department of the treasury internal_revenue_service washington d c date of f i c e of c h i e f c ou n s e l number release date cc psi tl-n-1993-00 uilc internal_revenue_service national_office field_service_advice memorandum for associate area_counsel san francisco cc lm ctm sf from donna m young acting branch chief cc psi subject tl-n-1993-00 this field_service_advice responds to your memorandum dated date field_service_advice is not binding on examination or appeals and is not a final case determination this document is not to be cited as precedent disclosure statement field_service_advice is chief_counsel_advice and is open to public inspection pursuant to the provisions of sec_6110 the provisions of sec_6110 require the service to remove taxpayer identifying information and provide the taxpayer with notice of intention to disclose before it is made available for public inspection sec_6110 and i sec_6110 also authorizes the service to delete information from field_service_advice that is protected from disclosure under u s c sec_552 b and c before the document is provided to the taxpayer with notice of intention to disclose only the national_office function issuing the field_service_advice is authorized to make such deletions and to make the redacted document available for public inspection accordingly the examination appeals or counsel recipient of this document may not provide a copy of this unredacted document to the taxpayer or their representative the recipient of this document may share this unredacted document only with those persons whose official tax_administration duties with respect to the case and the issues discussed in the document require inspection or disclosure of the field_service_advice legend partnership foreign_partner domestic partner n1 n2 tl-n-1993-00 n3 n4 n5 n6 n7 n8 n9 n10 n11 n12 n13 date1 year1 year2 year3 year4 state country assets issues do partnership’s special allocations of tax items have substantial economic_effect so that they may be respected under sec_704 if the special allocations do not have substantial economic_effect how should partnership’s tax items be re-allocated may there be a re-allocation of partnership’s tax items pursuant to sec_482 conclusions further case development is required before it can be decided whether the special allocations at issue in this case have substantial economic_effect and relatedly whether partnership’s allocations of nonrecourse_deductions are in accordance with the partners’ interests in the partnership further case development is also required before it can be decided whether there can be a re-allocation of partnership’s tax items pursuant to sec_482 this memorandum discusses the known facts and applicable law in response to the issues presented fact sec_1 the sec_1_701-2 partnership anti-abuse rule overrides the sec_704 allocation rules however the sec_1_701-2 partnership anti-abuse rule is not at issue in this field_service_advice tl-n-1993-00 partnership was formed as a state general_partnership in year1 partnership is currently organized as a state limited_liability_company foreign_partner established in country in year has an established line_of_business as a lessor of assets having over dollar_figuren1 of assets at original cost under management the operations of partnership consist of purchasing assets which are manufactured by third parties to specifications determined by foreign_partner and leasing the assets foreign_partner has entered into a management agreement with partnership under which foreign_partner assumes responsibility for the leasing repair rent collection and other operations of partnership’s assets foreign_partner is compensated for these services in the annual amount of n2 percent of the acquisition_cost of assets under management domestic partner is the other partner of partnership foreign_partner owns a n3 percent interest in and is the managing member of domestic partner domestic partner was formed to serve as an entity through which parties may invest in up to dollar_figuren4 of assets which partnership acquired on date1 the relevant assets were originally purchased by foreign_partner in year3 and year4 and were placed on initial lease into the foreign_partner asset pool prior to being purchased by partnership to fund the purchase foreign_partner and domestic partner each made capital contributions to partnership equal to n5 percent of the dollar_figuren4 cost of the assets the remaining acquisition_cost and initial working_capital was funded through nonrecourse loans acquired by partnership the assets are depreciable_property and partnership depreciates the full cost of the assets over a six year life on a straight_line basis partnership’s partnership_agreement is drafted to comply with the regulations under sec_1_704-1 annual operating income or loss in the absence of an overriding special_allocation for a particular taxable_year is generally allocated n6 percent to foreign_partner and n7 percent to domestic partner with domestic partner receiving a larger amount as partnership’s gross operating margin increases from n8 percent asset disposition gains or losses are generally allocated n7 percent to foreign_partner and n6 percent to domestic partner with foreign_partner receiving a larger amount as partnership’s cumulative disposition net_cash_flow increases from n9 percent of the original equipment cost the partnership_agreement also contains special allocations that provide as follows i during years n10 all recourse deductions are allocated n7 percent to foreign_partner and n6 percent to domestic partner until domestic partner’s adjusted tax basis in its partnership_interest equals zero we find the wording of this allocation to be less than clear however it may be appropriate to interpret this language as only allocating recourse deductions to domestic partner up to the amount of that partner’s capital_contribution tl-n-1993-00 ii nonrecourse_deductions are allocated n7 percent to foreign_partner and n6 percent to domestic partner iii beginning in year n11 of the partnership gross rental income is allocated n7 percent to foreign_partner and n6 percent to domestic partner to the extent necessary to eliminate any recourse deficit in domestic partner’s capital_account iv beginning in year n12 of the partnership gross_income is allocated n6 percent to foreign_partner and n7 percent to domestic partner to the extent necessary to eliminate any recourse deficit in foreign partner’s capital_account v gross_income is allocated to each partner to the extent required by the minimum_gain_chargeback rule_of sec_1_704-2 and vi in the year of liquidation all income and gain is allocated to any partner with a deficit capital_account to the extent necessary to eliminate such deficit because of these special allocations domestic partner will be allocated n6 of partnership’s deductions which is a considerable amount due to the depreciation of the assets in the first few years of the partnership and will recognize n6 percent of partnership’s income in the last few years of the partnership foreign_partner on the other hand will be allocated n6 percent of partnership income in the first few years of the partnership and n6 percent of the losses in the last few years of the partnership approximately n13 percent of partnership’s income would be considered u s source income as such foreign_partner has a much lower effective_tax_rate than the investors in domestic partner and appears to be functionally indifferent to the large distributive_share of taxable_income the special_allocation scheme has the effect of front_loading deductions for the investors in domestic partner law and analysis issue do partnership’s allocations of tax items have substantial economic_effect so that they may be respected under sec_704 sec_704 of the internal_revenue_code provides that a partner’s distributive_share of income gain loss deduction or credit shall be determined by the partnership_agreement this general_rule is limited by sec_704 which states that a partner’s distributive_share of income gain loss deduction or credit or item thereof shall be determined in accordance with the partner’s interest in the partnership determined by taking into account all facts and circumstances if the partnership_agreement does not provide as to the partner’s distributive_share of income gain loss deduction or credit or item thereof or the allocation to a partner under the agreement of income gain loss deduction or credit or item thereof does not have substantial economic_effect tl-n-1993-00 sec_1_704-1 provides a two-part test for determining whether an allocation of income gain loss or deduction or item thereof to a partner has substantial economic_effect the first part of the test determines whether the allocation has economic_effect the second part determines whether the economic_effect of the allocation is substantial economic_effect sec_1_704-1 provides that in order for an allocation to have economic_effect it must be consistent with the underlying economic arrangement of the partners this means that in the event there is an economic benefit or economic burden that corresponds to an allocation the partner to whom the allocation is made must receive such economic benefit or bear such economic burden sec_1_704-1 provides that an allocation will have economic_effect if and only if throughout the full term of the partnership the partnership_agreement provides - for the determination and maintenance of the partners’ capital accounts in accordance with the rules of sec_1_704-1 upon liquidation of the partnership or any partner’s interest in the partnership liquidating distributions are required in all cases to be made in accordance with the positive capital_account balances of the partners as determined after taking into account all capital_account adjustments for the partnership taxable_year during which such liquidation occurs other than those made pursuant to this requirement and requirement of this paragraph b ii b by the end of such taxable_year or if later within days after the date of such liquidation and if such partner has a deficit balance in his capital_account following the liquidation of his interest in the partnership as determined after taking into account all capital_account adjustments for the partnership taxable_year during which such liquidation occurs other than those made pursuant to this requirement he is unconditionally obligated to restore the amount of such deficit balance to the partnership by the end of such taxable_year or if later within days after the date of such liquidation which amount shall upon liquidation of the partnership be paid to creditors of the partnership or distributed to other partners in accordance with their positive capital_account balances in accordance with requirement of this paragraph b ii b partnership’s agreement specifically article sec_11 and article sec_4 and b contains the three provisions required by sec_1 b ii b therefore partnership’s allocation scheme appears to have economic_effect however while the explicit terms of the agreement appear to meet the requirements for tl-n-1993-00 the allocations to have economic_effect the partnership_agreement includes all agreements among the partners whether oral or written sec_1_704-1 any evidence of a side agreement that negated the deficit_restoration_obligation for domestic partner would prevent the allocations at issue from having economic_effect substantiality in addition to having economic_effect a partnership’s allocations must also be substantial in order to be respected under sec_1_704-1 sec_1_704-1 provides that the economic_effect of an allocation is substantial if there is a reasonable possibility that the allocation will affect substantially the dollar amounts to be received by the partners from the partnership independent of tax consequences sec_1_704-1 and c describes two situations in which the economic_effect of an allocation is not substantial however even if an allocation is not described in sec_1_704-1 or c its economic_effect may be insubstantial under the general rules stated in sec_1_704-1 the allocations described in sec_1 b iii b shifting allocations are not similar to partnership’s allocations but the allocations described in sec_1_704-1 transitory allocations are similar to partnership’s allocations allocations are deemed to be shifting allocations where at the time the allocation becomes part of the partnership_agreement there is a strong likelihood that the net changes in the partners’ respective capital accounts for the taxable_year will not differ substantially from the net changes that would be recorded in the capital accounts for such year in the absence of such allocations and the total_tax liability of the partners will be less than if the allocations were not contained in the partnership_agreement as illustrated by sec_1_704-1 example shifting allocations involve offsetting allocations within the taxable_year the present case does not involve offsetting allocations within the same taxable_year and so the allocations will not be deemed to be shifting allocations transitory allocations involve offsetting allocations over a period of time if a partnership_agreement provides for the possibility that one or more allocations the original allocations will be largely offset by one or more other allocations the offsetting allocations and at the time the allocations become part of the partnership_agreement there is a strong likelihood that the net increases and decreases to the partners’ capital accounts will not differ substantially from the net increases and decreases to the partners’ capital accounts if the allocations were not contained in the partnership_agreement and the total_tax liability of the partners will be less than if the allocations were not contained in the partnership_agreement the economic_effect of the original allocations and offsetting allocations will not be substantial however the regulations provide that if at the time the allocations become part of the partnership tl-n-1993-00 agreement there is a strong likelihood that the offsetting allocations will not in large part be made within five years after the original allocations are made the original and offsetting allocations will not be insubstantial under sec_1_704-1 sec_1_704-1 also indicates that where the original and offsetting allocations will not be made within five years then it will be presumed that there is a reasonable possibility that the allocations will affect substantially the dollar amounts to be received by the partners from the partnership sec_1_704-1 example involves allocations that have economic_effect under sec_1_704-1 and that are substantial under sec_1_704-1 the partnership in the example which is formed by partners c and d leases machinery and enters into a 12-year lease with a financially secure corporation under which the partnership expects to have a net taxable loss in each of its first partnership taxable years due to cost_recovery deductions with respect to the machinery and net taxable_income in each of the following partnership taxable years in part due to the absence of such cost_recovery deductions the partnership_agreement further provides that partnership net taxable loss will be allocated percent to partner c and percent to partner d until such time as there is partnership net taxable_income and thereafter partner c will be allocated percent of such taxable_income until he has been allocated partnership net taxable_income equal to the partnership net taxable loss previously allocated to him the example concludes that even though there is a strong likelihood that the allocations of net taxable loss in taxable_year sec_1 through of the partnership will be largely offset by other allocations in partnership taxable years through and even if it is assumed that the total_tax liability of the partners in year sec_1 through will be less than if the allocations had not been provided in the partnership_agreement the economic_effect of the allocations is substantial under sec_1_704-1 this is because at the time such allocations became part of the partnership_agreement there was a strong likelihood that the allocations of net taxable loss in year sec_1 through would not be largely offset by allocations of income within years the allocation scheme in the present case involves allocations of partnership losses to domestic partner that will largely be offset by allocations of partnership income in future years however as in sec_1_704-1 example the offsetting allocations in the present case will not occur within the first five years after the original allocations are made therefore it is presumed that there is a reasonable possibility that the allocations will affect substantially the dollar amounts to be received by the partners from the partnership of course this presumption would not apply if there is any type of agreement that prevents domestic partner from bearing the economic loss if the value of the assets falls below the note balance notwithstanding the above discussion the economic_effect of an allocation still may not be substantial under the after-tax economic consequences test in sec_1 b iii a although sec_1_704-1 provides that an allocation that is not tl-n-1993-00 described in that section is presumed to have substantial economic_effect under the first sentence of sec_1_704-1 ie the allocation will affect substantially the dollar amounts to be received by the partners from the partnership the economic_effect of the allocation may still be insubstantial under the second sentence of sec_1 b iii a the second sentence of sec_1_704-1 provides that notwithstanding the first sentence the economic_effect of an allocation is not substantial if at the time the allocation becomes part of the partnership_agreement the after-tax economic consequences of at least one partner may in present_value terms be enhanced compared to such consequences if the allocation were not contained in the partnership_agreement and there is a strong likelihood that the after-tax economic consequences of no partner will in present_value terms be substantially diminished compared to such consequences if the allocation were not contained in the partnership_agreement in the present case the test in sec_1_704-1 will be met if it is found that domestic partner’s after-tax economic consequences are enhanced and foreign partner’s after-tax economic consequences are not substantially diminished domestic partner receives a time_value_of_money advantage from the timing differences in its allocations of partnership loss and income however by assuming a deficit_restoration_obligation domestic partner assumes the risk of economic loss in the event partnership fails to earn sufficient income to offset its large capital_account deficit as a result it may be that domestic partner’s after-tax economic consequences are not enhanced by the special allocations foreign_partner is allocated more income and fewer deductions in the first years of partnership than it would be allocated if the special allocations were not in the partnership_agreement as a result depending on whether it has other losses to offset its net_income from partnership foreign_partner will most likely pay more in u s tax under the special allocations than it would if they were not in the partnership_agreement however foreign_partner only pays u s tax on n13 percent of the income it receives from partnership as a result it may be that foreign partner’s after-tax economic consequences are not substantially diminished compared to such consequences if the special allocations were not in the partnership_agreement nonrecourse_deductions allocations of losses and deductions attributable to partnership nonrecourse liabilities nonrecourse_deductions cannot have economic_effect because the creditor alone bears any economic burden that corresponds to these allocations sec_1_704-2 thus nonrecourse_deductions must be allocated in accordance with the partners’ interests in the partnership id sec_1_704-2 provides a safe_harbor for determining whether allocations of nonrecourse_deductions are deemed to be in accordance with the partners’ interests in the partnership if the test is not satisfied the partners’ distributive shares of tl-n-1993-00 nonrecourse_deductions are determined under sec_1_704-1 according to the partners’ overall economic interests in the partnership sec_1_704-2 under sec_1_704-2 the following four requirements must be met throughout the full term of the partnership requirements and of sec_1_704-1 are satisfied ie capital accounts are maintained in accordance with b iv and liquidating distributions are required to be made in accordance with positive capital_account balances and requirement of either sec_1_704-1 or sec_1_704-1 is satisfied ie partners with deficit capital accounts have an unconditional deficit_restoration_obligation or agree to a qualified_income_offset beginning in the first taxable_year of the partnership in which there are nonrecourse_deductions and thereafter throughout the full term of the partnership the partnership_agreement provides for allocations of nonrecourse_deductions in a manner that is reasonably consistent with allocations of some other significant partnership_item attributable to the property securing the nonrecourse liabilities and those allocations have substantial economic_effect beginning in the first taxable_year of the partnership that it has nonrecourse_deductions or makes a distribution of proceeds of a nonrecourse_liability that are allocable to an increase in partnership minium gain and thereafter throughout the full term of the partnership the partnership_agreement contains a provision that complies with the minimum_gain_chargeback requirement of sec_1_704-2 and all other material allocations and capital_account adjustments under the partnership_agreement are recognized under sec_1_704-1 without regard to whether allocations of adjusted tax basis and amount_realized under sec_613a are recognized under sec_1_704-1 in the present case requirements and of sec_1_704-2 are satisfied in article sec_11 article sec_4 and article sec_4 of the partnership_agreement it is not clear whether requirement of sec_1_704-2 is satisfied because as discussed above it has not been determined whether any of partnership’s allocations have substantial economic_effect if sec_1_704-2 is satisfied partnership’s nonrecourse_deduction allocations are made in accordance with the partners’ interest in partnership and will not be reallocated under sec_1_704-1 if sec_1_704-2 is not satisfied the nonrecourse_deduction allocations are not made in accordance with the partners’ interests and must be reallocated issue if the special allocations do not have substantial economic_effect how should partnership’s tax items be re-allocated tl-n-1993-00 sec_1_704-1 provides that a partner’s interest in a partnership is the manner in which the partners have agreed to share the economic benefit or burden if any corresponding to the income gain loss deduction or credit or item thereof that is allocated the determination of a partner’s interest in a partnership shall be made by taking into account all facts and circumstances relating to the economic arrangement of the partners all partners’ interests in the partnership are presumed to be equal determined on a per capita basis however this presumption may be rebutted by the taxpayer or the irs by establishing facts and circumstances that the partners’ interests in the partnership are otherwise under sec_1_704-1 the following factors are considered in determining a partner’s interest in a partnership a the partners’ relative contributions to the partnership b the interests of the partners in economic profits and losses if different from that in taxable_income or loss c the interests of the partners in cash_flow and other non-liquidating distributions and d the rights of the partners to distributions of capital upon liquidation as discussed above it is not clear whether any of partnership’s items of deduction credit income or loss will need to be reallocated issue may there be a re-allocation of partnership’s tax items pursuant to sec_482 sec_1_704-1 provides in part that an allocation that is respected under sec_704 and this paragraph nevertheless may be reallocated under other provisions such as sec_482 this regulation goes on to state that the examples in paragraph b of this section concern the validity of allocations under sec_704 and this paragraph and except as noted do not address the effect of other sections or limitations on such allocations sec_482 provides in any case of two or more organizations trades_or_businesses owned or controlled directly or indirectly by the same interests the secretary may distribute apportion or allocate gross_income deductions credits or allowances between or among such organizations trades_or_businesses if he determines that such distribution apportionment or tl-n-1993-00 allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations trades_or_businesses the first requisite for applying sec_482 is that the taxes or income of two or more organizations trades_or_businesses be involved this phrase has been broadly construed thus sec_482 has been applied to reallocate income among corporate partners rodebaugh v commissioner tcmemo_1974_36 aff’d 518_f2d_73 6th cir another requisite for applying sec_482 to a transaction is that the transaction take place between two or more entities owned or controlled by the same interests this control requirement is like the first requirement construed very broadly sec_1_482-1 any kind of control whether direct or indirect and whether or not legally enforceable satisfies the control requirement id in addition arbitrary shifting_of_income or deductions raises a presumption of control id the regulations also state that control may exist as a result of the actions of two or more taxpayers acting in concert with a common goal or purpose id thus under the regulations joint legal ownership or overlapping ownership is not required for unrelated corporations to come within the purview of sec_482 if income_or_deduction shifting is present or if there is a common goal to shift income or deductions assuming the secretary has proven that the parties are controlled by the same interests he may distribute apportion or allocate deductions between or among such organizations trades_or_businesses if he determines that such distribution apportionment or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organizations trades_or_businesses sec_482 generally the commissioner’s determinations under sec_482 must be sustained absent an abuse_of_discretion 88_tc_252 the taxpayer must demonstrate that commissioner’s determinations are arbitrary capricious or unreasonable in order for the courts to set_aside the commissioner’s determinations id further case development is required before it can be decided whether there can be a re-allocation of partnership’s tax items pursuant to sec_482 case development hazards and other considerations the service’s position is not strong the facts seem to support a ruling that partnership’s allocations have substantial economic_effect under sec_1_704-2 it is not disputed that the allocations have economic_effect the only question is whether the economic_effect is substantial the allocations in the present scheme largely offset each other over time but they do not meet the definition of transitory allocations under for purposes of sec_482 the term evasion of taxes is synonymous with tax_avoidance 80_tc_34 tl-n-1993-00 sec_1_704-1 because the off-setting allocations are not made within years the allocations may be substantial under the after-tax economic consequences test in sec_1_704-1 because the after-tax economic consequences of domestic partner may not be enhanced by these special allocations domestic partner has a deficit_restoration_obligation under the partnership_agreement and its capital_account will have a much greater deficit than if the special allocations were not in the partnership_agreement the economic risk to domestic partner that it may be obligated to restore the deficit in its capital_account makes it difficult to conclude that domestic partner’s after-tax economic consequences may be enhanced compared to what its after-tax economic consequences would be if the special allocations were not in the partnership_agreement it may be possible to conclude that partnership’s allocations do not have substantial economic_effect if there is evidence showing that domestic partner’s deficit_restoration_obligation really does not subject domestic partner to economic risk examples of such evidence includes domestic partner and foreign_partner are commonly controlled entities if so the controlling party is the party who is actually subject_to a risk of economic loss and the leasing agreements are structured in such a way that a party other than domestic partner assumes the risk of nonpayment for example assume partnership leases the assets to foreign_partner and foreign_partner then leases the assets to third parties in this scenario the risk is shifted from domestic partner to foreign_partner facts like the ones in the above two situations or any other facts that indicate that domestic partner’s deficit_restoration_obligation does not create a real economic risk to domestic partner may allow the service to determine that domestic partner’s after-tax economic consequences are enhanced by the special allocations for purposes of sec_1_704-1 specifically it may be worthwhile to look for hold harmless agreements or other side agreements between domestic partner and foreign_partner also an analysis of foreign partner’s historic_business experience particularly with similar partnership arrangements as well as trends in the asset leasing industry would be relevant to an inquiry as to the likelihood that domestic partner could be called upon to make additional capital contributions even if it is determined that domestic partner’s after-tax economic consequences are enhanced the service may be unable to find that foreign partner’s after-tax consequences are not substantially diminished the special allocations cause foreign_partner to have more taxable_income than it would if the special allocations were not in the partnership_agreement foreign_partner only pays u s income_tax on n13 percent of partnership income it is allocated and while it is possible that a partner’s after-tax economic consequences are not substantially diminished when it tl-n-1993-00 pays slightly more in taxes than it would without the allocation see sec_1_704-1 example more information is needed about foreign partner’s total_tax liability before this determination may be made for example in year foreign_partner was able to use losses from other sources to offset most of its u s source income from partnership we would like to know if this is typical for every taxable_year of foreign_partner the principal facts regarding possible application of sec_482 are the same as those related to the issue of substantial economic_effect if the partnership_allocations lack substantial economic_effect there would seem to be a strong basis for concluding that the allocations result in evasion of taxes or in a failure clearly to reflect income so that re-allocations may be made under sec_482 if the other conditions for its application are established if the further factual development that is suggested does not support the conclusion that the partnership_allocations lack substantial economic_effect then the field may wish to consider seeking a further field_service_advice on whether re- allocations may be made under sec_482 please call catherine moore at if you have any further questions by donna m young acting branch chief branch associate chief_counsel passthroughs special industries


department of the treasury internal_revenue_service washington d c t a x e x e m p t a n d g o v e r n m e n t e n t i t i e s d i v i s i o n -------------------- -------------------- contact person contact number identification_number ------------------ number release date se t eo ra date uniform issue list numbers employer_identification_number legend taxpayer a b c_corporation m x dear ------------------ this is in response to a letter dated date as revised in a letter dated date in which your legal_representative requested rulings that the provision of certain health benefits in the manner described below will not adversely affect your status as an organization described in sec_501 of the internal_revenue_code the code you received a determination_letter from the internal_revenue_service that you were a tax- exempt entity under sec_501 of the code you provide various group_life_insurance and health insurance to your members through group policies you also provide other_benefits for your members including a dependent scholarship program discounts on prescription drugs travel benefits and an affinity credit card program your membership is open to individuals described in a b and c you administer the above-described insurance programs under contract with the insurance carrier by providing services such as underwriting premium collections and payment of agent commissions where applicable assistance with claims handling marketing and issuance of enrollment certificates and you receive compensation_for the insurance carrier for such administrative services you wish to make available the same type of insurance benefits that you provide to your members available to two additional categories of individuals adult former dependents of individuals described in a b and c and individuals who retired from a before becoming eligible for retirement benefits you intend to have corporation m your wholly-owned for-profit subsidiary make available to these two groups the same type of insurance benefits which you make available to your members you would be willing to have corporation m hold in its name the group policy that covers these individuals but applicable state insurance regulations require that the entity in whose name the group policy is held be at least five years old and that such policy cover all members of the association in whose name the policy is held since corporation m is less than five years old you intend to create a new voting membership category for the two groups and to cover them under the same group policy that covers a b and c you intend to call members of this new voting membership auxiliary members therefore you intend to amend your articles of organization to create a new category of auxiliary members to be covered by the same group_insurance policy that covers a b and c this program will be structured so that corporation m enters into a contract with the insurance carrier for m corporation to provide all administrative services in support of that portion of the group policy which covers the auxiliary members including provision of administrative services such as underwriting premium collection payment of agent commissions where applicable assistance with claims handling marketing and the issuance of enrollment certificates all payments for such administrative services will be paid_by the carrier to corporation m you will incur no expenses or time in connection with the administrative services necessary to provide group_insurance policy benefits to the auxiliary members and shall receive no income from the provision of the group_insurance policies to auxiliary members all income derived from the offering of such group_insurance program benefits to auxiliary members shall be received by corporation m not you and corporation m as a for-profit subsidiary will pay taxes on such income after offset of allowable deductions you will take care to hold out corporation m as a separate legal entity to maintain a separate non-identical board_of directors and to hold separate board_of director meeting you request the following two rulings that individuals who terminated employment as a before becoming eligible for retirement benefits are employees within the meaning of sec_1_501_c_9_-2 of the income_tax regulations and therefore you may provide life sick accident and other_benefits allowed by sec_501 of the code without adversely affecting your exemption under sec_501 that the use of m corporation to administer that portion of your group_insurance policies that covers the adult former dependents of a b and c in a manner which results in m corporation and not you incurring all administrative expenses for and deriving all income from the provision of such group_insurance policy benefits to such adult former dependents does not constitute the provision by you or more than a de_minimis amount of unpermitted benefits under sec_1_501_c_9_-3 and therefore does not adversely affect your exempt status under sec_501 of the code so long as the number of such covered adult former dependents does not exceed x of the total number of individuals for whom you provide benefits sec_501 of the internal_revenue_code provides that a voluntary employee benefit association veba that provides for the payment of life sick accident or other_benefits to the members of such association or their dependents or designated beneficiaries shall be exempt from taxation sec_1_501_c_9_-3 of the regulations describes the term sick_and_accident_benefits to mean amounts furnished to or on behalf of a member or a member's dependents in the event of illness or personal injury to a member or dependent sec_1_501_c_9_-2 states that the term employee includes an individual who became entitled to membership in the association by reason of being or having been an employee an individual who would otherwise qualify under this paragraph therefore will continue to qualify even though such individual is on leave of absence works temporarily for another employer or has been terminated by reason of retirement disability or lay off the determination that a terminated employee is eligible for inclusion under a veba is made with reference to the reasons for termination of employment eligibility for retirement benefits is not one of the relevant criteria individuals who retire from employment with the common employer but do not receive retirement benefits are included among the types of terminated employees who are employees within the meaning of sec_1_501_c_9_-2 thus the provision of health benefits to terminated employees who retired without retirement benefits will not adversely affect your exempt status under sec_501 of the code sec_1_501_c_9_-3 of the income_tax regulations provides that the life sick accident or other_benefits provided by a veba must be payable to its members their dependents or their designated beneficiaries for the purpose of sec_501 dependent means the member's spouse any child of the member or the member's spouse who is a minor or a student any other minor child residing with the member and any other individual who an association relying on information furnished to it by a member in good_faith believes is a person described in sec_152 an organization is not described in this section if it systematically and knowingly provides more than a de_minimis amount of impermissible benefits sec_152 of the code defines the term dependent to include any of the following individuals over half of whose support for the calendar_year in which the taxable_year of the taxpayer begins was received from the taxpayer sons and daughters stepsons and stepdaughters nieces and nephews aunts and uncles in-laws and an individual other than the spouse who for the taxable_year has as his her principal_place_of_abode the home of the taxpayer and is a member of the taxpayer's household an adult former dependent defined in the proposed benefit is not a dependent within the meaning of sec_1_501_c_9_-3 of the regulations and sec_152 of the code sec_1_501_c_9_-3 of the regulations provides that sick_and_accident_benefits may not be provided to a member's other designated beneficiaries individuals who are not a member's dependents therefore providing such benefits to an employee's domestic partner would constitute non qualifying benefits which would cause a veba to lose its tax exempt status under sec_501 unless the provision of such benefit could be considered a de_minimis amount you have submitted information indicating that your role will be limited to the ministerial role of holding ownership of the insurance policies covering the adult former dependents that all expenses_incurred and income derived from the administration of benefits for such adult former dependents would be incurred by your for profit subsidiary and not by yourself and that no more than x of your current membership will be adult former dependent_children of a b and c based on the facts submitted it appears that operations with respect to health coverage for adult former dependent are of a b and c will be no more than de_minimis provision of a de_minimis amount of nonqualifying benefits will not adversely affect exemption under sec_501 of the code accordingly we rule that based upon the information you have submitted your proposal to provide otherwise unallowable health benefits to adult former dependents of members will not cause you to lose your exempt status under sec_501 of the code this ruling is based upon your representations that the provision of such benefits will be a de_minimis amount of the total benefits you provide except as we have specifically ruled above we express no opinion as to the federal_income_tax consequences of the transactions described above under any other provision of the code this ruling will be made available for public inspection under sec_6110 of the code after certain deletions of identifying information are made for details see enclosed notice notice of intention to disclose a copy of this ruling with deletions that we intend to make available for public inspection is attached to notice if you disagree with our proposed deletions you should follow the instructions in notice any changes that may have bearing on your tax status should be reported to the service we are informing your key district_director of this ruling because this ruling could help resolve future tax questions about your federal_income_tax status you should keep it in your permanent records if you have any questions please contact the person whose name and telephone number are shown in the heading of this letter this ruling is directed only to the organization that requested it sec_6110 of the internal_revenue_code provides that it may not be used or cited as precedent sincerely yours jane baniewicz manager exempt_organizations technical group


internal_revenue_service appeals_office alpha road suite mc 3000nwsat dallas tx date aug - number release date certified mail dear department of the treasury person to contact employee id number tel fax refer reply to in re employer identification no form required to be filed tax period s ended uil we considered your appeal of the adverse action proposed by the director exempt_organizations rulings and agreements your exemption from federal_income_tax under internal_revenue_code irc sec_501 is confirmed your foundation status has been modified to that of a private_operating_foundation as described in sec_4942 effective date you have agreed to this modification of your foundation status contributions to your organization remain deductible under sec_170 of the code you have waived your right to contest this determination under the declaratory_judgment provisions of sec_7428 of the code by your execution of form_906 closing_agreement concerning specific matters an executed copy of which is being sent to you under separate cover you also 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 and ask for taxpayer_advocate assistance see the enclosed notice helpful contacts for your notice_of_deficiency for additional taxpayer_advocate telephone numbers and addresses if you have any questions please contact the person whose name and telephone number are shown in the heading of this letter sincerely ’ karen a skinder appeals team manager enclosure notice ce form_886 a name of taxpayer explanation of items department of the treasury - internal_revenue_service org pay schedule no or exhibit year period ended 20xx 20xx legend org organization name county county bm-2 bm-3 ra companies xx date city city state state president president board member co-1 co-2 co-3 co-4 co-5 secretary secretary bm-1 ra-1 ra-2 ra-3 mgr mgr whether or not this organization is operating exclusively for any charitable educational or scientific reason under sec_501 primary issue facts a corporate information articles of incorporation the org ‘foundation’ was incorporated under the nonprofit public benefit corporation jaw of the state of state on january it would 20xx its stated purpose was that e e e e e e operate exclusively for charitable education scientific and other charitable purposes that it will not except fo an insubstantial degree engage in any activities or exercise any powers that are not in the furtherance of the purposes of this corporation that no substantial part of the activities shall consist of carrying on propaganda or otherwise attempting to influence legislation that the property of this corporation is irrevocably dedicated to educational scientific and charitable purposes no part of the net_earnings shall inure to the benefit of its directors trustees officers private shareholders or to any individual and that upon dissolution remaining assets will be distributed to other organizations that are tax-exempt ' president’ was noted as the incorporator of the ‘foundation’ and signed as such on january 20xx these articles were filed by him on january 20xx kk ok ' president does not appear in any other operation or activity of the organization department of the treasury - internal_revenue_service form acrev page -1- department of the treasury - internal_revenue_service form 886a name of taxpayer explanation of items org schedule no or exhibit year period ended 20xx 20xx bylaws- governing body according to the organization's bylaws the governing body was stated to be comprised of three board_of director bod members and three officers the officers’ positions consist of the president secretary and chief financial officer at the discretion ofthe bod other officers may be appointed as may be required each officer shall hold such office for such period have such authority and perform such duties as are provided in the bylaws the officers are any two or more offices may be held by the same person the duties of e president - shall be the general manager and chief_executive_officer and is subject_to the bod will have general supervision direction and control_over the corporation's business and officers shall have general powers and duties of management customarily vested in a corporation's president secretary - shall keep books of minutes of all meetings and actions taken by the written consent of the bod or any committees appointed by the bod will give notice of all meetings chief financial officer - shall keep and maintain adequate and correct books_and_records of corporation’s properties businesses transactions accounts of assets liabilities receipts disbursements gains losses and shares shall be responsible for all funds securities and other valuables receive and give receipts for monies due and payable to corporation deposit all monies and other duties prescribed by the bod - both the bod officers are supposed to be elected at each annual meeting annual meetings are supposed to be conducted on the t monday of may of each year or the next monday if that day is a holiday in an attachment to the bylaws was a document titled certificate of secretary the purpose was to certify that the bylaws adopted by the ‘foundation’ were official this certificate was signed on january exhibit a _ 20xx by secretary as secretary see - in a second attachment to the bylaws titled written consent by directors in lieu of first meeting president acting as the incorporator of the ‘foundation’ adopted the bylaws of the corporation and appointed secretary as president cfo and secretary secretary was also designated as the agent of the ‘foundation’ for the’purpose of service of process subsequent to all of the resolutions made in this document secretary signed the document as the newly appointed president on exhibit b 20xx see department of the treasury - internal_revenue_service form acrev page -2- 86a fe om n explanation of items schedule no or exhibit - year period department of the treasury - internal_revenue_service f t en org pene 20xx 20xx form_1023 application in february 20xx the ‘foundation’ submitted an application to the service to request tax-exempt status for its activities per the application the ‘foundation’ identified four general categories under which its activities would be conducted mission research education and grants mission aspect of the taxpayer was the e eradication of world hungry er through such means as improved health of and brea e ding techniques of livestock taxpayer will engage in research sponsor research will disseminate the results of research develop educations programs all relating to addressing world hunger research aspect is to e e e initially engage in research designed to improve the health of livestock look to the application of alternative health care techniques that are being applied to humans to determine the effectiveness of same when applied to livestock and investigate innovative breeding techniques that enhance the output of quality protein from livestock education aspect is to e integrate results of all research conducted into curriculum that is intended for veterinarians animal geneticists universities colleges agricultural clubs governmental agencies ie fda who un and others to be shared with the agricultural community teaching at existing accredited educations institutions special conferences and seminars or through classes orchestrated by the taxpayer publish initially without charge the results of its research to veterinarians animal geneticists eventually develop programs and research designed to achieve its goals of elimination of world hunger or through and grants aspect is to select candidates for grants with principal requirements with expertise and prior research experience because the determination specialist believed that this organization was like an organization described in regulations sec_1_501_c_3_-1 iii scientific e e form ackev e department of the treasury - internal_revenue_service page -3- department of the treasury - internal_revenue_service form ft n explanation of items org ope schedule no or exhibit ai year period e 20xx 20xx organization based solely upon the documentation submitted exemption from federal income taxes was granted on june 20xx under sec_501 as a public charity described in sec_170 see exhibit c secretary signed and submitted the form_1023 application_for recognition of exemption under penaities of perjury b activities in 20xx an examination was opened to examine the organization's operations for tax years ending material concerns were identified that would preclude the organization from 20xx during that examination a number of 20xx and having received exemption initially if all items were accurately disclosed and or that would disqualify the organization from retaining exemption these areas of concern were reviewed circumspectly to determine if exemption should be retained l false statements in application the form_1023 application was submitted in february 20xx in an attachment to the application it was stated that there were no assets of the organization per part il item assets and that since the organization was dormant there was no current financial information with regard to source_of_income or use of proceeds part iv-item a - revenue and expenses see exhibit d 20xx secretary and ra-1 nevertheless in a meeting of the co-1 co-1 met to discuss the formation of a new corporation in state during that meeting the two agreed to provide financial assistance to this new corporation which is the org and to transfer the improvements and any assets to the new corporation once it was formed see exhibit e on april kek kk ok co-1 formerly the org non-profit housing corporation is a state state nonprofit tax-exempt_organization created by secretary in 19xx for the purpose of housing and providing services to children with autism it receives its primary finding from secretary ra-1 is the mother of secretary and presently resides in state department of the treasury - internal_revenue_service form a rev page -4- form_886 a name of taxpayer explanation of items department of the treasury - internal_revenue_service org schedule no or exhibit year period ended 20xx 20xx in 20xx co-1 reported expending dollar_figuredollar_figure as a grant see exhibit f to another 501_c_3_organization an expense analysis of the grant amount showed that dollar_figuredollar_figure was actual expenses paid out of the personal funds of secretary for the improvement of her personal real_property dollar_figuredollar_figure were management and general_expenses of the ‘foundation’ paid out of the personal funds of secretary dollar_figuredollar_figure was actual expenses paid in 20xx the remaining dollar_figuredollar_figure was direct expenses drawn from the bank account of co-1 see exhibit g the ‘foundation’ did not record any receipt of this grant in its budgets submitted with the application did not recognize any transfer of assets it did not file any type of tax information_return to record the receipt of the income post formation and 5y secretary controls the activities of the co-1 secretary also controlled the formation and creation of the org statements made on the form_1023 application with respect to no current financial information did not coincide with other known and readily available evidence in secretary's possession and knowledge it was secretary's her money that was used to make the alleged grant the form_1023 application was signed under penalties of perjury noncompliance with federal reporting requirements nonfiler evidence from an examination of secretary's form_1040 returns divulged that charitable_contributions were made by secretary or one or more of her for-profit and nonprofit extensions to the ‘foundation’ during 20xx and 20xx in excess of dollar_figuredollar_figure this minimum threshold would require the ‘foundation’ to file form_990 returns for both years however upon reviewing the service database none had been filed see exhibit h when returns were requested in an initial information_document_request idr unsigned copies were provided to the agent this indicates that forms returns had been prepared these copies were then signed by secretary on april 20xx and sent to the service for processing by the revenue_agent the organization vehemently claims that it had timely filed the returns but the service had lost or misplaced those returns see exhibit i but prior to 20xx there was no indication that any form_990 return had ever been filed and in spite of numerous requests for any corroborating evidence that would contradict the information on the service database the organization was not able to produce such kkkk tk secretary’s form_1040 is presently under examination in tandem with the examination of this organizaion the dollar_figuredollar_figure is being disallowed on the form_1040 for 20xx tf an actual grant was made the matter of transferring the assets would be immaterial _ department of the treasury - intemal revenue service form a rev page -5- sss ih sss ann ' a e name of taxpayer anpays explanation of items org schedule no or a exhibit year period ende 20xx 20xx department of the treasury internal_revenue_service this ‘foundation’ is not the only nonprofit organization created by secretary that has a poor or nonexistent history of filing required information returns governing body -tenuous no independent boara per the organization’s bylaws the officers consist of the president secretary and chief financial officer per the organization's form_990 part v officers directors trustees and key employees are listed as figure title 20xx 20xx 20xx president secretary secretary ra-1 secretary ra-1 secretary ra-1 20xx the purpose of the meeting was to the organization held a meeting on may appoint mgr as manager of animal projects and to re-elect herself as president mgr is an employee of secretary's and is paid_by co-2 the position of manager of animal projects is not listed in the bylaws as a position entitled to vote on the activities of the organization the only person with the official right to vote on the organization's operations was secretary and she voted herself as president to serve another term attending a meeting held on january purpose of this meeting was to commence communications with experts in the animal husbandry world for the purpose of appointing a bod three names were selected bm- veterinarian and former sheep breeder bm-2 director of sheep program at co-3 and bm-3 head of sheep program at co-4 20xx was secretary ra-2 and mgr the _ even though the date of the minutes is outside the parameters of the examination period neither ra-2 nor mgr was listed on the form_990 as individuals with the right to govern the operations of the organization additionally neither was appointed and approved in writing by the sole bod member secretary to a position that would accommodate a vote sources of income revenue not a public charity per the delinquently filed form_990 returns the organization reported gross_receipts of dollar_figuredollar_figure and dollar_figuredollar_figure for 20xx and 20xx respectively of the gross amounts received the following sources were derived from secretary or one or more of her for-profit or nonprofit controlied corporations listed below figure eke oe ibid department of the treasury - internal_revenue_service form 886-ackev page -6- f a orm name explanation of items axpayer ay department of the ‘treasury - internal_revenue_service schedule no or exhibe year period ere ende 20xxk 20kx total secreta co-2 co-5 cco-1 co-2 totals co-2 and co-5 are two wholly-owned for-profit subchapter_s_corporations of secretary co-1 is a nonprofit tax-exempt corporation that was organized and is controlled by secretary it also received more than of its funding from secretary co-2 was incorporated as a for-profit entity in the state of state in 20xx and automatically dissolved in july 20xx ra-3 the listed resident agent is also an employee of co-2 and was so during the years of examination secretary claimed a charitable_contribution_deduction for the amounts paid directly to or on behalf of the ‘foundation’ from her personal return co-2 and co-5 while the amount_paid from the co-1 to or on behalf of the ‘foundation’ would generally be treated as a grant secretary only claimed a charitable_contribution_deduction with respect to the original amount_paid to the co-1 with respect to the amounts paid_by co-2 this entity is a regular for-profit corporation and would generally be limited to a contribution deduction of for 20xx of the dollar_figuredollar_figure recorded as gross_receipts dollar_figuredollar_figure or secretary for 20xx of the dollar_figuredollar_figure recorded as gross_receipts dollar_figuredollar_figure or from her for the years of operation secretary president has been the primary funding for the ‘foundation’ was derived from was derived uses of income revenue-meeting minutes inurement subsequent to the ‘foundation’s’ incorporation and prior to the date exemption was granted the organization had a meeting on 20xx see exhibit j there were two people present at the meeting secretary who is listed as the president and ra-2 who is purported to be the acting secretary ra-2 was not listed as a board_of director member on the delinquent form 990’s secured from the organization the purpose of the meeting was for the attendees to vote on a document called the affidavit of irrevocable restriction and indemnification see exhibit k proposed by secretary per this affidavit secretary is to purchase acres of land in city state acres are for the unlimited use of the ‘foundation’ the remainder is to be used by secretary for development the ‘foundation’ is to incur costs of land development including roads department of the treasury - internal_revenue_service form acrev page -7- department of the treasury - internal_revenue_service explanation of items f 886a name of taxpayer org onpay od schedule no or exhibit year period ended 20xx 20xx clearing wells and waterlines etc for the entire property ‘foundation’ will be reimbursed for all costs f property is sold and indemnified against any loss conditions are legally binding on herself heirs etc and that the document will be recorded in the local county this agreement was signed by secretary as property owner on 20xx the document was alleged to have been notarized but did not have the notary seal and date additionally the document was not recorded in the county prior to june 20xx when details of expenses were reviewed it was noted that the majority of the funds were indeed used to enhance the acres of land owned by secretary our review noted the following uses h a o q n to purchase farming assets ie livestock to purchase supplies and other items feed to support livestock and operate a farm to purchase farming equipment truck to make major improvements of the land owned by the president to maintain the upkeep of land and buildings owned by the president to pay for utilities and phone service in the name of the president and - to pay for legal service related to easements of property owned by the president only a minimal amount of monies were expended for items that might be considered related to the administrative operations of an exempt_organization none of the funds were used for any educational_purposes or scientific research the specific categories are noted as follows 20xx figure total unidentified farming or other farm assets farm_land equipment general maintenance leasehold miscellaneous ti start - personal form acrev department of the treasury - internal_revenue_service page -8- sss ss ss sss tel 886a form name of explanation of items department of the treasury- imernal revenue service taxpa org oper schedule no or exhibit - year period ende 20kxk 20xx annual totals dollar_figuredollar_figure ldollar_figuredollar_figure details of categorized terms are briefly described below and can be reviewed per attached see exhibit l e unidentified expenses were paid out of secretary's personal funds and deducted as a c contribution as an expense paid on behalf ofa qualified charitable_organization no other evidence regarding these amounts were verified e equipment expenses included the purchase of a 20xx polaris truck other farming machinery e farm assets were determined to be the purchase of sheep donkeys and a goat the goat was sold during the year also other sheep had been sold during the year e farming expenses included items like oats hay grain sheep shearing expenses farming supplies etc e legal services were paid for discussion relating to property easements e land equipment maintenance and other includes costs associated with mowing barn repairs truck repairs and fuel utilities trash removal etc e leasehold improvements included permanent additions or renovations to the land such as fencing well drilling dirt road construction bam construction and capitalized architect expenses e personal expenses included telephone service for two numbers and the former number address data was unpublished and the latter number was listed under the name of secretary e start-up costs included the payment of fees for incorporation in the state of state application user_fee and general consulting on corporation structure and e operational expenses included bank charges office supplies and faxing information these were believed to be administrative costs of operating an organization all expenditures were made and approved by secretary there was no official lease agreement between the organization and secretary property owner for the alleged use of the acres of land prior to june 20xx false statements in form_990 regarding program activities department of the treasury - internal_revenue_service form acrev page -9- 886a r name of taxpayer explanation of items department of the ‘treasury - internal_revenue_service org vey schedule no or exhibit year period i ende 20xx 20xx on the form_990 part ill the organization said it paid out dollar_figuredollar_figure and dollar_figuredollar_figure for 20xx and 20xx respectively for research for improved health breeding techniques of livestock and matters related thereto for the purpose of eradication of world hunger through such means’ see exhibit m from the factual analysis of the expenses the significant majority of expenditures made during 20xx and 20xx and even prior to actual incorporation were for the improvement maintenance and upkeep on the acres of land that is owned by secretary the return was signed under penalties of perjury by secretary as president on april 20xx law internal_revenue_code sec_501 provides for the exemption from federal_income_tax of corporations organized and operated exclusively for religious charitable literary scientific and educational_purposes no part of the net earings of which inures to any private_shareholder_or_individual sec_1_501_c_3_-1 of the income_tax regulations provides that in order to qualify for exemption under sec_501 an organization must be both organized and operated exclusively for one or more exempt purposes failure to meet either the organizational or operational_test will disqualify an organization from exemption under c sec_1_501_c_3_-1 states 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 sec_501 an organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt_purpose thus in construing the meaning of the phrase exclusively for educational_purposes in 326_us_279 the supreme court of the united_states stated this plainly means that the presence of a single non-educational purpose if substantial in nature will destroy the exemption regardless of the number or importance of truly educational_purposes sec_1_501_c_3_-1 states that 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 sec_1_501_a_-1 defines a private_shareholder_or_individual in sec_501 as those persons having a personal and private interest in the activities of the organization department of the treasury - intemal revenue service form 886-avrev page - 886a form on name of taxpayer ‘ explanation of items department of the treasury - intemal revenue service schedule no or exhibit year period ended 20xx 20xx org sec_1_501_c_3_-1 provides that 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 moreover even though an organization may have exempt purposes it will not be considered as operating exclusively for such purposes if more than an insubstantial part of its activities serve private interests in 71_tc_1067 the non profit organization engaged in activities relating to est programs involving training seminars lectures etc in areas of intrapersonal awareness and communication such activities were conducted under licensing arrangements with for-profit corporations the courts held that although the activities were educational in nature the non-profit served the commercial purposes of the for-profit thus the non-profit was not operated exclusively for exempt purposes within the meaning of sec_501 of the code in 69_tc_488 the founder of a for-profit entity formed a non profit corporation to take over the educational functions of the for-profit the non-profit assumed an excessive liability of the for-profit the court found the academy failed to meet the requirements of sec_501 in john marshall law school and john marshall university v us ustc an organization that operated a law school and university did not qualify as an exempt_organization because a portion of the organization's net_earnings intired to the benefit of the private individuals who operated the organization and their families the corporation contended that the benefits inuring to the individuals were reasonable_compensation for the services they performed but the court concluded that the payment of personal expenses purchases and interest-free loans involved here far exceeded an ordinary and necessary level of compensation in 30_tc_642 exemption was denied when leasehold improvements were made to property owned by the principal of the corporation revrul_76_441 cumulative bulletin page held that a nonprofit organization takes over a school's assets and its liabilities which exceed the value of the assets and include notes owed to the former owners and current directors of the school is serving the director's private interest and is not operated exclusively for department of the treasury - internal_revenue_service form acrev page -11- 886a e n org explanation of items department of the treasury- internal_revenue_service schedule no or exhibit a5 ende year period 20xx 20xx ft educational and charitable purposes argument form evidence submitted in the form_1023 and related documentation revealed that secretary made material false statements to the internal_revenue_service in support of budgets and other sources of revenue expenses she indicated that no monies had been received by the ‘foundation’ when in fact she was fully aware that monies had been paid to the ‘foundation’ during 20xx as a grant from the co-1 nonfiler there is prima facie evidence that this organization did not file forms for any of the years that it was required to file until it was examined by the service the mere preparation of a form_990 is not evidence of filing while one may say that the ‘foundation’ intended to file a form_990 they did not follow through with that intention while an intention to file might absolve the organization of the willful and intentional disregard rules for the imposition of certain delinquency penalties it does not serve as evidence of filing this organization also has a non-existent history of filing other required information returns ie forms it is not that this organization is not required to file the returns but that it has not filed any such returns the inference here is that this organization has difficulty in complying with federal reporting requirements with respect to its business operations noncompliance in this area can be deemed as not operating for exempt purposes and could disqualify this organization from retaining exemption governing body secretary has made a number of concerted efforts to lend some legitimacy to the creation purpose and operation of this organization in its creation another person president as incorporator’ assigns the overall management and oversight of the organization to secretary as president secretary and chief financial officer bylaws are created to lend some evidence of being governed properly however created they are not engaged in the actual operations of the organization and are it is with minimal consideration such as the conduct of an annual meeting if they meetings are held and recorded to support actions taken or proposed but in fact the board_of directors or ad hoc officers are either a family_member ie ra-1 an employee ie mgr of one of the for-profit entities or an added body ie ra-2 for the department of the treasury - internal_revenue_service form arev page -12- 886a form om name org explanation of items department of the treasury - internal_revenue_service of t schedule no or exhibit - ende year period 20xx 20xx purpose of approving actions decided upon by secretary who has the controlling_interest in all of the decisions made certificates written consents and affidavits are prepared to give some sense of credibility that this organization will be operated in the best interest of the general_public the certificates written consents and affidavits have questionable authenticity ie written consent and certificates with no notarized seal or scratched off dates or are not enforceable ie affidavit of irrevocable restriction and indemnification even if secretary did indeed enforce the conditions of the affidavit she has nonetheless conferred upon herself a benefit far greater than the cost to repay if the property were sold it would be sold at its appreciated value which includes the cost of the leasehold improvements the organization would only be receiving dollar for dollar value while the value of the property will far exceed the cost of the original improvements this is part and parcel of the inurement proscription furthermore none of the aforementioned documents were arms-length ‘not a public charity secretary reporting of revenue gives the public the illusion that this organization is supported by the general_public in spreading out her contributions amongst a number of of the funds different controlled entities the facts show otherwise more than contributed to this organization come from secretary or one or more of her wholly- owned for-profit entities or her controlled nonprofit entities this organization is nota public charity described in rc sec_501 inurement there is general agreement that inurement is a subset of private benefit and involves unjust payment of money the inurement proscription contained in regulation sec_1_501_c_3_-1 states that 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 inurement is likely to arise where the financial benefit represents a transfer of the organization's financial resources to an individual solely by virtue of the individual relationship with the organization without regard to the accomplishment of exempt purposes inurement of income is strictly forbidden under sec_501 without regard to the amount_involved this proscription applies to persons who because of their particular relationship with an organization have an opportunity to control or influence its activities such persons are considered insiders for purposes of determining whether there is inurement of income generally an organization's officers directors founders and their families are considered insiders a federal court_of_appeals held that the term inurement may include more than the term net profits as shown by the books of the organization or than the difference form acrev department of the treasury - internal_revenue_service page - form 886a name of taxpayer explanation of items deparment of the treasury - internal_revenue_service org schedule no or exhibit year period ended 20xx 20kx between the gross_receipts and disbursements in dollars and that p rofits may inure to the benefit of shareholders in other ways than dividends see northwestem municipal ass'n v commissioner secretary has enjoyed a tremendous tax_benefit from financially supporting the activities of the ‘foundation’ secretary created the org secretary supports the org with her own personal funds funds from one or more of her wholly-owned for-profit entities or from a second nonprofit entity co-1 created and controlled by her these funds invariably revert back to secretary in the form of leasehold improvements’ property maintenance livestock purchase or in the form of payment of personal expenses secretary for all intents and purposes is an insider the payment of leasehold improvements to a property not owned by the organization was sufficient to preclude exemption under c in the texas trade school case in the john marshall law school and john marshall university the payment of personal expenses was deemed inurement and caused the organization to not qualify as an exempt_organization in est of hawaii the operation of the organization was not exclusively for exempt purposes within the meaning of sec_501 c of the code per regulations sec_1_501_c_3_-1 even though an organization may have exempt purposes it will not be considered as operating exclusively for such purposes if more than an insubstantial part of its activities serve private interests see better business bureau in this instance more than a substantial amount of the funds of the ‘foundation’ are used for private interests false statement in evidence submitted in the forms retum further indicated that secretary made a material false statement to the service when it was stated that monies of the ‘foundation’ were paid for research for improved health breeding techniques of livestock and matters related thereto for the purpose of eradication of world hunger through such means’ in the amount of out dollar_figuredollar_figure and dollar_figuredollar_figure for 20xx and 20xx respectively the expenses of the organization did not evidence any of the purported amounts for the purpose stated taxpayer’s position taxpayer has not officially advocated a position but ascertains that it is a valid organization operating for the benefit of the public and not for private purposes government’s conclusion form acrev de partme nt of the treasury - internal_revenue_service page -14 886a fe name of taxpayer explanation of items department of the ‘treasury - internal_revenue_service org schedule no or a exhibit year period ende 20xx 20xx based upon cited court cases the regulations and code we hold that your organization is not operated exclusively for any charitable educational or scientific purpose and that you have excessive private benefit and inurement thereby defeating the retention of exemption therefore we have concluded that you do not qualify for exemption from federal_income_tax as an organization described in sec_501 of the code revocation of your exempt status will be effective as of january 20xx your organization is not entitled to internal revenue sec_7805 relief because your organization made material false statements in its form_1023 application had the organization disclosed the fact that income sources were derived from a related_organization and expended for leasehold improvements to the property owned by the creator this information would have precluded this organization from receiving exemption consequently the organization’s tax-exempt status should be revoked retroactively to the date it received recognition of its exemption in accordance with this determination you are required to file federal_income_tax returns on form_1120 contributions to your organization are not deductible by donors under sec_170 of the code in accordance with the provisions of sec_6104 of the code a copy of this letter will be sent to the appropriate state officials on december 20xx the d c circuit ruled that the service will disclose our denials and revocations under sec_6110 effective august 20xx tax analysts v irs f d c cir 20xx alternative issue should it be determined that this organization is operated for one or more exempt purposes and its income does not inure to be the benefit of private individuals then based upon the income sources this organization should not be a public charity as described in sec_509 a but a private_foundation lf the organization is reclassified to a private_foundation then is it subject_to the excise_tax provisions of sec_4941 facts the org ‘foundation’ was incorporated under the non-profit public benefit 20xx on september corporation laws of the state of state on january 19_ it department of the treasury - internal_revenue_service form a rev page -15- a f om name of explanation of items departmem of the treasury- internal_revenue_service taxpayer schedule no or exhibit year period 20xx 20xx t e was granted exemption under sec_501 as other than a private_foundation under sec_509 and sec_170 sources of income revenue not a public charity per the delinquently filed form_990 returns the organization reported gross_receipts of dollar_figuredollar_figure and dollar_figuredollar_figure for 20xx and 20xx respectively of the gross amounts received the following sources were derived from secretary or one or more of her for-profit or nonprofit controlled corporations listed below donor 20xx 20xx total co-2 co-5 co-1 co-2 totals dollar_figure dollar_figuredollar_figure e e e co-2 and co-5 are two wholly-owned for-profit subchapter_s_corporations of secretary co-1 is a nonprofit tax-exempt corporation that was organized and is controlled by secretary it also received more than co-2 was incorporated as a for-profit entity in the state of state in 20xx and automatically dissolved in july 20xx ra-3 the listed resident agent is also an employee of co-2 and was so during the years of examination of its funding from secretary secretary claimed a charitable_contribution_deduction for the amounts paid directly to or on behalf of the ‘foundation’ from her personal return co-2 and co-5 with respect to the amouhile the amount_paid from the co-1 to or on behalf of the ‘foundation’ would generally be treated as a grant secretary only claimed a charitable_contribution_deduction with respect to the original amount_paid to the co-1 with respect to the amounts paid_by co-2 this entity is a regular for-profit corporation and would generally be limited to a contribution deduction of for 20xxx of the dollar_figuredollar_figure recorded as gross_receipts dollar_figuredollar_figure or secretary for 20xx of the dollar_figuredollar_figure recorded as gross_receipts dollar_figuredollar_figure or from her for the years of operation secretary president has been the primary funding for the ‘foundation’ was derived from was derived - law form acrev department of the treasury - internal_revenue_service page -16- 886a form name org explanation of items department of the ‘treasury - trtemal revenue service schedule no or - exhibit year period ende 20xx 20xx of t internal_revenue_code sec_509 the term private_foundation means a domestic or foreign organization described in sec_501 other than an organization which normally receives more than one-third of its support in each taxable_year from any combination of-- i gifts grants contributions or membership fees and ii gross_receipts from admissions sales of merchandise performance of services or furnishing of facilities in an activity which is not an unrelated_trade_or_business within the meaning of sec_513 not including such receipts from any person or from any bureau or similar agency of a governmental_unit as described in sec_170 in any taxable_year to the extent such receipts exceed the greater of dollar_figure the organization's support in such taxable_year percent of or from persons other than disqualified persons as defined in sec_4946 with respect to the organization from governmental units described in sec_170 or from organizations described in sec_170 other than in clauses vii and viii and b normally receives not more than one-third of its support in each taxable_year from the sum of- i gross_investment_income as defined in subsection e and ii the excess if any of the amount of the unrelated_business_taxable_income as defined in sec_512 over the amount of the tax imposed by sec_511 internal_revenue_code sec_4946 states that the term disqualified_person means with respect to a private_foundation a person who is-- a a substantial_contributor to the foundation b a foundation_manager within the meaning of subsection b c an owner of more than percent of-- i the total combined voting power of a corporation ii the profits interest of a partnership or iii the beneficial_interest of a_trust or unincorporated enterprise which is a substantial_contributor to the foundation d a member_of_the_family as defined in subsection d of any individual described in subparagraph a b or c department of the treasury - internal_revenue_service form a rev page -17- department of the treasury - internal_revenue_service form 886a name of taxpayer explanation of items org schedule no or exhibit year period ended 20xx 20xx e a corporation of which persons described in subparagraph a b c or d own more than percent of the total combined voting power f a partnership in which persons described in subparagraph a b c or d own more than percent of the profits interest g a_trust or estate in which persons described in subparagraph a b c or d hold more than percent of the beneficial_interest h only for purposes of sec_4943 a private foundation- i which is effectively controlled directly or indirectly by the same control the private_foundation in question or person or persons who ii substantially_all of the contributions to which were made directly or indirectly by the same person or persons described in subparagraph a b or c or members of their families within the meaning of subsection d who made directly or indirectly substantially_all of the contributions to the private_foundation in question and i only for purposes of sec_4941 a government_official as defined in subsection c substantial contributors --for purposes of paragraph the term substantial_contributor means a person who is described in sec_507 b foundation_manager --for purposes of this subchapter the term foundation_manager means with respect to any private foundation- an officer director or trustee of a foundation or an individual having powers or responsibilities similar to those of officers directors or trustees of the foundation and with respect to any act or failure to act the employees of the foundation having authority or responsibility with respect to such act or failure to act d members_of_family --for purposes of subsection a the family of any individual shall include only his spouse ancestors children grandchildren great grandchildren and the spouses of children grandchildren and great grandchildren internal_revenue_code sec_507 -for purposes of paragraph the term substantial_contributor means any person who contributed or bequeathed an aggregate amount of more than dollar_figure more than percent of the total contributions and bequests received by the foundation before the close of the taxable_year of the foundation in which the contribution or bequest is received by the foundation from such person in the case of a_trust the term substantial_contributor also means the creator of the trust to the private_foundation if such amount is department of the treasury - internal_revenue_service form 886-acrev page - form 886a name of taxpayer explanation of items department of the treasury - interna revere service org schedule no or exhibit year period ended 20xx 20xx internal_revenue_code sec_4941 states that there is hereby imposed a tax on each act of self-dealing between a disqualified_person and a private_foundation the rate_of_tax shall be equal to percent of the amount_involved with respect to the act of self-dealing for each year or part thereof in the taxable_period the tax imposed by this paragraph shall be paid_by any disqualified_person other than a foundation_manager acting only as such who participates in the act of self- dealing in the case of a government_official as defined in sec_4946 a tax shall be imposed by this paragraph only if such disqualified_person participates in the act of self-dealing knowing that it is such an act internal_revenue_code sec_4941 in any case in which a tax is imposed by paragraph there is hereby imposed on the participation of any foundation_manager in an act of self-dealing between a disqualified_person and a private_foundation knowing that it is such an act a tax equal to percent of the amount_involved with respect to the act of self-dealing for each year or part thereof in the taxable_period unless such participation is not willful and is due to reasonable_cause the tax imposed by this paragraph shall be paid_by any foundation_manager who participated in the act of self-dealing internal_revenue_code sec_4941 additional taxes -- on self-dealer --in any case in which an initial tax is imposed by subsection a on an act of self-dealing by a disqualified_person with a private_foundation and the act is not corrected within the taxable_period there is hereby imposed a tax equal to percent of the amount_involved the tax imposed by this paragraph shall be paid_by any disqualified_person other than a foundation_manager acting only as such who participated in the act of self-dealing on foundation_manager --in any case in which an additional tax is imposed by paragraph if a foundation_manager refused to agree to part or all of the correction there is hereby imposed a tax equal to percent of the amount_involved the tax imposed by this paragraph shail be paid_by any foundation_manager who refused to agree to part or all of the correction internal_revenue_code sec_4941 special rules -for purposes of subsections a and b -- joint_and_several_liability --if more than one person is liable under any paragraph of subsection a or b with respect to any one act of self-dealing all such persons shall be jointly and severally liable under such paragraph with respect to such act dollar_figure limit for management --with respect to any one act of self-dealing the maximum amount of the tax imposed by subsection a shall not exceed dollar_figure department of the treasury - internal_revenue_service form 886-avrev -68 page - form_886 a name of taxpayer explanation of items ‘department of the treasury - intemal revenue service org schedule no or exhibit year period ended 20xx 20xx and the maximum amount of the tax imposed by subsection b shall not exceed dollar_figure internal_revenue_code sec_4941 in general -for purposes of this section the term self-dealing means any direct or indirect- a sale_or_exchange or leasing of property between a private_foundation and a disqualified_person b lending of money or other extension of credit between a private_foundation and a disqualified_person c furnishing of goods services or facilities between a private_foundation and a disqualified_person d payment of compensation or payment or reimbursement of expenses by a private_foundation to a disqualified_person e transfer to or use by or for the benefit of a disqualified_person of the income or assets of a private_foundation and f agreement by a private_foundation to make any payment of money or other_property to a government_official as defined in sec_4946 other than an agreement to employ such individual for any period after the termination of his government service if such individual is terminating his government service within a 90-day period internal_revenue_code sec_4941 for purposes of paragraph - a the transfer of real or personal_property by a disqualified_person to a private_foundation shall be treated as a sale_or_exchange if the property is subject_to a mortgage or similar lien which the foundation assumes or if it is subject_to a mortgage or similar lien which a disqualified_person placed on the property within the 10-year period ending on the date of the transfer b the lending of money by a disqualified_person to a private_foundation shall not be an act of self-dealing if the loan is without interest or other charge determined without regard to sec_7872 and if the proceeds of the loan are used exclusively for purposes specified in sec_501 c the furnishing of goods services or facilities by a disqualified_person to a private_foundation shall not be an act of self-dealing if the furnishing is without charge and if the goods services or facilities so furnished are used exclusively for purposes specified in sec_501 department of the treasury - internal_revenue_service form acrev page -20- 886a f name of t explanation of items ayer department of the treasury - intemal reverme service org onpey schedule no or exhibit - ende year period 20xx 20xx d the furnishing of goods services or facilities by a private_foundation to a disqualified_person shall not be an act of self-dealing if such furnishing is made on a basis no more favorable than that on which such goods services or facilities are made available to the general_public e except in the case of a government_official as defined in sec_4946 the payment of compensation and the payment or reimbursement of expenses by a private_foundation to a disqualified_person for personal services which are reasonable and necessary to carrying out the exempt_purpose of the private_foundation shall not be an act of self-dealing if the compensation or payment or reimbursement is not excessive f any transaction between a private_foundation and a corporation which is a disqualified_person as defined in sec_4946 pursuant to any liquidation merger redemption recapitalization or other corporate adjustment organization or reorganization shall not be an act of self-dealing if all of the securities of the same class as that held by the foundation are subject_to the same terms and such terms provide for receipt by the foundation of no less than fair_market_value g in the case of a government_official as defined in sec_4946 paragraph shall in addition not apply to-- i prizes_and_awards which are subject_to the provisions of sec_74 without regard to paragraph thereof if the recipients of such prizes_and_awards are selected from the general_public ii scholarships and fellowship grants which would be subject_to the provisions of sec_117 as in effect on the day before the date of the enactment of the tax_reform_act_of_1986 and are to be used for study at an educational_organization described in sec_170 yaxii iii any annuity_or_other_payment forming part of a stock-bonus pension or profit-sharing_plan by a_trust which is a qualified_trust under sec_401 iv any annuity_or_other_payment under a plan which meets the requirements of sec_404 v any contribution or gift other than a contribution or gift of money to or services or facilities made available to any such individual if the aggregate value of such contributions gifts services and facilities to or made available to such individual during any calendar_year does not exceed dollar_figure vi any payment made under chapter of title united_states_code or department of the treasury - internal_revenue_service form 886-arrev page -21- form 886a name of taxpayer explanation of items department of the treasury - tnternal revenue service org schedule no or exhibit year period ended 20xx 20xx vii any payment or reimbursement of traveling expenses for travel solely from one point_in_the_united_states to another point_in_the_united_states but only if such payment or reimbursement does not exceed the actual cost of the transportation involved plus an amount for all other traveling expenses not in excess of percent of the maximum amount payable under sec_5702 of title united_states_code for like travel by employees of the united_states and h the leasing by a disqualified_person to a private_foundation of office space for use by the foundation in a building with other argument of its gross_income see figure from in 20xx the ‘corporation’ received secretary secretary is not only a disqualified_person as described in sec_4946 but also a foundation_manager as noted in sec_4946 in 20xx and 20xx more than one-third of the income sources were derived from gross_investment_income and unrelated_business_income billboard advertising with respect to code sec_509 this organization does not meet the public support_test and thus is a private_foundation dollar_figuredollar_figure dollar_figuredollar_figure dollar_figuredollar_figure verified total annual payouts the excise_tax is computed as noted below figure of the funds received from the disqualified_person foundation more that manager were used to improve land owned by the disqualified_person purchase farm equipment or purchase other farming related supplies additionally other sources were used to pay attorneys and accountants and other service providers on behalf or for the private use of secretary in accordance with sec_4941 the transfer to or use by or for the benefit of a disqualified_person of the income or assets of a private_foundation constitutes an act of self-dealing the excise_tax is imposed on the amount_involved with respect to the years in question the amount_involved is sec_4941 a b dollar_figuredollar_figure b totals department of the treasury - internal_revenue_service taxpa yer’s position form 886-acrev 20xx - dp 20xx-fm 20xx-dp 20xx-fm dollar_figure dollar_figuredollar_figure dollar_figuredollar_figure dollar_figuredollar_figure dollar_figuredollar_figure dollar_figuredollar_figure dollar_figuredollar_figure dollar_figuredollar_figure dollar_figuredollar_figure dollar_figuredollar_figure dollar_figuredollar_figure 886a f name of taxpayer org ampaye explanation of items department of the treasury - intemal revenue service schedule no or exhibi year period eaa e 20xx 20xx the ‘corporation’ agreed with the service regarding this classification albeit it jumped the gun in filing a form_990-pf for 20xx when the examination had not reached its final audit conclusions the organization does not agree with the imposition of the excise_tax on the acts of self-dealing government’s conclusion the organization is a private_foundation consequently it is required to file delinquent form 990-pf's effective january 20xx the transaction between the organization and disqualified_person foundation_manager constitutes an act of self-dealing secretary as disqualified_person and foundation_manager is liable for the excise imposed under chapter with respect to page -23- department of the treasury - internal_revenue_service form 886-avrev -68