June 7, 2023
IRS declines or revokes tax-exempt status in four recent rulings
The IRS revoked tax exemptions in three recent rulings and declined to issue exempt status in another ruling. All four rulings reflect the IRS's emphasis on complying with the organization and operational tests under IRC Sections 501(c)(3) and (4).
Tax-exempt status revoked
Organization operated a coffee shop
In PLR 202321005, the IRS revoked the IRC Section 501(c)(3) tax-exempt status of an organization that operated a coffee shop on the grounds it was operated similar to a for-profit organization.
According to the IRS, the organization was granted tax-exempt status based on its claims that it would provide in-house training programs and employment opportunities for a certain population to enable it to reintegrate back into society. The IRS found, among other factors, that (1) the organization's emphasis was on profits and it only gave a small percentage of actual assistance to the targeted population it said it was trying to help; (2) the organization had no records of assisting the targeted population and no programs to reintroduce it into society; and (3) the internal controls of the organization were inadequate (e.g., the founder/executive director was in charge of opening the organization's mail, making deposits, and writing and signing checks).
In revoking the tax-exempt status, the IRS said the organization was operating similar to a for-profit organization because (1) its primary purpose was carrying on a trade or business that does not further charitable purposes; (2) it was operated for the substantial commercial purpose of selling to the public; and (3) the income, expenses and time spent on the activities that were unrelated to the exempt purpose were substantial.
Organization operated a bar and game room
In PLR 202321009, the IRS revoked the IRC Section 501(c)(4) tax-exempt status of an organization that operated a bar and game room on the grounds it did not exclusively promote social welfare.
According to the IRS, the primary activity of the organization was operating a bar and game room for members of a related veterans' organization. All of the organization's revenue and expenditures were related to operating the bar, restaurant and gaming activities, which were open to the public and had paid employees.
In revoking the organization's tax-exempt status, the IRS noted that IRC Section IRC 501(c)(4) exempts civic leagues or organizations that are not organized for profit but operated exclusively for promoting social welfare. In contrast, the IRS explained that the primary activities of the organization were operating a bar and gaming room for members of a related exempt organization, and that its business was carried out in a manner similar to organizations operated for profit. Therefore, the organization did not exclusively promote social welfare.
Organization provided sport activities for underprivileged youth
In PLR 202321013, the IRS revoked the IRC Section 501(c)(3) tax-exempt status of an organization that was organized, and initially operated, to provide underprivileged youth the opportunity to participate in sports activities, but had sold its operations to a for-profit organization. The IRS revoked the organization's exemption on the grounds that it failed the operational test after ceasing its activities. The IRS noted the organization never engaged in any substantial activity that accomplished one or more exempt purposes after selling its operations to the for-profit organization.
Tax-exempt status denied
Organization that partners with insurance provider for member benefits and assists members in career development
In PLR 202321016, the IRS denied an organization's Form 1023-EZ application for recognition of IRC Section 501(c)(3) tax-exempt status. The organization partnered with an insurance provider to provide benefits to its members and assisted members in career development. The IRS denied the application on the grounds that the organization was operated for the substantial non-exempt purpose of serving the private interests of its members.
The organization claimed that its primary purpose was to partner with an insurance provider to assist the organization's members (all from a specific industry) in gaining access to medical, dental, disability and life insurance at affordable group rates, as well as free financial-planning advice. The organization also assisted members in career development and promotion by providing electronic press kits, webinars and travel discounts. Anyone in the organization's industry could become a member. The organization is supported solely by membership dues.
In denying tax-exempt status, the IRS determined that the organization did not meet the operational test because it was not operating exclusively for tax-exempt purposes. Rather, the IRS concluded that a substantial part of the organization's activities furthered the private business interests of members. "Your organization is a vehicle for advancing the personal careers of your members," according to the IRS. "This is a substantial non-exempt purpose that will destroy exemption regardless of the number and importance of any truly exempt purposes."
These IRS rulings demonstrate the importance of maintaining compliance with the organizational and operational tests under IRC Sections 501(c)(3) and (4) by making certain that an organization's activities are substantially related to its exempt purposes rather than substantially benefitting private interests.
Of particular note is PLR 202321013, in which the organization was forced to change its activities due to special circumstances (presumably COVID-19). Even though the organization initially complied with the operational test, it went dormant after selling its operations to a for-profit organization, thereby failing the operational test for IRC Section 501(c)(3) tax exemption. As this and the other revocations have shown, it is important for organizations to maintain at least some level of tax-exempt activity, which could include board/committee/officer meetings to plan activities in the near future, rather than ceasing exempt activity for even a short period.
— For more information about EY's Exempt Organization Tax Services group, visit us here.
Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor