Another IRS Adverse Private Letter Ruling | Revocation of Tax-Exempt Status and Organizational and Operational Issues
Private Letter Ruling 202226013 | July 1, 2022
Short Summary:
In this ruling, a corporation’s I.R.C. § 501(c)(3) tax exempt status was under scrutiny. The corporation (“Company”) represented in its articles of incorporation and during its Form 1023 application process that it was organized to provide a “broad range” of educational and other community-based services to benefit the elderly, disabled, veterans, and children, but no program services or activities were reported on the Company’s Form 990 returns or accompanying tax schedules for a period of years. The return which the IRS selected for audit reported no revenues and only one unsubstantiated expense for the audited year. Questions raised by these filings were not addressed during the examination. The revenue agent attempted repeatedly but failed to secure an interview with a Company officer. The CPA who represented the entity knew little about the Company’s operations and the documents he turned over, including corporate minutes, gave no indication of the Company’s mission or activities. The Company’s submissions did not include the Company’s financials, requested bank statements, or a description of activities undertaken in the year under examination. The Company’s balance sheet contained unexplained irregularities.
Key Issue:
- Whether the Company’s exemption status under section 501(c)(3) should be revoked due to its lack of activities in line with any charitable purpose.
Primary Rulings:
- The Company’s tax exempt status should be revoked. The Company failed to establish that it met the operational test for a section 501(c)(3) organization for the tax year under examination.
- Neither the Form 990 returns filed by the Company for a period of years nor submissions during the IRS examination sufficed to show that the Company engaged in any activities accomplishing any exempt purpose(s), as statutorily required.
- The Q&A and documents provided during the Company’s tax examination supports the position that the Company is an inactive organization.
Key Points of Law:
- Section 501(c)(3) exempts from federal income tax corporations and other entities organized and operated exclusively for charitable, religious, educational and certain other listed purposes, no part of the net earnings of which inures to the benefit of any private shareholder or individual.
- Reg. § 1.501 (c)(3)-1(d)(1)(i) states an organization may be exempt as an organization described in section 501 (c)(3) if it is organized and operated primarily for one or more of the following purposes: (a) religious, (b) charitable, (c) scientific, (d) testing for public safety, (e) literary, (f) education, or (g) prevention of cruelty to children or animals.
- Organizations described in section 501(c)(3) and exempt from tax under section 501(a) must be both organized and operated exclusively (or, according to the Treasury Regulations, “primarily”) for exempt purposes. I.R.C. § 501(c)(3); Treas. Reg. § 1.501 (c)(3)-1(a)(1).
- If an organization fails to meet either the organizational test or the operational test, it is not exempt. Reg. § 1.501 (c)(3)-1(a)(1).
- Reg. § 1.501 (c)(3)-1(c)(1) states 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 the exempt purposes specified in 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.
- The organization seeking or seeking to maintain section 501(c)(3) exempt status must establish, e., has the burden of proving that it engages primarily in activities which accomplish one or more of the specified exempt purposes.
- Organizations that are not exempt under section 501 generally are required to file federal income tax returns and pay tax, where applicable.
- An adverse IRS determination of tax exempt status may be challenged by filing a petition or complaint for declaratory judgment under I.R.C. § 7428 in the U.S. Tax Court, U.S. Court of Federal Claims or the U.S. District Court for the District of Columbia within 90 days of the date of the determination letter (here, the ruling).
Insights: This ruling illustrates that a section 501(c)(3) organization, to maintain its tax exempt status, must continue to pursue its charitable activities, must properly document those activities on tax returns and in its corporate records, and is advised to cooperate with the IRS in its exercise of investigatory and audit authority over the privilege of tax exemption.
For additional information on legal and tax issues facing tax-exempt and nonprofit organizations, search this Freeman Law Insights blog for topics such as:
Adverse Rulings from the IRS on Tax-Exempt Entities/Nonprofits (other July 1, 2022 IRS Private Letter Rulings)
Three-Part blog on Tax Exemption and Unrelated Business Income Rules
Can Nonprofits Fundraise for Other Nonprofits?
