Housing Group Loses Exemption

Person to Contact: * * *

This is a final adverse determination regarding your exempt status under section 501(c)(3) of the Internal Revenue Code (the Code). Our favorable determination letter to you dated April 17, 19XX is hereby revoked and you are no longer exempt under section 501(a) of the Code effective January 1, 20XX

The revocation of your exempt status was made for the following reason(s):

You are not operating exclusively for any charitable purpose, educational purpose, or any other exempt purpose. Our examination reveals that you are not engaged primarily in activities which accomplish charitable, educational or other exempt purposes as required by Treas. Reg. 1.501(c)(3)-1(c)(1). Your activities, including your financial transactions, more than insubstantially furthered non-exempt purposes. Moreover, you failed to establish that you were not operated for the benefit of private interest of your chairman and private shareholders or individuals, as required for continued recognition of exemption pursuant to Treas. Reg. 1.501(c)(3)-1(d)(1)(ii). Your income inured to the benefit of private shareholders and individuals.

Contributions to your organization are no longer deductible under IRC § 170 after January 1, 20XX

You are required to file income tax returns on Form 1120. These returns should be filed with the appropriate Service Center for the tax year ending December 31, 20XX and for all tax years thereafter in accordance with the instructions of the return. You have filed taxable returns on Form 1120 for the years ended December 31, 20XX, December 31, 20XX, December 31, 20XX, December 31, 20XX, December 31, 20XX and December 31, 20XX with us.

Processing of income tax returns and assessments of any taxes due will not be delayed should a petition for declaratory judgment be filed under section 7428 of the Internal Revenue Code.

If you decide to contest this determination under the declaratory judgment provisions of section 7428 of the Code, a petition to the United States Tax Court, the United States Claims Court, or the district court of the United States for the District of Columbia must be filed before the 91^st Day after the date this determination was mailed to you. Please contact the clerk of the appropriate court for rules regarding filing petitions for declaratory judgments by referring to the enclosed Publication 892. You may write to these courts at the following addresses:

If you have any questions, please contact the person whose name and telephone number are shown in the heading of this letter.

We have enclosed a copy of our report of examination explaining why we believe revocation of your exempt status under section 501(c)(3) of the Internal Revenue Code (Code) is necessary.

If you accept our findings, take no further action. We will issue a final revocation letter.

If you do not agree with our proposed revocation, you must submit to us a written request for Appeals Office consideration within 30 days from the date of this letter to protest our decision. Your protest should include a statement of the facts, the applicable law, and arguments in support of your position.

An Appeals officer will review your case. The Appeals office is independent of the Director, EO Examinations. The Appeals Office resolves most disputes informally and promptly. The enclosed Publication 3498, The Examination Process, and Publication 892, Exempt Organizations Appeal Procedures for Unagreed Issues, explain how to appeal an Internal Revenue Service (IRS) decision. Publication 3498 also includes information on your rights as a taxpayer and the IRS collection process.

You may also request that we refer this matter for technical advice as explained in Publication 892. If we issue a determination letter to you based on technical advice, no further administrative appeal is available to you within the IRS regarding the issue that was the subject of the technical advice.

If we do not hear from you within 30 days from the date of this letter, we will process your case based on the recommendations shown in the report of examination. If you do not protest this proposed determination within 30 days from the date of this letter, the IRS will consider it to be a failure to exhaust your available administrative remedies. Section 7428(b)(2) of the Code provides, in part: "A declaratory judgment or decree under this section shall not be issued in any proceeding unless the Tax Court, the Claims Court, or the District Court of the United States for the District of Columbia determines that the organization involved has exhausted its administrative remedies within the Internal Revenue Service." We will then issue a final revocation letter. We will also notify the appropriate state officials of the revocation in accordance with section 6104(c) of the Code.

You have the right to contact the office of the Taxpayer Advocate. Taxpayer Advocate assistance is not a substitute for established IRS procedures, such as the formal appeals process. The Taxpayer Advocate cannot reverse a legally correct tax determination, or extend the time fixed by law that you have to file a petition in a United States court. The Taxpayer Advocate can, however, see that a tax matter that may not have been resolved through normal channels gets prompt and proper handling. You may call toll-free 1-877-777-4778 and ask for Taxpayer Advocate Assistance. If you prefer, you may contact your local Taxpayer Advocate at:

Thank you for your cooperation.

* * * * *

 

 

 

 

ISSUE

 

* * * was incorporated on October 21, 19XX, in the State of * * *. The specific purpose of the organization, as stipulated by Article II of the Articles of Incorporation is "to engage in the solicitation, receipt and administration of property and from time to time to disburse such property and the income therefrom [sic] for activities related to the development of new housing, for low to moderate income families, or for other charitable purposes, in accordance with Section 501(c)(3) . . ."

The Internal Revenue Service ("The Service") received the Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue code, signed by * * *, the President of * * *, on February 6, 19XX. Its intended purposes as described in the application were:

In response to the Service's requesting a list of steps taken to involve the community or the residents, * * * stated that it would "provide education and advice to local residents who would like to become home owners."

In response to the Service's questioning about what * * * would be doing for the estimated $0 annual compensation, * * * provided a list of matters * * * would be doing and stated "The president will spend in excess of 150 hours per unit conducting his duties. The basis of setting the compensation will be to provide "token" compensation for his services."

In response to the Service's request to adopt the safe harbor guidelines with a statement signed by two officers under the penalties of perjury, * * * made the following statement:

A determination letter was issued on April 17, 19XX granting exemption status under the Code § 501(c)(3) as an organization described under the Code § 509(a)(2) with an advanced ruling period through December 31, 20XX. In a letter dated April 25, 20XX, the Service reaffirmed the exempt status of * * * as a publicly supported organization.

Issue 1 -- Operational Test

On April 21, 20XX, the Service initiated a review of the Forms 990, Return of Organization Exempt From Income Tax, and activities of * * * for the years ending December 31, 20XX through 20XX. * * * was involved in two separate but related activities: low-income-housing rental, and rehabilitating and selling of old homes purchased from HUD.

* * * owned 6 properties in the beginning of 20XX and rented 5 of them out. * * * stated the units were rented to low-income tenants and provided rental agreements. A review of the 20 rental agreements indicated 75% of the tenants received Section 8 housing assistance from HUD. Each tenant would pay the same amount of rent regardless of the Section 8 assistance. For example, if the rent was $1,000.00 a month and the tenant received $850.00 in Section 8 voucher, than * * * would receive $850.00 from the Housing Authority of the County of * * * and this tenant would pay * * * the difference of $150.00 with his own money.

We visited the website of the Housing Authority of the County of * * * at which provided information related to Section 8 program. To become a participating owner, all one need to do is to lease the rental unit to a Section 8 voucher-holder. There is no requirement that a participating owner/landlord has to be an exempt organization, nor does it have any special rules or regulations to follow.

* * * would not explain how this rental activity constituted a charitable activity.

The other activity * * * involved in was the purchasing, refurbishing and reselling HUD properties. This activity began in 19XX and reached its peek in 20XX and tapered off. By 20XX, * * * was no longer purchasing properties from HUD. However, * * * fixed-up and sold two of the 6 properties in 20XX. We searched the public records for property transactions by * * *. The HUD properties * * * sold to individuals are summarized in the table below:

 

 

We reviewed Forms 990 for the years ending December 31, 19XX through 20XX. The sales of the properties were only in 19XX through 20XX, and they were reported on Forms 990 as follows:

 

 

 

 

In the Form 1023, * * * indicated it would be operating after-school programs for "at risk" school students. There was one expense named "after school program". Our review of the financial records indicated for 20XX through 20XX the payments were for school/personal related expenses of the office manager's daughter.

Issue 2 -- Net Earnings Inuring to the Benefit of Officers and Directors

Issue 2, Category 1 -- Office space and staffs utilized by related entities

In order to determine whether there were net earnings inuring to the benefit of its officers and board members, we need to look at how day-to-day matters were handled. For the 5 rental properties, * * * contracted a property management company to rent out each unit, collect rents, maintain the property, etc. At the end of each month, the property management company would produce a monthly statement that summarized the rent collected, expenses incurred, including its management fees, and paid the net amount to * * *. This property management company was also the contact person for the Section 8 assistance. In other words, * * * work related to the rental activities were to record net rental income, and pay some bills such as mortgages, property taxes and utilities. We wanted to review the exact responsibilities of the property management company, but* * * would not provide a copy.

During 20XX, * * * rebuilt/constructed properties and made the following payments:

 

 

For the amount of work described above, * * * rented a space in * * *, * * * that appeared to be a 2-room apartment converted into office for over $1,100.00 per month. * * * hired a full-time office manager with compensation and benefits exceeding $0 per year. Since there were more works than the office manager could handle, * * * hired a part-time helper and paid her $0 in 20XX, $0 in 20XX, and $0 in 20XX. The payment to the part-time helper included $0 bonus each year, including 20XX, the year she was compensated by * * * for the first 2 months only.

A search of public records indicated several other entities were using the same Post Office Box and/or the office addresses. We asked * * * to identify its related entities and percentage of ownership by the officers and directors. * * * provided the ownership of * * * for each of the entities. The following table summarizes his ownership:

 

 

 

 

We questioned whether * * * employees provided any services to these related entities and * * * responded by stating:

We reviewed 3 phone bills from Cingular Wireless, and observed that there were 4 phone lines. In response to our question of who were the individuals using the phones, * * * stated "* * * and * * * were two of the users. We have to check the other two numbers." * * * did not provide the names of the other 2 users.

Beginning in the year 20XX, * * * borrowed funds from * * * to cover some of the office expenses. By early 20XX, the borrowed funds accumulated to over $0. * * * agreed to apply this loan as corrections toward office expenses inuring to the benefits of * * *, * * * and * * * during the years under examination totaling $0.

Issue 2, Category 2 -- Health Insurance for * * * Family

* * * had 2 full-time employees, * * * and the office manager. Since 5/1/XX, * * * provided health insurance coverage for the entire family of these 2 employees. However, beginning on 5/1/XX * * * also provided health insurance for * * * family at $0 per month. We questioned why * * * was paying for * * * family and the response was "It was agreed that * * * would pay the health insurance for * * * from 5/1/XX. His insurance was paid for until 10/26/XX." The coverage for * * * family continued through October 20XX. This represented a total benefit of $0 in 20XX and around $0 in 20XX.

* * * agreed and utilized the loan from * * * to * * * as corrections for these excess benefit transactions.

Issue 2, Category 3 -- Properties transferred out of * * *

We observed several questionable property transactions from the public records. * * * quitclaimed 3 of the rental properties (* * * property, the * * * property, and the * * * property) to * * * back in 20XX and remained under his name throughout these years. We questioned why this was the case. * * * response was "The properties were quitclaimed to * * * in order to obtain favorable financing terms from Bank of America. The properties were supposed to be quitclaimed back to * * * on the same day as the closing of the loan. This is what was done with on 12/14/XX. The fact that this was not done on subsequent properties was an error. * * * has signed quitclaim deeds back to * * *. * * * has not recorded those deeds because it would trigger a reassessment of the property."

The property records indicated that * * * quit claimed the * * * property to on 9/23/XX, who then quit claimed to * * * ("* * * ") on the same day. * * * quit claimed the * * * property to * * * on 9/20/XX, who then quit claimed to * * * on the same day. * * * quit claimed the property to * * * on 10/29/XX, who then quit claimed to * * * on 2/6/XX. We questioned what * * * received in exchanged for these properties and the response was "The properties were sold in 20XX for valuable consideration. The sales were recorded on the 20XX tax returns." We questioned why rental incomes from the * * * property and the * * * property were recorded on * * * general ledger in January 20XX, and the response was "Rental income deposited in January 20XX would have been for November or December 20XX rents. Since * * * is on the cash accounting basis, the income was recorded in 20XX when the checks were received." This response did not match the records, because one property was quitclaimed out of * * * in September 20XX and the other in October 20XX.

* * * quit claimed the * * * property to * * * on 9/23/XX, who then quit claimed to * * * on 10/31/XX. * * * then sold it to an individual on 9/5/XX for $0. We questioned what * * * received in exchange for this property, and the response was "The property was sold in 20XX for valuable consideration. The sale was recorded on the 20XX tax returns."

* * * quitclaimed the * * * property to * * * on 1/1/* * */XX but did not record the quit claim until 6/17/XX. * * * then sold it to an individual on 9/12/XX for $0. We questioned what * * * received in exchange for this property, and the response was "The property was sold in 20XX for valuable consideration. The sale was recorded on the 20XX tax returns." We questioned why the recording of the quitclaim did not take place until 2 and 1/2 years later, and the response was "The property was sold on 12/26/20XX to * * *. If the deed was not recorded until later, that was an error."

* * * quitclaimed the * * * property to * * * on 7/12/XX. * * * then sold it to an individual on 8/6/XX for $0. We questioned what * * * received in exchange for this property, and the response was "The property was sold on 9/23/20XX for $0. The sale was recorded on the 20XX tax returns."

The transactions related to the * * * property were unusual, and we have to summarize it as follows:

• 8/3/* * * sold it to * * *, the 501(c)(3) organization with * * * as its President, for $0.

• 12/21/XX -- * * * sold it to * * * for $0.

• 12/29/XX -- * * * quit claimed it to * * *.

• 6/8/XX -- * * * quit claimed it to * * *.

• 12/27/XX -- * * * quit claimed it back to * * *.

• 10/17/XX -- * * * quit claimed to * * *.

* * * stated there were no appraisals for any of these properties when they were transferred out of * * *. We requested documentations regarding discussions and approval of these transfers, and * * * response was there were "no written minutes, memos, or emails" regarding these transfers. We requested * * * general ledgers for 20XX and 20XX to understand how these property transactions were records. * * * chose not to provide them.

In September 20XX, * * * made corrections for these property transactions. * * * quitclaimed three properties at * * *, * * *, and * * * to * * * for the purpose of getting a better mortgage rate. * * * transferred these properties back to * * *. We determined that the excess benefit amounts for the remaining 5 properties that went to him or totaled to $0. The remaining balance of * * * loan to * * * in the amount of $0 was used to reduce these excess benefit amounts. The remaining excess benefit amounts of $0 plus applicable interest were given to an unrelated organization exempt under the IRC § 501(c)(3).

Facts Applicable to All Issues:

Board Members:

Section 6.02 of the Bylaws stated that the authorized number of directors shall be five (5). The Form 1023 listed the following 5 individuals for officers, directors, trustees, etc. under #4 of Part II:

 

 

 

 

In response to our request for the minutes of the meetings of the governing body, including committee meetings, * * * provided the minutes of annual meetings dated 12/19/XX, 12/16/XX, and 12/15/XX. All three minutes have the following statements except as indicated:

Section 6.06 of the Bylaws states "Annual meetings of the board of directors shall be held for the purpose of organization, election of directors and officers and the transaction of other business. Annual meetings shall be held on the first day of February of each year at 10:00 a.m."

Section 6.09 of the Bylaws states "A majority of the authorized number of directors shall constitute a quorum for the transaction of business . . . A meeting at which a quorum is initially present may continue to transact business, notwithstanding the withdrawal of directors, if any action taken is approved by at lease a majority of the required quorum for that meeting."

We compared the minutes to the bylaws to see whether * * * complied with its own rules, and observed the following inconsistencies:

• With the references to shareholders and dividends, the minutes appeared to follow the format of a for-profit corporation.

• None of the minutes mentioned which officers and board members were present, and whether a quorum was met.

• The minutes began with the statement "We, the undersigned, being all of the shareholders, directors, and the secretary of the Corporation, hereby agree and consent. . ." It appeared to imply that * * * was the sole shareholder/director/secretary of * * *

• These annual meetings were held in December, even though the Bylaws required them to be held on or the nest working day after the first day of February.

• There were no elections of directors.

• The property transfers from * * * to * * * and to Residential Investment were director related transactions. However, there were no discussions or approval by the board.

• The use of office space and sharing office staffs by related entities were not addressed.

• In May 20XX, * * * family was added into the health insurance policy, and was paid for by * * *. In other words, the board member, * * *, * * * wife, was receiving benefits from * * * without the board's approval and without consideration of conflict of interest. This transaction was not discussed or approved by the board.

The exempt organization listed under the Code § 501(c)(3) is described as "Corporations . . . organized and operated exclusively for religious, charitable . . . no part of the net earnings of which inures to the benefit of any private shareholder or individual . . ." [Emphasis added.]

The Income Tax Regulations ("the Regulation") § 1.501(a)-1(c) states "The words "private shareholder or individual" in section 501 refer to persons having a personal and private interest in the activities of the organization."

The Regulation § 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 such 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 Regulation § 1.501(c)(3)-1(c)(2) states "An organization is not operated exclusively for one or more exempt purposes if its net earnings inure in whole or in part to the benefit of private shareholders or individuals." [Emphasis added.]

The Regulation § 1.501(c)(3)-1(d)(1)(ii) states "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."

The Regulation § 1.501(c)(3)-1(d)(1)(ii), although states in terms of the "net earnings" of an organization, the inurement doctrine applies to any of an organization's charitable assets. See People of God Community, 75 T.C. 127, 133 (1980). Payment of excessive compensation is a form of inurement. For example, in Mabee Petroleum Corp. v. U.S., 203 F. 2d 872, 875 (5th Cir. 1953), the Fifth Circuit held that the organization's payment of a full-time salary for part-time work was inurement.

The Regulation § 1.501(c)(3)-1(d)(2) states "The term "charitable" . . . includes: Relief of the poor and distressed or of the underprivileged; . . . or (iv) to combat community deterioration and juvenile delinquency."

In Better Business Bureau of Washington, D.C. v. U.S., 326 U.S. 279, 283 (1945), the Supreme Court held that the "presence of a single . . . (nonexempt) purpose, if substantial in nature, will destroy the exemption regardless of the number or importance of truly . . . (exempt) purposes."

Revenue Ruling 70-585, 1970-2 C.B. 115, provides that nonprofit housing organizations created to aid low and moderate income families by lessening neighborhood tensions, eliminating prejudice and discrimination, and combating community deterioration may qualify for exemption under § 501(c)(3) of the Code.

Receipt by an exempt organization of less than fair market value in a sale or exchange of property with an insider is also a form of inurement. In Sonora Community Hospital v. Commissioner, 46 T.C. 519 (1966), two doctors transferred their private practice of medicine, including the building in which the practice was housed, to a non-profit hospital they controlled. A portion of the building was occupied by a for-profit laboratory under a prior agreement with the two doctors. The doctors caused the hospital to acquiesce in the arrangement with the laboratory. The hospital received no consideration for the assignment of its space to the laboratory either as part of the sale or through a share of the laboratory's gross revenues. Payments in consideration of the assignment that should have been paid to the hospital were paid directly to the two doctors. The doctors performed no services for the laboratory. The Tax Court held that the arrangement resulted in an inurement of the hospital's charitable assets to the two doctors.

In Anclote Psychiatric Ctr. v. Commissioner, T.C. Memo 1998-273 (1998), an organization's board of directors caused the organization to sell its largest asset -- a hospital -- to a for-profit entity formed by the directors. The board of directors obtained an independent appraisal of the hospital and hired independent counsel to represent the organization. The closing, however, occurred almost two years after the appraisal. The parties failed to make adjustments to the values established in the appraisal. The Tax Court determined that the purchase price received by the organization on the sale of the hospital was not within a reasonable range of what could be considered fair market value. Accordingly, the Tax Court held that the sale transaction resulted in inurement within the meaning of § 501(c)(3).

The provision of inurement can be direct or indirect. In Anclote Psychiatric Ctr., supra, the sale transaction giving rise to the inurement was between an exempt organization and a for-profit corporation formed by the organization's directors. Although the for-profit corporation was the direct beneficiary of the below-market sale transaction, the Tax Court held that the transaction resulted in "an advantage" to the shareholders of the for-profit corporation and that this "advantage" constituted inurement of the organization's charitable assets to the shareholders.

In Church By Mail, Inc. v. Commissioner, 765 F.2d 1387 (9^th Cir. 1985), the Ninth Circuit treated as inurement compensation paid by a controlled entity to the organization's insiders. In Church by Mail, two individuals, Reverend Ewing and Reverend McElrath, ran a church that mailed printed sermons to several million homes. They also owned a for-profit advertising agency which provided the Church's printing and mailing services. The Ninth Circuit found that the combined compensation paid to Reverend Ewing and Reverend McElrath by the Church and the advertising agency was excessive. The Ninth Circuit rejected the Church's argument that the portion of the compensation paid by the advertising agency should not be included in the determination of reasonableness and treated this portion as indirect inurement of the Church's earnings to the Church's insiders. Id. The Ninth Circuit based its conclusion on the following legal principle: "[W]hen a second organization is created which serves to funnel income to the individual who controls the purportedly exempt organization and the income exceeds a reasonable salary, the income inures to the benefit of a private person within the meaning of I.R.C. section 501(c)(3)." Id.

Indirect inurement can occur even if the organization's insiders are not formally in control of the intermediary used to funnel the funds from the organization to the insiders. In Church of Scientology of California v. Commissioner, 823 F.2d 1310, 1315 (9^th Cir. 1987), the organization transferred in excess of $3.5 million to a for-profit corporation incorporated by the organization's founder and his wife. The directors of the corporation were high-ranking members of the Church of Scientology. At the time of the transfer, the founder and his wife were not directors, officers or employees of the corporation. The founder was no longer serving as the head of the church but continued to exert significant control over the church by making policy statements, directives and orders. 823 F.2d at 1314. In particular, his approval was required for all financial planning. Id. The directors of the corporation approved the founder's decision to transfer $2 million from the corporation's account to the ship Apollo aboard which the founder and his family lived. The Ninth Circuit held that the organization's funds funneled through the corporation constituted inurement to the founder and his family. 823 F.2d at 1318.

The prohibition on inurement in the Code § 501(c)(3) is absolute. The Service has the authority to revoke an organization's exempt status for inurement regardless of the amount of inurement. See Spokane Motorcycle Club v. U.S., 222 F.Supp. 151 (E.D. Wash. 1963); The Founding Church of Scientology, 412 F.2d 1197, 1202; Airlie Foundation, 283 F. Supp. 2d 58. Moreover, for purposes of establishing that inurement occurred, it is not necessary to calculate the precise amount of inurement as long as it is shown that the value of the transfer giving rise to inurement is not within a reasonable range of what could be considered fair market value. See Anclote Psychiatric Ctr. v. Commissioner, T.C. Memo 1998-273.

Record Keeping Requirement

The Code § 6001 states, "Every person liable for any tax imposed by this title, or for the collection thereof, shall keep such records, render such statements, make such returns, and comply with such rules and regulations as the Secretary may from time to time prescribe. Whenever in the judgment of the Secretary it is necessary, he may require any person, by notice served upon such person or by regulations, to make such returns, render such statements, or keep such records, as the Secretary deems sufficient to show whether or not such person is liable for tax under this title."

The Code § 6033(a)(1) states, "In general. . . . every organization exempt from taxation under section 501(a) shall 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, and shall keep such records, render under oath such statements, make such other returns, and comply with such rules and regulations as the Secretary may from time to time prescribe . . ."

The Regulation § 1.6001-1(a) states, "In general. . . . any person required to file a return of information with respect to income, shall keep such permanent books of account or records, including inventories, as are sufficient to establish the amount of gross income, deductions, credits, or other matters required to be shown by such person in any return of such tax or information."

The Regulation § 1.6001-1(c) states, "Exempt organizations. -- In addition to such permanent books and records as are required by paragraph (a) of this section with respect to the tax imposed by section 511 on unrelated business income of certain exempt organizations, every organization exempt from tax under section 501(a) shall keep such permanent books of account or records, including inventories, as are sufficient to show specifically the items of gross income, receipts and disbursements. Such organizations shall also keep such books and records as are required to substantiate the information required by section 6033."

The Regulations § 1.6001-1(e) states, "Retention of records. -- The books or records required by this section shall be kept at all times available for inspection by authorized internal revenue officers or employees, and shall be retained so long as the contents thereof may become material in the administration of any internal revenue law."

The Revenue Ruling 59-95, 1959-1 CB 627, (Jan. 01, 1959) states, "An organization previously held exempt from Federal income tax was requested to produce a financial statement as of the end of the year and a statement of its operations during such year. However, its records were so incomplete that it was unable to furnish such statements. . . . Held, failure or inability to file the required information return or otherwise to comply with the provision of section 6033 of the Code and the regulations which implement it, may result in the termination of the exempt status of an organization previously held exempt, on the grounds that the organization has not established that it is observing the conditions required for the continuation of an exempt status."

Effective date of revocation

The Regulation § 1.501(a)-1(a)(2) states "Subject only to the Commissioner's inherent power to revoke rulings because of a change in the law or regulations or for other good cause . . . an organization that has been determined by the Commissioner or the district director to be exempt under section 501(a) or the corresponding provision of prior law may rely upon such determination so long as there are no substantial changes in the organization's character, purposes, or methods of operation."

The Regulation § 601.201(n)(3)(ii) states a "ruling or determination letter recognizing exemption may not be relied upon if there is a material change inconsistent with exemption in the character, the purpose, or the method of operation of the organization."

The Regulation § 601.201(n)(6)(i) states "[a]n exemption ruling or determination letter may be revoked or modified by a ruling or determination letter addressed to the organization . . . The revocation or modification may be retroactive if the organization omitted or misstated a material fact, operated in a manner materially different from that originally represented . . ."

In order for an organization to retain its exempt status it must demonstrate to the Service that it meets both the organizational and the operational tests. The facts stated above indicate that failed the operational test.

Charitable purposes include relief of the poor and distressed, the Regulation § 1.501(c)(3)-1(d)(2). * * * rental activity and selling of real properties in the manner described above doesn't address the needs of low-income people. In fact, the rental activity and the selling of real properties were operated in a manner no different than other business entities that are engaging in such activities in a commercial manner.

The rental rate was the same regardless of whether a tenant receives rental assistance from government agencies. In fact, * * * required the tenant to pay the difference if the rental assistance amount was less than the rental rate. The government agency did not require the landlord to be an exempt organization.

In 20XX * * * also sold 2 properties. Fixing and selling properties at market rate doesn't constitute assisting low-income families. Therefore, the activities as described above did not meet the operational test as described under § 1.501(c)(3)-1(c) of the Regulation.

* * * has bylaws but chooses not to comply with them. It held the annual board member meetings in December instead of February. It made no elections during the annual meetings. It did not discuss and/or approve many of the significant matters that took place during the years. These actions represent * * * disregarding its own rules and regulations, which in turn indicates that * * * did not meet the operational test as described under § 1.501(c)(3)-1(c) of the Regulation.

Issue 2 -- Net Earnings Inuring to the Benefit of Officers and Directors

* * * was an officer of * * *. * * * was the spouse of * * *, the operating director of * * *. More than insubstantial amount of each of the entities utilizing * * * street and PO Box addresses are/were owned by * * * and * * *. Therefore, * * *, * * * and all entities they own/owned are private shareholders or individuals within the meaning of the Regulation § 1.501(a)-1(c).

Issue 2, Category 1 -- Office space and staffs utilized by related entities

* * * allowed * * *, * * * and entities they own/owned to utilize its staffs, supplies, and office space, without any reimbursements. Such usage was not approved by the * * * board members. Therefore, such usage inured to the benefit of * * *, * * * and entities they own/owned, and represented an act prohibited by the Code § 501(c)(3).

Issue 2, Category 2 -- Health Insurance for the * * * Family

During the years 20XX and 20XX, * * * paid for the health insurance of * * * family, which was not approved by the board of directors. Therefore these payments constituted net earnings inuring to the benefits of * * *, and represented an act prohibited by the Code § 501(c)(3).

Issue 2, Category 3 -- Properties transferred out of * * *

Any transactions between an exempt organization and another party should be at market rate or below market rate to the benefit of the exempt organization. If a transaction is below market rate but the party being short-changed is the exempt organization, then the transaction constitutes misuse of exempt organization's funds.

Since 20XX, * * * transferred several properties to * * *. The monetary considerations were limited to the amount of outstanding loans. These transfers were not approved by the board members of * * *. Therefore these transfers constituted net earnings inuring to the benefits of * * *, and represented an act prohibited by the Code § 501(c)(3).

Issue 2, Overall

The records indicate there were substantial net earnings inuring to the benefits of private shareholders and individuals going as far back as 20XX year. There was no oversight by a disinterested board. The individuals in charge of * * * utilized * * * as if it was another for profit business under their control. No segregation of duties, funds, or authorities observed. Accordingly, the exemption status of * * * should be revoked due to its net earnings inured to the benefit of these private shareholders and individuals within the meaning of the Regulation § 1.501(c)(3)-1(c)(2).

Issue 3 -- Record Keeping Requirement

Through out the examination, * * * was unwilling or unable to produce the records necessary to support and substantiate the financial information reported on the annual returns it filed. The records it managed to provide did not match one another in several instances. Accordingly, failed to comply with requirements under the Code §§ 6001 and 6033 and the Regulations thereunder.