The Treasurer, who completed the filing of the also possesses an ( ) Certification and owns and operates a bookkeeping and tax practice, where he works year-round as a tax preparer. It is a reasonable expectation that, based on the Officer's education and experience in the handling of business matters and tax issues, they should have known about the filing requirement. Additionally, making a mistake generally is not in keeping with the ordinary business care and prudence standard and does not provide a basis for reasonable cause.
The penalty is computed based on the taxpayer's figures, as follows:
Income
Contributions
Gross Receipts
5% of Gross Receipts
Number of days delinquent
Rate per day
Total proposed penalty
Maximum penalty
$
$
$
$
$
$
Lesser of Maximum penalty or 5% of gross receipts $
Total Failure to File Information Return Penalty
IRC 6652(c)
Income
Contributions
Rents
Gross Amount Sales of Assets other than Inventory Gross Receipts 5% of Gross Receipts Number of days delinquent Rate per day Total proposed penalty Maximum penalty $ $ $ $ $ $ $ $ $ Lesser of Maximum penalty or 5% of gross receipts $
Total Failure to File Information Return Penalty
IRC 6652(c)
$ www.irs.gov
ISSUE#2-ls organized and operated exclusively for an exempt purpose within the meaning of §501(c)(3) of the Code?
TAXPAYER'S POSITION
The Taxpayer's position is unknown.
GOVERNMENT'S POSITION
It has been determined that the is not organized and operated exclusively for and exempt purpose because it does not meet the organizational test or the operational test under Treas. Reg. §1.501(c)(3)-1 (a)(1).
Organizational Test
The Articles of Incorporation do not contain a provision that dedicates its assets to exempt purposes described in Code §501(c)(3) upon dissolution. Furthermore, the is organized in the State of , who does not have statutes applicable to nonprofit charitable corporations that satisfy the provisions of Treas. Reg. §1.501(c)(3)-1(b)(4), per Rev. Proc. 82-2. The was granted exemption based on their statement on Form 1023-EZ that the organizing document contained the required language. During the examination, the Service reviewed the articles of incorporation, found no dissolution language, and confirmed that there were no amendments to the document that effected the dissolution clause. Therefore, the does not meet the organizational test as described in Treas. Reg. §1.501(c)(3)-1(b)(4).
Operational Test
The substantially engaged in non-exempt activity that conferred more than a nonincidental private benefit on disinterested parties. Treas. Reg. §1.501(c)(3)-1(c)(1) provides that an organization will be regarded as operated exclusively for exempt purposes only if it engages primarily in activities which accomplish one or more exempt purposes. 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. §1.501(c)(3)-1(d)(1)(ii) provides that an organization is not operated exclusively for exempt purposes unless it serves a public rather than a private interest. Thus, even if an organization has many activities which further exempt purposes, exemption may be precluded if it serves a private interest.
The activity involving the acquisition and disposition of real estate as apart of bargain sales transactions served the private interests of the and the donors of the properties. Private benefit has been defined as "nonincidental benefits conferred on disinterested persons that service private interests." American Campaign Academy v. Commissioner, 92 T.C. 1053 (1989). "Prohibited private benefit may include an 'advantage; profit; privilege; gain; [or] interest."' In analyzing the factors of the transactions against the factors observed by the courts, the Service considered the benefit conferred and whether that benefit was qualitatively and quantitatively incidental. Qualitatively incidental means that the private benefit is a mere byproduct of the public benefit. For private benefit to be quantitatively incidental, it must be insubstantial in amount. The private benefit must be compared to the public benefit of the specific activity in question, not the public benefit provided by all the activities.
The benefits in question are the $ in fees paid to the for the facilitation of the bargain sales transactions, as well as the $ in charitable deduction documentation given to the donors, which were based on appraisals that the currently suspects to be overvalued. First, the entered an exclusive contract to acquire, manage, and dispose of property through the , and completed a total of transactions encompassing the purchase and sale of individual properties. The fee schedule was based on the appraised value of the property, not the actual purchase or sale price, which was substantially less. This arrangement maximized the earnings of the , while minimizing the earnings of the . Typically, an entity looking to purchase goods and services would deal with a number of different entities. In addition, it is abnormal to accept unfavorable terms or fail to compare prices prior to entering a contract. In this case, the entered into an exclusive contract with a for-profit entity that had a highly unfavorable fee structure.
On , during the initial interview, the indicated that it discontinued the relationship with the after the Treasurer reviewed the documentation and fee schedule and determined that the was "taking a lot of money out of the transactions" and that the net proceeds were low.
Second, the structure of the .acquisition transaction involved a seller who would transfer the property to the for a value below the appraised amount, treat the difference between the FMV and the sales price as a non-cash contribution, and claim a charitable deduction under Code §170(a) based on the appraised FMV of the property at the time of the sale. In this case, the found the donor and connected them with a taxexempt entity willing to participate in the transaction. The FMV was determined by an appraiser who was chosen from a list of preferred appraisers provided by the . During the initial interview, the stated that it was minimally involved in the appraisal process, and never met with or talked to the appraiser. The further stated that at the time it did not doubt the valuation, but now believes that the and the appraisers were working together to overstate the values of the properties. As apart of each transaction, the provided a signed, written communication to the donor listing their name, date and amount of donation, based on the potentially overstated FMV, totaling$ . As a result, any excess benefit received by the donor in the form of deductions that are not allowable serves their private benefit, and not the benefit of the public at large.
The benefits received by the and the donors were not a mere byproduct of a benefit received by the public. The real estate transactions were not related to the charitable purpose, or any activity carried on to fulfill that charitable purpose. The purchase and sale of the real estate was purely for investment purposes with the goal of generating capital. The activity had no direct benefits to the public at large. Therefore, the benefit was not qualitatively incidental.
The benefits received by the and the donors were not insubstantial. The fee schedule of the transaction is structured so that the EO retains very little profit and the real estate broker and their related contractors (appraiser, title search company, etc.) receive the largest benefit from the transaction. Analysis of the individual transactions show the proportion of financial benefit received by the the , and the other related contractors. On average, the retained % of the proceeds ($ in Fees/$ in Adjusted Gross Profit (computed as $ Sales of Investments less $ Contract Prices)). On Average, The retained % of the proceeds ($ $ in Adjusted Gross Profit (computed above)). Of the$ in proceeds received, the Acquisition Net Profit/ issued only $ in grants to individuals. Therefore, the benefit was not quantitatively incidental. See Exhibit 4 on Page 16 in the Appendix for comparison of the income distribution between the , the and Other by property. Also refer to Exhibit 2 for additional details related to income by property.
The Service also analyzed the other activities to determine if it served an exempt purpose, specifically the provision of financial assistance to and family members of , talking to in need of conversation, outreach efforts at the , referring to the for services, and promotion of . After review of all the facts and circumstances, the failed to provide evidence of substantial exempt activities.
The failed to substantiate that the payments made to individuals were given to a charitable class, such as the poor, elderly, physically or mentally handicapped, or distressed, and that the payments furthered a charitable purpose. As indicated by the CEO during the initial interview, the primary criteria for assistance is being a or the family member of a . Assisting and their families alone does not constitute as charitable under the meaning of Treas. Reg. 1.503( c)(3)-1 ( d)(2). By his statement, the does not assist who are % disabled because they can receive assistance directly from the . The does not have a process to analyze need. No application or formal request for assistance is required. No established procedures of oversight are in place, such as board member approvals. Instead, if contacted, the CEO reviews the driver's license, or state identification, and assesses whether they currently receive benefits from the . This practice supports the government's assertion that the criteria for assistance is more associated with the recipient's status as a than being in a charitable class. The determination to assist the individual is then made at the CEO's discretion. No documentation exists to establish a financial need, such as a past due bill. No documentation related to the transaction is kept, other than the cancelled check, to establish the recipient as a member of a charitable class. Furthermore, the explanations provided by the about each grant does not clearly identify how the expenditure advanced an exempt purpose.
In addition, it is noted that during the years under examination, grants were issued totaling$ . No grants were awarded in the period ending . Based on the Service's analysis of the books and records, outside of noncash contributions, rental income and real estate sales proceeds received in connection with the bargain sales transactions, charitable receipts totaled $ in the period ending , $ in the period ending , and $ in the period ending . Between and , prior to the receipt of the real estate proceeds, the paid a total of$ in grants to fulfill their exempt purpose. In the absence of the funding gained from non-exempt real estate activities during , there would be little to no exempt activities. Taking the scope of their prior activities into consideration, and when measured in comparison with the magnitude of the real estate activities that resulted in in gross Income, these activities appear substantially insignificant.
Activities related to conversations with was not shown to serve and exempt purpose, as no information was provided to establish that the discussions were conducted with a charitable class. In addition, referrals were not shown to advance an exempt purpose. While lessening the burden of government is a charitable purpose under §501(c)(3), the failed to demonstrate that it acts on the government's behalf, and thereby actually free up government assets - human, material, and fiscal. In addition, no relevant factors to determine if the government unit has made the necessary objective manifestation exists. While the activities with the are found to serve an exempt purpose, they were not found to be substantial. The explained that, since formation, it received referrals from the , of which it assisted individual. The outreach activities at the events are shown to support the by allowing the general public to find out about their services and donate, however no substantiation was provided to show how the public benefitted from the activity.
Activities associated with did not advance an exempt purpose, but instead would serve the private interests of the Vice President and his business entities. Based on the statement of the Vice President during an interview on , the arrangement entailed the licensing the brand and use of image from . The would assist in the promotion of the product, cases would be pre-ordered, and the product would be manufactured to fill the order. The would cover all expenses, donate $ per bottle to the , take a charitable deduction, and retain any remaining profit.
This arrangement allows an insider to receive a financial benefit, specifically the charitable deduction and the gross profit, through their affiliation with the . The CEO and Vice President assert that sales were insignificant, and no profit or charitable deductions were realized. However, the shared their name and logo with the product and actively promoted the through advertisement on their website. In addition, the website also contains live links to the websites of for-profit businesses owned by their board members, including . Regardless of the actual income realized from these activities, the insiders received an advantage created by the promotion of the product and services. The court established in American Campaign Academy v. Commissioner, 92 T.C. 1053 (1989) that a prohibited private benefit may include an 'advantage; profit; privilege; gain or interest'. The existence of the advertisement and links to the websites of insider's for-profit entities on the website, in conjunction with the arrangement with that advances the private interest of an insider, are factors that contribute to the determination that the activities served private interests.
The presence of a single non-exempt purpose, if substantial in nature, will destroy the exemption regardless of the number or importance of truly exempt purposes. Better Business Bureau of Washington, D.C. v. U.S., 326 U.S. 279 (1945). In the case of , evidence indicates that there is a lack of activities fulfilling an exempt purpose, where there is an abundance of activities that fulfill non-exempt purposes. Like the ruling in est of Hawaii v. Commissioner, the for-profit entities were able to use the as an "instrument" to further their for-profit purposes. The allowed for the for-profit entities to receive substantial private benefit from the arrangements. In the instance of the arrangement with the , the participated in separate transactions, and was used as an instrument resulting in $ of earnings in one fiscal period.
As such, the fails the operational test under Treas. Reg §1.501(c)(3)-1(c)(1) and Treas. Reg.
§1.501 (c)(3)-1 (d)(1 )(ii) as it engaged in activities that served private interests, and therefore more than an insubstantial part of their activities is not in furtherance of an exempt purpose.
ISSUE #3 - Should the taxpayer continue to be recognized as tax exempt under §501 (a) of the Code as an organization described in §501(c)(3)?
TAXPAYER'S POSITION
The Taxpayer's position is unknown.
GOVERNMENT'S POSITION
It has been determined that the does not qualify for exemption as an organization described in Code §501(c)(3) because it does not meet the organizational test or the operational test under Treas. Reg.
§1.501(c)(3)-1(a)(1). The should not continue to be recognized as tax exempt under §501(a) of the Code as an organization described in §501(c)(3).
The fails the organizational test because its organizing document does not contain the required dissolution clause dedicating its assets to exempt purposes. It fails the operational test because more than an insubstantial part of its activities is not in furtherance of an exempt purpose, as it serves a private rather than a public benefit.

# CONCLUSION

As required under Code §6033(c)(1}, the did not timely file an annual return that correctly and completely stated their gross income, receipts, disbursements, and assets held for the periods, and failed to establish reasonable cause for the purposes of determining penalty relief. The is liable for penalties under Code §6652(c) of$ and$ for the periods ending and respectively.
The is not an organization described in Code§ 501(c)(3} and therefore is not exempt from federal income tax. The government will propose revocation of exemption on the first day of the tax year in which the noncompliant activities were substantiated, which is the first period under examination. Therefore, the effective date of revocation is . Forms 1120, U.S. Corporate Income Tax Return, should be prepared and filed by the for the period of examination forward.
Appendix
Exhibit 1
Schedule of Grants Paid through
Periods ending
Check
Date
Name Amount Memo
Good Luck
Tools
Bills
(Illegible)
Electric, Etc.
Christmas
Page 13 www.irs.gov
Exhibit 2
Real Estate Transactions Detail by Property
Net Income and Fee Structure
Transaction
Gross Income
Total Gross Income
Acquisition Contract Price (Note)
Total Acquisition Contract Price (Note)
Price
$
$
$
$
_i
$
$
$
$
_i
Subtotal
$
($
Closing Cost (After payoff of Acquisition Contract Price (Note)
$
$
$
$
--2_
($
Total Closing Cost (After payoff of Acquisition Contract Price (Note)
Fees
Total Fees
Total Fees
Net Profit
$
$
$
$
$
$
$
$
$
$ www.irs.gov
($ )
($ )
$
Exhibit 3
Form Return Data, As Filed by Taxpayer
Periods ending
$
$
Contributions, gifts, grants:
Investment Income: $
$
Other Revenue:
TOTAL REVENUE $
$
Grants and similar amounts paid:
$
Other Expenses:
$
TOTAL EXPENSES
REVENUE LESS EXPENSES $
Total Assets:
$
Total Liabilities:
NET ASSETS OR FUND BALANCES $ catalog Number 20810W through
GROSS RECEIPTS
$
REVENUES
$
$
$ $
$
$
$
EXPENSES
$ $
$ $
$ $
$
$
NET ASSETS
$
$
$
$
Form 886-A {Rev. 5-2017) www.irs.goy
Exhibit 4
Real Estate Transaction Income as a Percentage by Property
Income as a Percentage (after payment of Note)
Other
Total
Income as a Percentage (after payment of Note)
Other
Total
%
%
%
%
Income as a Percentage (after payment of Note)
Other
Total
%
%
%
%
Income as a Percentage (after payment of Note)
Other
Total
%
%
%
%
Income as a Percentage (after payment of Note)
Other
Total
Page 16 www.irs.gov
%
%
%
%

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