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Tuesday October 20, 2020

Private Letter Ruling

Exemption Denied for Employment Organization

GiftLaw Note:
Organization was formed for the purpose of developing employment opportunities for disabled individuals and to improve their quality of life. Organization intends to lease an outdoor advertising medium to disabled individuals. These individuals will sell advertisements to be displayed publicly. Organization intends the advertising revenue to exceed the lease payments, allowing the individuals to support themselves with the revenue. Organization will be funded by receipts from its leases. It also plans to engage in fundraising through email campaigns, social media and website posts and crowd funding.

An organization is tax-exempt under Sec. 501(c)(3) if it is organized and operated exclusively for religious, charitable, scientific, testing for public safety, literacy or educational purpose, or to foster national or international amateur sports, or to prevent cruelty to children or animals, so long as no part of the net earnings inure to the benefit of any private shareholder or individual. Section 513(a) defines an unrelated trade or business as a trade or business that is not substantially related to the exercise or performance of the organization's exempt purpose. Under Reg. 1.501(c)(3)-1(a)(1), the organization must be both organized and operated exclusively for an exempt purpose. Under Reg. 1.501(c)(3)-1(c)(1), if more than an insubstantial part of the organization's activities are not in furtherance of its exempt purpose, it is not operated exclusively for an exempt purpose. According to Reg. 1.501(c)(3)-1(c)(1), an exempt organization may operate a trade or business as a substantial part of its activities if it is in furtherance of its exempt purpose and not primarily for carrying on an unrelated trade or business. Here, the Service determined that Organization operated a trade or business for the purpose of producing income rather than for an exempt purpose. It stated that the fact that Organization provides "services to disabled individuals is not sufficient to characterize the activity as charitable." Therefore, the Service denied Organization's application for exempt status.
PLR 202039019 Exemption Denied for Employment Organization

9/25/2020 (7/1/2020)

Dear * * *:

We considered your application for recognition of exemption from federal income tax under Internal Revenue Code (IRC) Section 501(a). We determined that you don't qualify for exemption under IRC Section 501(c)(3). This letter explains the reasons for our conclusion. Please keep it for your records.

Issues


Do you qualify for exemption under IRC Section 501(c)(3)? No, for the reasons stated below.

Facts


You were formed in B on C. Your corporate purpose in part is to develop employment opportunities for the welfare of the disabled and improve their quality of life. You will accomplish this by leasing D to handicap individuals for w dollars per month. D is an * * * ready for outdoor use, which is designed to display advertising in public places such as sidewalks and comers at busy traffic intersections where there is maximum visibility. Specifically, there are sign systems on D which enable up to * * * businesses to advertise on D.

Handicapped individuals who lease D will then be able to use the signage on D to sell advertising in order to generate advertising income to cover the lease payments and also allow them to become self-sufficient through the remainder of the receipts. You believe that they will be able to generate revenue in the range of x dollars per month depending on their pricing and the number of hours the individual devotes to this. Additionally, you indicated the leasing fees cover the design, modification and acquisition of the vehicle costs.

You will be funded through the receipts from leasing D. You will also raise funds through direct email campaigns, postings on social media and on your website as well as through crowd funding websites. You currently have a campaign on E. There are no restrictions, but goods and services are developed for the disabled. Recipients are selected by the ability to * * *

You have a governing board consisting of * * * individuals who receive some compensation. Your expenses are for advertising and marketing, equipment, supplies and compensation. You will primarily market and promote B through social media web sites and the internet.

Finally, you indicated that although your goods and services are targeted to help the disabled, participation is, however not limited to the disabled.

Law


IRC Section 501(c)(3) exempts from taxation any corporation organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition, or for the prevention of cruelty to children or animals, provided no part of the net earnings of which inures to the benefit of any private shareholder or individual.

IRC Section 513(a) describes an "unrelated trade or business" as any trade or business the conduct of which is not substantially related to the exercise or performance by such organization of its charitable, educational, or other purpose or function constituting the basis for its exemption under Section 501 Code.

IRC Section 513(c) provides that a "trade or business" includes any activity which is carried on producing income from the sale of goods or the performance of services. Where an activity carried on for profit constitutes an unrelated trade or business, no part of such trade or business shall be excluded from such classification merely because it does not result in profit.

Treasury Regulation Section 1.501(c)(3)-1(a)(1) provides that, in order to be exempt as an organization described in IRC Section 501(c)(3), an organization must be both organized and operated exclusively for one or more of the purposes specified in IRC Section 501(c)(3). If an organization fails to meet either the organizational or operational test, it is not exempt.

Treas. Reg. Section 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 IRC 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.

Treas. Reg. Section 1.501(c)(3)-1(c)(1) provides that an organization may meet the requirements of IRC Section 501(c)(3) although it operates a trade or business as a substantial part of its activities, if the operation of such trade or business is in furtherance of the organization's exempt purpose or purposes and if the organization is not organized or operated for the primary purpose of carrying on an unrelated trade or business as defined in IRC Section 513.

In Rev. Rul. 72-369, 1972-2 C.B. 245, an organization was formed to provide managerial and consulting services for section 501(c)(3) organizations to improve the administration of their charitable programs. The organization enters into agreements with unrelated section 501(c)(3) organizations to furnish managerial and consulting services on a cost basis. This revenue ruling stated that:

An organization is not exempt merely because its operations are not conducted for the purpose of producing a profit. To satisfy the 'operational test,' the organization's resources must be devoted to purposes that qualify as exclusively charitable within the meaning of section 501(c)(3) of the Code and the applicable regulations. Providing managerial and consulting services on a regular basis for a fee is a trade or business ordinarily carried on for profit. The fact that the services in this case are provided at cost and solely for exempt organizations is not sufficient to characterize this activity as charitable within the meaning of section 501(c)(3) of the Code. Furnishing the services at cost lacks the donative element necessary to establish this activity as charitable.

In Airlie Foundation v. Internal Revenue Service, 283 F. Supp. 2d 58 (D.D.C., 2003), the Court determined the organization was operated for non-exempt commercial purposes rather than for exempt purposes because of the commercial manner in which the organization conducted its activities. The organization did not qualify for exemption.

Application of law


You do not meet the requirements for recognition of tax exemption under IRC Section 501(c)(3) because you fail the operational test.

You fail the operational test for IRC Section 501(c)(3) because your primary activity is the conduct of a trade or business for the production of income. You lease D to handicapped individuals who can pay the fees to cover the costs. They are then expected to use D to sell advertising to cover their costs. This shows that you operate in the same manner as a for profit business. Based on Treas. Reg. Section 1.501(c)(3)-1(e)(1), you do not meet the requirements for recognition of tax exemption under Section 501(c)(3) because you are operated for the primary purpose of carrying on an unrelated trade or business, as defined in IRC Section 513(a) and IRC Section 513(c).

Furthermore, you fail the operational test as described in Treas. Reg. Section 1.501(c)(3)-1(a)(1). You are not operating per Treas. Reg. Section 1.501(c)(3)-1(c)(1) because you operate for a substantial nonexempt commercial purpose. Your activities consist of leasing D to handicapped individuals to cover your costs of modifying it for them. This is a substantial nonexempt purpose which precludes you from exemption.

You are like the organization described in Rev. Rul. 72-369, 1972-2 C.B. 245 because you are operating in a commercial manner. Your leasing fee is based on your costs to cover the acquisition, design, and the modification of D for the particular user. The fact that you mainly provide your services to disabled individuals is not sufficient to characterize the activity as charitable because this lacks the donative element necessary to establish this activity as charitable.

You are similar to the organization described in Airlie Foundation v. Internal Revenue Service. The fact that you sell products and provide services to the public for a fee directly competes with other businesses that provide similar products and services. Like any commercial business, your products arc available to any individual willing to pay your leasing fees.

Conclusion


Based on the above facts and analysis, you do not qualify for tax exemption because you are not operated exclusively for purposes described in IRC Section 501(c)(3). You have a substantial nonexempt commercial purpose. Accordingly, you do not qualify for exemption under Section 501(c)(3).

If you agree

If you agree with our proposed adverse determination, you don't need to do anything. If we don't hear from you within 30 days, we'll issue a final adverse determination letter. That letter will provide information on your income tax filing requirements.

If you don't agree

You have a right to protest if you don't agree with our proposed adverse determination. To do so, send us a protest within 30 days of the date of this letter. You must include;

Your name, address, employer identification number (EIN), and a daytime phone number

A statement of the facts, law, and arguments supporting your position

A statement indicating whether you arc requesting an Appeals Office conference

The signature of an officer, director, trustee, or other official who is authorized to sign for the organization or your authorized representative

The following declaration:

For an officer, director, trustee, or other official who is authorized to sign for the organization: Under penalties of perjury, I declare that I have examined this request, or this modification to the request, including accompanying documents, and to the best of my knowledge and belief, the request or the modification contains all relevant facts relating to the request, and such facts are true, correct, and complete.

Your representative (attorney, certified public accountant, or other individual enrolled to practice before the IRS) must file a Form 2848, Power of Attorney and Declaration of Representative, with us if they haven't already done so. You can find more information about representation in Publication 947, Practice Before the IRS and Power of Attorney.

We'll review your protest statement and decide if you gave us a basis to reconsider our determination. If so, we'll continue to process your case considering the information you provided. If you haven't given us a basis for reconsideration, we'll send your case to the Appeals Office and notify you. You can find more information in Publication 892, How to Appeal an IRS Decision on Tax-Exempt Status.

If you don't file a protest within 30 days, you can't seek a declaratory judgment in court later because the law requires that you use the IRC administrative process first (IRC Section 7428(b)(2).

Where to send your protest


Send your protest, Form 2848, if applicable, and any supporting documents to the applicable address:

U.S, mail:

Internal Revenue Service
EO Determinations Quality Assurance
Mail Stop 6403
P.O. Box 2508
Cincinnati, OH 45201

Street address for delivery service:

Internal Revenue Service
EO Determinations Quality Assurance
550 Main Street, Mail Stop 6403
Cincinnati, OH 45202

You can also fax your protest and supporting documents to the fax number listed at the top of this letter. If you fax your statement, please contact the person listed at the top of this letter to confirm that they received it.

You can get the forms and publications mentioned in this letter by visiting our website at irs.gov/forms-pubs or by calling 800-TAX-FORM (800-829-3676). If you have questions, you can contact the person listed at the top of this letter.

Contacting the Taxpayer Advocate Service


The Taxpayer Advocate Service (TAS) is an independent organization within the IRS that can help protect your taxpayer rights. TAS can offer you help if your tax problem is causing a hardship, or if you've tried but haven't been able to resolve your problem with the IRS. If you qualify for TAS assistance, which is always free, TAS will do everything possible to help you. Visit taxpayeradvocate.irs.gov or call 877-777-4778.

Sincerely,

Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements

Published October 2, 2020
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