Originally published on Passive Activities and Other Oxymorons on January 24th, 2011.
Of all the areas I look for material in I find private letter rulings the most challenging. They tend to come in blocks on particular subjects and there will frequently be several virtually identical ones in a row. The most typical probably concern late S elections. I've yet to see one of those that could make a good story. My eyes light up, however, when I see a batch that have 501 as the relevant code section. They are frequently about organizations having their exempt status revoked, which is quite often a good story. The post I consider most amusing was a Tax Court decision on exempt status. I've still got a fairly large backlog of material to share with you, so I am going to give you a few of those rulings. I think I could make a whole post out of a couple of them, but I'm not going to get to them and they are starting to get a little stale.
Private Letter Ruling 201050041
My tentative title for this was "Sober House". It's great when you can mix business and pleasure, but its not so great to mix a business you own with a not for profit that you run. That was the problem with this group. Their mission was to provide substance abuse recovery services. The clients, however, lived in real estate owned by the people running the not for profit. If you are going to do something like that, which I don't recommend, you need to be scrupulous in your record keeping. They were less than perfect.
RA-1. There appears to much overlap in the activities of the two entities. In reviewing the expenses of the organization, it appears that expenses for the for-profit entity were paid by the non-profit entity. There were a great deal of checks paid and referenced to the Intensive OutPatient Program (TOP) which is a program of the CO-1.
There were several rental properties located in City, City, City and City which were acquired and owned by RA-1, members of his family and an employee of the organization. The employee was a Counselor of ORG and it was stated that RA-1 and Counselor, Counselor acquired the real estate together. According to RA-1, these properties were bought, maintained and used for the purpose for providing housing services to the clients of ORG.
The organization was unable to substantiate amount reported on its Form 990. In particular, it reported grants to individuals, but was unable to provide records showing who received grants, how much was received by each individual or how the recipients were determined. The organization was unable to provide client records which would detail services provided. Amounts paid to workers were often paid to relatives of RA-1 and no verification of work done for the exempt organization were provided.
The organization did not establish that the rent paid by ORG for the rental properties owned by RA-1 and his relatives was a fair market value rate. Furthermore, there were no documentation which detailed out who occupied the rental properties, how much was paid for rent and the time period of occupancy.
There were other indications of a lack of internal control. Accountant had a difficult time providing documents that were clear and understandable. There were a great deal of commingling of the revenue and expenses with the for-profit entity, as well as, expenses that could not be substantiated. .
There were Board of Directors listed on the Form 990, however, during the initial interview. VP stated "there were no Board of Directors officially, however decisions regarding the organization were made by himself and RA-1. According to him, the reason for this was that people didn't want to make time to participate.
So it could have all worked out if we were just a little more civic minded. I have to say that if you are a young CPA and somebody asks you to volunteer to be treasurer of something like this, run for the hills.
Private Letter Ruling 201050036
I thought there must be something serendipitous in this ruling being so close to the previous one. My tentative title for it was "Barroom Buddies". There is a lot more to Section 501 than 501(c)(3). You hear the most about 501(c)(3) because those are the ones that you can make deductible contributions to. There are, however, a plethora of 501 organizations that are just themselves exempt from tax to some greater or lesser extent. Among these are 501(c)(10) organizations which are :
Domestic fraternal societies, orders, or associations, operating under the lodge system—
(A) the net earnings of which are devoted exclusively to religious, charitable, scientific, literary, educational, and fraternal purposes, and
(B) which do not provide for the payment of life, sick, accident, or other benefits.
A real life example of a qualified 501(c)(10) organization is The Grand Lodge of Ancient Free and Accepted Mason of North Carolina. The get the benefit of being featured here by the luck of the draw in my poking around in GuideStar. I have little doubt that they are an example of the right way to qualify for 501(c)(10) status.
The subject of this PLR known as ORG is another matter entirely. Here is an interesting little sidelight on exempt status. Sometimes the motive for obtaining exempt status has little to do with the direct federal tax benefits. In the case of ORG there was the matter of a state law that held:
"in order for a licensee to sell intoxicating liquor outside city limits, a licensee must meet certain provisions such as having obtained an exemption from the payment of federal income taxes as provided in IRC sections 501(c)(3), 501(c)(4), 501(c)(5), 501(c)(7), 501(c)(8), 501(c)(10), 501(c)(19), or 501(d) of the United States Internal Revenue Code of 19XX,
Since DIR-1 inception with the ORG she has been able to sell liquor by the drink because of his organization's exemption from Federal income tax under IRC 501(c)(10).
During our interview on July 30, 20XX I asked DIR-1 why she joined the ORG, and her response was, "it allowed us to obtain a liquor license."
"The neighborhood tavern has been owned and operated by my family since 19XX DIR-1 took over the family business in 19XX." DIR-1 never transferred ownership of the building or any other assets to the parent organization. Instead, she pays the ORG Headquarters $ per year to lease the building and its contents.
ORG consists of 32 members, and all of them were asked to join by DIR-1. There are no requirements for membership, and there's only one class of membership. To become a member, each individual pays $, then fills out a card, providing such information as their address and phone number, and in return, the parent organization sends them an identification card indicating what post the member belongs to and the name of the member. New cards are issued every year. Upon becoming a member of ORG the individual receives their first drink for free, and ct off each additional drink. In July, dues are collected and remitted to the parent, ORG #1 in City, State. Additional members are recruited by current members or word of mouth.
The ruling has a fairly extensive discussion of how much of a fraternal bond is required for the organization to qualify. Part of the discussion goes as follows:
In National Union v. Marlow, 374 F. 775, 778 (1896): the court summed up the nature of a fraternal beneficiary society as follows: ".... a fraternal-beneficial society ... would be one whose members have adopted the same, or a very similar calling, avocation, or profession or who are working in union to accomplish some worthy object, and who for that reason have banded themselves together as an association or society to aid and assist one another, and to promote the common cause. The term "fraternal" can properly be applied to such an association, for the reason that the pursuit of a common object, calling or profession usually has a tendency to create a brotherly feeling among those who are thus engaged. As a general rule, such associations have been formed for the purpose of promoting the social, moral, and intellectual welfare of the members of such associations and their families, as well as for advancing their interests in other ways and in other respects...
The IRS found that ORG was not quite up to snuff:
ORG does not meet the requirements of an organization described in IRC section 501(c) (10). Members of ORG do not have a common fraternal bond. The members do not adopt the same or very similar calling, avocation, profession, or are working in unison to accomplish any worthy objective or common cause. ORG has not been operating for religious, charitable, scientific, literary, educational and fraternal purposes, nor has ORG devoted its net earnings exclusively to religious, charitable, scientific, literary, educational, and fraternal purposes. ORG is operating in a commercial manner which is not an exempt activity described under Internal Revenue Code section 501(c) (10).
In this circumstance, Merle Haggard not withstanding, barroom buddies are not the best kind.
Private Letter Ruling 201050033
Moving on to more salubrious pursuits we come to an "org' that was formed to support gymnastic activities. Perhaps it is consistent with the ethos of that sport (if that's what it is) to discourage slacking :
Your Bylaws state that to accomplish your purpose, "each family must fulfill their financial requirements and work their assigned number of hours at each fundraiser." Fundraising activities are held throughout the year, on almost a quarterly basis. Non-compliance results in a fee charge of $
Your Bylaws further provide that membership is open to "those persons who are parents or guardians of gymnasts who are members of the competitive teams and pre-teams at Gym" (the "members" or "member-parents"). The children of two of your directors participate in Gym and receive financial assistance from you to the extent they participate in fundraising activities.
In your application for exemption, you indicate that Gym is a for-profit organization. According to your Bylaws, the owner of Gym (the "owner") takes part in all meetings and "has a say" in your decision making. You are required to inform the owner of all pending major decisions, and the owner may be invited to submit input.
If a gymnast's family does not raise enough funds through the various fundraising activities to cover the costs of its portion of the block fees, the family must pay the difference in cash or not participate in the Gym competitive program. If payment is not received promptly, the gymnast is not allowed to compete at the following meet. You are entitled to any surplus funds on a gymnast's block fee account if the gymnast leaves the competitive program before the end of the competition season. Any surplus funds are used at your members' discretion.
In addition to the private benefit conferred to your member-parents through your fundraising activities, the equipment you own and loan to Gym for no charge results in more than incidental private benefit to the gym and its owner, because the for-profit gym gets the benefit of the use of the equipment for free. Purchasing such equipment for use by a non-exempt entity is not an exempt purpose.
Your primary purpose is raising funds to offset the costs of participation in the competitive program of Gym, a for-profit organization, for children of your member-parents. Members are credited with funds raised based upon participation in fundraising events. If members do not raise sufficient funds through fundraising activities, the parents pay the balance of the fees required for their child to participate in Gym's competitive program. You state that you do not provide financial or any other assistance to gymnasts outside of the Gym's competitive program.
Because of the direct financial benefits that your member-parents receive, your activities violate the prohibition against inurement, thereby preventing you from qualifying for exemption as an organization described in section 501(c)(3) of the Code. The requirement that each parent-member participate in your fundraising activities in direct proportion to the benefits they expect to receive causes a direct benefit to flow to these member-parents. Consequently, your earnings are being used to pay for benefits to specific individuals rather than to a charitable class, which allows your earnings to inure to the benefit of specific insiders, namely the parents of Gym's participants.
In addition, the owner of Gym sits on your board of directors and is also considered an insider. You have purchased equipment that is used for no charge by Gym, a commercial business. This transfer of your financial resources to the owners of Gym is in violation of the inurement proscription and is also sufficient to defeat exemption under section 501(c)(3) of the Code.
This bunch applying for exempt status could motivate me to launch a jeremiad about selfish narcissism but what do you expect from people who think subjectively judging kids running around and jumping constitutes a sport ?