department of the treasury internal_revenue_service washington d c tax_exempt_and_government_entities_division number release date date date contact person se t eo ra t uil identification_number contact number employer_identification_number form required to be filed tax years dear this is our final_determination that you do not qualify for exemption from federal_income_tax as an organization described in internal_revenue_code sec_501 recently we sent you a letter in response to your application that proposed an adverse determination the letter explained the facts law and rationale and gave you days to file a protest since we did not receive a protest within the requisite days the proposed adverse determination is now final because you do not qualify for exemption as an organization described in code sec_501 donors may not deduct contributions to you under code sec_170 you must file federal_income_tax returns on the form and for the years listed above within days of this letter unless you request an extension of time to file instructions and do not send them to this office failure_to_file the returns timely may result in a penalty file the returns in accordance with their we will make this letter and our proposed adverse determination_letter available for public inspection under code sec_6110 after deleting certain identifying information please read the enclosed notice notice of intention to disclose and review the two attached letters that show our proposed deletions if you disagree with our proposed deletions follow the instructions in notice if you agree with our deletions you do not need to take any further action in accordance with code sec_6104 we will notify the appropriate state officials of our determination by sending them a copy of this final letter and the proposed adverse letter you should contact your state officials if you have any questions about how this determination may affect your state responsibilities and requirements if you have any questions about this letter please contact the person whose name and telephone number are shown in the heading of this letter federal_income_tax status and responsibilities please contact irs customer service pincite-829-1040 or the irs customer service number for businesses the irs customer service number for peopie with hearing impairments is if you have any questions about your sincerely robert choi director exempt_organizations rulings agreements enclosure notice redacted proposed adverse determination_letter redacted final adverse determination_letter department of the treasury internal_revenue_service washington d c contact person identification_number contact number fax number employer_identification_number government entities division date date uniform issue list egen i z i z i o i d i q - d s f - o k k n i u o t a h a dear we have considered your application_for recognition of exemption from federal_income_tax under sec_501 of the internal_revenue_code as an organization described in sec_501 based on the information submitted we have concluded that you do not qualify for exemption under that section the basis for our conclusion is set forth below facts you m are a state nonprofit corporation formed on date your articles of incorporation provide that you are organized exclusively for charitable religious literary educational cultural and scientific purposes including for such purposes the making of distributions to organizations that qualify as exempt_organizations under sec_501 of the internal_revenue_code and specifically for the purpose of providing grants to low income borrowers your form_1023 application provides that you will provide grants to low-income individuals to assist such individuals in connection with the purchase of a home individuals applying for grants will complete a grant application home ownership counseling courses will be highly recommended it further provides that your primary source of financial support will come from donations from sellers of homes to help stimulate low-income individuals in purchasing a home your form_1023 application shows dollar_figurey in expected receipts from those involved in the real_estate community such as sellers of homes and lenders it showed dollar_figurez in anticipated payments by m to prospective buyers pursuant to the eligible_loan program established by the organization the amount will be paid to assist qualified homebuyers for the down payment and closing costs for the purchase of participating homes a participating home is a home owned by a seller who has entered into a participating home agreement a buyer will qualify for an eligible_loan program which is a single-family mortgage loan product that allows m to provide gift funds toward a buyer’s down payment and closing costs a qualified buyer is a buyer that has been i credit approved for a qualifying loan program ii has completed an approved home ownership counseling course indicating the responsibilities of home ownership and iii purchases a participating home the qualified buyer will be the one that is a dedicated and deserving buyer in the real_estate market who with a down payment and closing cost assist from m is ready willing and able to purchase a home to be utilized as the buyer’s principal_residence the only condition to the receipt of the grant is that the prospective recipient of a grant of gift funds must successfully complete an approved home ownership counseling course which is offered to the prospective recipient at no cost to the buyer by a registered real_estate agent lender or title company your letter dated date states that you hope there will be an alliance with various mortgage brokers with experience in working with low-income individuals it further provides that mortgage lenders will be made aware of m through home counseling programs word of mouth and advertising your website provides an overview of your grant program it states that n a marketing and fundraising organization is the exclusive administrator of m’s grant program the grant is a gift to homebuyers and can be used for their down payment debt payoff and or closing costs the grant is a bona_fide gift to the homebuyer with no obligation to pay back whatsoever the seller or builder of the home being purchased pays a service fee to grant america for their services the fee is a percentage of the sales_price of the home the fee is based on how much cash the buyer needs to get into the home whether or the grant and then of the sales_price is added to the grant amount for example if the buyer needs a grant of for his down payment the seller would pay a service fee at closing the buyer receives a grant from m from an existing pool of funds after closing the seller pays the service fee to m and the pool of funds is replenished for future grants a seller would be interested in using the program because the availability of the grant can increase their pool of potential buyers and their bottom-line net is comparable to a traditional sale if a buyer wants to use the program m will refer the buyer to a realtor or lender that is familiar with m’s program if the buyer is already working with a realtor or lender the realtor or lender can contact m and m will provide them with the necessary information to use the program buyer can receive a grant of or of the purchase_price of the home they are buying depending on what the loan program requires the buyer qualifies for the program after they have been approved by the lender for the mortgage m’s program works with fha as well as conventional loans as provided in your letter dated date m works with the buyer realtor and mortgage company in the process of using the grant to accomplish the financing solutions for the buyer in order to enable the buyer to purchase a residence and to have a problem free settlement the program will not increase house prices to cover fees paid to them m provides that up to the date of its letter it has only used the grant with fha financing and requires a direct endorsement underwriter to review the appraisal report and the buyer’s credit and qualifying ratios your letter dated date provides facts regarding seller's contributions and m's service fees m will only allow disbursement of a grant if a fully direct endorsement underwritten approval exists the price is determined by way of a negotiation between buyer and seller and approved by a fha appraiser and underwriter m average sec_2 - grants per month the amount of contribution is determined by the buyer's needs to complete the purchase limited to the down payment and closing costs the seller contributes only upon completion of the loan settlement seller's contribution is collected only at settlement there is never a need for a reimbursement the seller's contribution is contingent upon the sale of the seller's home through the program m collects a service fee to maintain the program the service fee amount was determined to pay for advertising personnel overhead and to be competitive with other grant programs if the property does not settle the seller does not pay any fees the service fee of is firm and is the same in every transaction the amount to the buyer is determined based upon the need of the home buyer to complete the transaction there is no charge to the buyer to participate in the program the seller’s contribution is never greater than the total of the down payment and closing costs any excess must be returned to the seller your letter dated date states that m had only had grants with fha financing and only requires fha approved appraisers and fha suggests independent inspection of all homes but does not require it although in earlier correspondence m stated that homeowners would jearn about the program from home ownership courses m now says it did not state that and also denies stating that counseling courses are recommended m does not offer any services after the closing of the purchase and at that time had not offered the grant to anyone other than owner-occupied individuals m requires that anyone using fha financing be fully approved by an endorsement underwriter in addition the individual must meet all of the eligibility requirements of the program since fha financing tends to be used by more first time home buyers in modest priced communities m feels that the program does stimulate low_income_housing all grants utilized with fha financing therefore qualify as low_income_housing under fha criteria your letter dated date provides that m offers joint advertising incentive to it states that n is unrelated to m or to its officers or mortgage brokers that do business with m board members it further states that m’s website does not state that grants can be used for debt payoff referenced website materials are enclosed with this determination_letter your letter dated date indicates that m paid fees for social service facilitators who work for a local service_center for the spanish speaking community which help borrowers with forms documents language barriers etc potential buyers take buyer education courses to hopefully ensure that buyer’s acquire and keep homes without incurring a default in their financing it states further that m assists a segment of the hispanic population in southern o in obtaining home ownership and that m would contact housing departments in inner cities to notify them of the grant program once exemption is it also states that m suggests achieved it indicates that m has advertised in a limited number of local newspapers and received free publicity on a local radio station known as p provided by the station as a community service your letter dated date provides that m does not offer homeowner education programs nor directly offer credit counseling to homeowners m's criteria for approving homeownership counseling courses will be by a direct examination of courses offered and a determination by the m as to value of such courses m provided a list of homeownership courses the letter states that m does not require evidence of homeowner counseling courses completed however such documentation is requested from recipient and used as part of criteria receiving a grant the letter provides that m believes that any grant offered with fha financing has a very structured set of guidelines and as such no additional requirements other than hud guidelines necessary it states that m adheres strictly to fha hud guidelines and that all business has been generated through hud financing it further states that m offers all individuals an opportunity to obtain a grant and does not discriminate with arbitrary guidelines m intends to direct buyers to mortgage companies and realtors that are aware of existence and benefit of program the letter provides that hud does not indicate a maximum income that can be used in hud program however it has been indicated by hud that fha’s purpose is to stimulate first home purchases and that it has been shown that fha financing is used predominately with low-income_housing the letter states that m does not set any income limitations m’s income requirements are fha guidelines your letter dated date contains data from your website which states that no roof it states that gift letters go out same day as grant application is received it certification homeowner warranties or homebuyers education are required it states that funding will occur at loan closing after receipt of executed grant application and contract addendum if necessary it provides that the grant is typically of sales_price that m may grant a higher percentage if needed it explains the grant amount is limited to actual borrower incurred costs explains that grants are available on fha conventional and sub-prime loans and provides that seller can save hundreds of dollars your website provides step-by-step instructions for lenders as follows the real_estate contract addendum shoul be filled out and signed by seller builder and the buyer at same time sales agreement is executed the addendum is then forwarded to lender grant application should then be filled out by lender which can be done on line at m's website or faxed along with contract addendum gift letter for buyer is prepared and faxed to lender by m it further states that when the loan is approved the lender notifies m of the target closing date closing instructions are faxed to title company grants funds are wired from m to title company upon review and approval of estimated settlement statements and finally the closing occurs your letter dated date contains data from your website on tips for lenders it it states that the grant is a gift to buyers to be used for down payment and or closing costs provides that gifts from non-profit organizations are allowed by fha guidelines it states that when packaging a loan with a gift from a nonprofit the underwriter will require a gift letter and that this is the only documentation that the underwriter needs finally it provides that m will provide evidence of tax exempt status for underwriter if necessary you submitted with your letter dated date the following forms form to register with exempt_organization grant funds application form participating home agreement form and real_estate contract addendum form the manner in which you operate is referred to as seller-funded downpayment assistance in the final report an examination of downpayment gift programs administered by non-profit organizations commissioned by office of housing united_states department of housing and urban development hud contract no c-opc-22550 m0001 date the report concludes that seller-funded downpayment assistance for mortgage downpayments has led to underwriting problems that require immediate attention furthermore the report concludes that the effective costs of homeownership are increased even more by the processing fees charged by the seller-funded downpayment assistance providers which get passed through to borrowers in higher property prices a copy of the report is enclosed with this determination_letter law sec_501 of the code provides for the exemption from federal_income_tax of corporations organized and operated exclusively for charitable or educational_purposes provided no part of the net_earnings inures to the benefit of any private_shareholder_or_individual sec_1_501_c_3_-1 of the income_tax regulations provides that an organization operates exclusively for exempt purposes only if it engages primarily in activities that accomplish exempt purposes specified in sec_501 of the code an organization must not engage in substantial activities that fail to further an exempt_purpose sec_1_501_c_3_-1 of the regulations provides that an organization is not organized or operated exclusively for exempt purposes unless it serves a public rather than a private interest to meet this requirement it is necessary for an organization to establish that it is not organized or operated for the benefit of private interests sec_1_501_c_3_-1 of the regulations defines the term charitable as used in sec_501 of the code as including the relief of the poor and distressed or of the underprivileged the term charitable also includes the advancement of education sec_1_501_c_3_-1 of the regulations provides that an organization that operates a trade_or_business as a substantial part of its activities may meet the requirements of sec_501 of the code if the trade_or_business furthers an exempt_purpose and provided the organization’s primary purpose does not consist of carrying on an unrelated_trade_or_business in 326_us_279 the supreme court held that the presence of a single nature will destroy the exemption regardless of the number or importance of truly exempt purposes in easter house v u s cl_ct aff'd 846_f2d_78 fed cir cert nonexempt purpose if substantial 488_us_907 the court found an organization that operated an adoption agency was not exempt under sec_501 of the code because a substantial purpose of the agency was a nonexempt commercial purpose the court concluded that the organization did not qualify for exemption under sec_501 because its primary activity was placing children for adoption in a manner indistinguishable from that of a commercial adoption agency the court rejected the organization’s argument that the adoption services merely complemented the health related_services to unwed mothers and their children rather the court found that the health-related services were merely incident to the organization’s operation of an adoption service which in and of itself did not serve an exempt_purpose the organization’s sole source of support was the fees it charged adoptive parents rather than contributions from the public the court also found that the organization competed with for-profit adoption agencies engaged in substantial advertising and accumulated substantial profits accordingly the court found that the business_purpose and not the advancement of educational and charitable activities purpose of plaintiff's adoption service is its primary goal and held that the organization was not operated exclusively for purposes described in sec_501 easter house cl_ct pincite in 92_tc_1053 the court held that an organization that operated a school to train individuals for careers as political campaign professionals but that could not establish that it operated on a nonpartisan basis did not exclusively serve purposes described in sec_501 of the code because it also served private interests more than incidentally the court found that the organization was created and funded by persons affiliated with certain partisan political_party entities and that most of the organization’s graduates worked in campaigns for the partisan political_party candidates consequently the court concluded that the organization conducted its educational activities with the objective of benefiting partisan political_party candidates and entities although the candidates and entities benefited were not organization insiders the court stated that the conferral of benefits on disinterested persons who are not members of a charitable_class may cause an organization to serve a private interest within the meaning of sec_1 c - d ii of the regulations the court concluded by stating that even if the partisan political_party candidates and entities did comprise a charitable_class the organization would bear the burden of proving that its activities benefited members of the class in a non-select manner in 71_tc_202 the court held an organization that marketed handicrafts made by disadvantaged artisans through museums and other non- profit organizations and shops be operated for exclusively charitable purposes within the meaning of sec_501 of the code the organization in cooperation with national craft agencies selected the handicrafts it would market from craft cooperatives in communities identified as disadvantaged based on objective evidence the bureau of indian affairs or other ‘government agencies the organization marketed only handicrafts it purchased in bulk from these communities of craftsmen it did not select individual craftsmen based on the needs of the purchasers the court concluded that the overall purpose of the activity was to benefit disadvantaged communities the method it used to achieve its purpose did not cause it to serve primarily private interests because the disadvantaged artisans directly benefited by the activity constituted a charitable_class and the organization showed no selectivity with regard to benefiting specific artisans for exempt purposes therefore the court held that the organization operated exclusively in 283_fsupp2d_58 d d c the court relied on the commerciality doctrine in applying the operational_test because of the commercial manner in which this organization conducted its activities the court found that it was operated for a non-exempt commercial purpose rather than for a tax-exempt purpose among the major factors courts have considered in assessing commerciality are competition with for profit commercial entities extent and degree of below cost services provided pricing policies and reasonableness of financial reserves additional factors include inter alia whether the organization uses commercial promotional methods eg advertising and the extent to which the organization receives charitable donations revrul_67_138 1967_1_cb_129 holds that helping low income persons obtain adequate and affordable housing is charitable because it relieves the poor and distressed or underprivileged the organization carried on several activities directed to assisting low-income families obtain improved housing including coordinating and supervising joint construction projects purchasing building sites for resale at cost and lending aid in obtaining home construction loans revrul_70_585 1970_2_cb_115 discusses four examples of organizations providing housing and whether each qualified as charitable within the meaning of sec_501 of the code situation describes an organization formed to construct new homes and renovate existing homes for sale to low-income families who could not obtain financing through conventional channels the organization also provides financial aid to eligible families who do not have the necessary down payment when possible the organization recovered the cost of the homes through very small periodic_payments but its operating funds were obtained from federal loans and contributions from the general_public the revenue_ruling holds that by providing homes for low-income families who otherwise could not afford them the organization relieved the poor and distressed situation describes an organization formed to ameliorate the housing needs of minority groups by building housing units for sale to persons of low and moderate income on an open- occupancy basis the housing is made available to members of minority groups who are unable to obtain adequate housing because of local discrimination the housing units are located to help reduce racial and ethnic imbalances in the community as the activities were designed to eliminate prejudice and discrimination and to lessen neighborhood tensions the revenue_ruling holds that the organization was engaged in charitable activities within the meaning of sec_501 of the code situation describes an organization formed to formulate plans for the renewal and rehabilitation of a particular area in a city as a residential community the median income level in the area was lower than in other sections of the city and the housing in the area was generally old and badly deteriorated the organization developed an overall plan for the rehabilitation of the area it sponsored a renewal project and involved residents in the area renewal plan the organization also purchased apartment buildings that it rehabilitated and rented at cost to low and moderate income families with a preference given to residents of the area the revenue_ruling holds that the organization is described in sec_501 of the code because its purposes and activities combated community deterioration situation describes an organization formed to alleviate a shortage of housing for moderate-income families in a particular community the organization planned to build housing to be rented at cost to moderate-income families the service held that the organization failed to qualify for exemption under sec_501 of the code because the organization's program did not provide relief to the poor or further any other charitable purpose within the meaning of sec_501 and the regulations revrul_72_147 1972_1_cb_147 holds that an organization that provided housing to low income families did not qualify for exemption under sec_501 of the code because it gave preference to employees of a business operated by the individual who also controlled the organization although providing housing for low income families furthers charitable purposes doing so in a manner that gives preference to employees of the founder’s business primarily serves the private interest of the founder rather than a public interest revrul_2006_27 r b discusse sec_3 examples of organizations providing down payment assistance for home buyers situation describes an organization that provides assistance exclusively to low-income individuals to help with the funds needed to make a down payment on the purchase of a home it also offers educational activities to help prepare potential low-income home buyers for the responsibility of home ownership it requires a home inspection report to ensure that the home being purchased will be habitable it conducts a broad based fundraising program it does not accept contributions contingent on the sale of a particular property its staff awarding grants does not know the identity of parties involved in the transaction the organization meets the requirements for exemption under sec_501 of the code its grantmaking procedures combined with its efforts to educate homebuyers ensures that it is operated to benefit low- income beneficiaries who constitute a charitable_class any benefit to other parties does not detract from its charitable purpose of relieving the poor and distressed situation describes an organization that receives most of its support from home sellers and real-estate businesses that may benefit from the sale of homes to buyers the amount received from a seller correlates to the amount of the down payment assistance provided to the buyer its staff considering an application_for a grant knows the identities of parties involved in the transaction c of the code its receipt of a payment from the home seller corresponding to the amount of the down payment assistance and its reliance on these contributions for most of its funding indicate that the benefit to the home seller is a critical aspect of its operations the business_purpose becomes a primary goal and it is structured and operated to assist private parties this organization does not qualify as an organization described in section situation describes an organization formed to combat community deterioration in an it participates in a renewal project for the area that includes economically depressed area making down payment assistance available to eligible home buyers who wish to participate in newly-constructed affordable housing units by the organization it conducts educational activities to help prepare the homebuyers for the responsibility of home ownership it conducts a broad based fundraising program its down payment assistance program exclusively serves a charitable purpose of combating community deterioration and so it meets the requirements for exemption under sec_501 of the code analysis based on the information you provided in your application and supporting documentation we conclude that you are not operated for exempt purposes under sec_501 of the code an organization cannot be recognized as exempt under sec_501 unless it shows that it is both organized and operated exclusively for charitable education or other exempt purposes among other things the application and supporting documentation must demonstrate conclusively that the organization meets the operational_test of sec_1_501_c_3_-1 of the regulations your information indicates that your primary purpose is to operate a down payment assistance program that does not exclusively serve a purpose described in sec_501 charitable purposes include relief of the poor and distressed or of the underprivileged however you do not conduct your down see sec_1_501_c_3_-1 of the regulations payment assistance program in a manner that establishes that your primary purpose is to address the needs of the poor or underprivileged by enabling low-income individuals and families to obtain decent safe housing see revrul_70_585 situation and revrul_2006_27 situation you have not demonstrated that your down payment assistance program exclusively serves any other exempt_purpose such as combating community deterioration and lessening racial tensions the information provided indicates that you do not limit your assistance to certain geographic areas or target those areas experiencing deterioration or racial tensions you have not shown that your program is designed to attract a mixed-income group of homeowners to a specifically defined geographical area that has a history of racial problems see revrul_70_585 situation sec_2 and and revrul_2006_27 situation your down payment assistance program does not serve exclusively low-income persons instead your program is open to anyone that qualifies for an fha or hud loan without any income limitations your program is available to anyone who is able to qualify for an fha mortgage from any lender in any state in the united_states arranging the purchase of homes in a broadly defined metropolitan area does not further charitable purposes within the meaning of sec_501 of the code see revrul_70_585 situation and revrul_2006_27 situation furthermore you do not engage in any activity to ensure that the house will be habitable or that the buyer will be able to afford to maintain the house over time instead you rely solely on information provided by fha and on the mortgage_lender insurance agency home inspector or other third party to conduct such review you do not provide oversight or conduct any educational program or other activity to ensure that buyers are purchasing properties that are safe decent sanitary and affordable see revrul_67_138 and rev rui situation only an insubstantial portion of the activity of an exempt_organization may further a inc v united_states supra the presence of a single non-exempt purpose if substantial in nonexempt purpose as the supreme court held in better business bureau of washington d c nature will destroy the exemption regardless of the number or importance of truly exempt purposes you conduct your operations in a manner that is consistent with a commercial firm seeking to maximize sales of services rather than in a manner that would be consistent with a charitable or educational_organization seeking to serve a charitable_class or the public at large the manner in which you operate your down payment assistance program indicates that you facilitate the sales of homes in a manner that is indistinguishable from an ordinary trade_or_business you operate as a business that provides services to home sellers for which you for example your literature and website explain how the seller and charge a market rate fee agent will benefit from your program as sellers are able to sell their homes at the full list price this type of approach helps to demonstrate that your primary purpose consists of maximizing the fees you derive from facilitating sales of real_property in this respect you are similar to an organization which was denied exemption because it operated a conference center for a commercial purpose see airlie foundation inc v u s supra likewise operating a trade_or_business of facilitating home sales is not an inherently charitable activity thus a substantial part of your activities further a nonexempt purpose another indication of your substantial nonexempt purpose is your lack of public support you are not supported by contributions from the general_public government or private_foundation grants almost all of your revenue comes from the sellers you serve that your primary activity is to promote and to further your private business interests is reflected in the financing structure of your down payment assistance program in this respect you are similar to the organization described in easter house v u s supra which derived most of its support from fees it charged for its adoption services in this case the court stated that the substantial fees were not incidental to the organization’s exempt_purpose because they were designed to make a profit charitable activity and receiving support primarily from fees charged to home sellers is indicative of your commercial purpose facilitating home sales like running an adoption service is not an inherently even if your program were changed to be directed to exclusively low-income individuals your reliance entirely on home sellers or other real-estate related businesses that stand to benefit from the transactions to finance your down payment assistance activities demonstrates that you are operated for the purpose of benefiting private parties contrary to sec_1 c -1 d ii of the regulations your grant making procedures indicate that gift funds are only provided if a seller has paid a service fee and made a contribution to you equal to the amount_of_the_gift provided by you to the buyer in fact these transactions are not contributions because they will not proceed from detached and disinterested generosity 363_us_278 any characterization of these transactions as contributions ignores the business realities surrounding the payments the sellers will make the payments to you and indirectly to the homebuyer to facilitate the sale of their homes in effect these payments have a circular character to them upon the closing of the sale the sellers contribution to you is returned to seller as part of the proceeds the seller receives from the sale of the home these contributions are appropriately characterized as fees received in exchange for the sale of a service your information indicates that your staff is able to take into account whether there is a home seller willing to make a payment to cover the down payment assistance an applicant has requested that you receive a payment from the home seller corresponding to the amount of the down payment assistance in every transaction indicates that the benefit to the home seller is not a mere accident but rather an intended outcome of your operations in this respect you are like easter house v u s supra which provided health care to indigent pregnant women but only when a family willing to adopt a woman’s child sponsored the care financially similar to american campaign academy v comm supra you are structured and operated to directly benefit the home sellers who pay for your services therefore a substantial part of your activities serve a private rather than a public interest conclusion based on the facts and information submitted you are not operated exclusively for exempt purposes you have not established that you activities exclusively serve a charitable_class or any other purpose defined in sec_501 your proposed operations further a substantial nonexempt business_purpose and will further the private interests of home sellers and other private parties therefore you are not described in sec_501 of the code accordingly you do not qualify for exemption as an organization described in section c of the code and you must file federal_income_tax returns contributions to you are not deductible under sec_170 of the code you have the right to file a protest if you believe this determination is incorrect to protest you must submit a statement of your views and fully explain your reasoning you must submit the statement signed by one of your officers within days from the date of this letter we will consider your statement and decide if the information affects our determination you also have a right to request a conference to discuss your protest this request should be made when you file your protest statement an attorney certified_public_accountant or an individual enrolled to practice before the internal_revenue_service may represent you if you want representation during the conference procedures you must file a proper power_of_attorney form_2848 power_of_attorney and declaration of representative if you have not already done so and power_of_attorney all forms and publications mentioned in this letter can be found at www irs gov forms and publications for more information about representation see publication practice_before_the_irs if you do not file a protest within days you will not be able to file a suit for declaratory_judgment in court because the internal_revenue_service irs will consider the failure to protest as a failure to exhaust available administrative remedies code sec_7428 provides in part that a declaratory_judgment or decree shall not be issued in any proceeding unless the tax_court the united_states court of federal claims or the district_court of the united_states for the district of columbia determines that the organization involved has exhausted all of the administrative remedies available to it within the irs if you do not intend to protest this determination you do not need to take any further action letter that letter will provide information about filing tax returns and other matters if we do not hear from you within days we will issue a final adverse determination if you do intend to protest this determination please send your protest statement form_2848 and any supporting documents to this address internal_revenue_service constitution ave n w washington dc you may also fax your statement using the fax number shown in the heading of this letter if you fax your statement please call the person identified in the heading of this letter to confirm that he or she received your fax if you have any questions please contact the person whose name and telephone number are shown in the heading of this letter sincerely robert choi director exempt_organizations rulings agreements enclosure an examination of downpayment gift programs administered by non-profit organizations hud contract no c-opc-22550 m0001 date


department of the treasury internal_revenue_service te_ge eo examinations commerce street dallas texas tax_exempt_and_government_entities_division release number release date legend org organization name xx date address address org address date taxpayer_identification_number form_990 ez and f-990t tax_year s ended person to contact id number contact numbers telephone fax certified mail - return receipt requested dear in a determination_letter dated july 19xx you were held to be exempt from federal_income_tax under sec_501 of the internal_revenue_code the code based on recent information received we have determined you have not operated in accordance with the provisions of sec_501 of the code accordingly your exemption from federal_income_tax is revoked effective may 20xx this is a final adverse determination_letter with regard to your status under sec_501 of the code we previously provided you a report of examination explaining why we believe revocation of your exempt status is necessary at that time we informed you of your appeal rights on september 20xx you signed form 6018-a consent to proposed action agreeing to the revocation of your exempt status under sec_501 of the code you have filed federal_income_tax returns for the tax period s shown above file returns for later tax years with the appropriate service_center indicated in the instructions for those returns you have the right to contact the office_of_the_taxpayer_advocate taxpayer_advocate assistance is not a substitute for established irs procedures such as the formal appeals process the taxpayer_advocate cannot reverse a legally correct_tax determination or extend the time fixed by law that you have to file a petition in a united_states court the taxpayer_advocate can however see that a tax matter that may not have been resolved through normal channels gets prompt and proper handling you may call toll-free and ask for taxpayer_advocate assistance if you prefer you may contact your local taxpayer_advocate at if you have any questions please contact the person whose name and telephone number are shown at the beginning of this letter sincerely nanette m downing acting director eo examinations form schedule or exhibit no explanation of items year period ended april 886-a_ name of taxpayer org legend org organization name poa poa state state ra 20xx xx date co-1 address address co-2 co-3 co-4 co-5 companies ra-1 thru ra-30 city city co-6 co-7 thru issues did organization keep records per rev_proc is the net_operating_loss deductible is there private benefit inurement to members is there a substantial non exempt activity from gross_income_test is revocation warranted 20xx04 no no yes yes yes facts initial interview was conducted with treasurer on october 20xx at the club’s facility is the current treasurer of the organization he provided the following information about the social_club org org is an organization with a tax exemption per sec_501 as described in sec_501 as a social_club it does not actively solicit membership but accepts application it’s membership is limited to it operates a facility located at address city state its facility is subdivided into two sections the section that is used on a daily basis is the private club with a gaming room and a bar the other section is an auditorium or a meeting or multi purpose hall that is rented to members and to the public private club the private club is for members only members are allowed to bring in guests except on wednesday nights where weekly membership meeting is held during wednesday nights it provides free dinner to members which does not include drinks such as beer and soda the private club has two sections one section has a billiard table and a card table to a bar with a lounge and large screen television beer is served at dollar_figure each while sodas are at dollar_figure each they do not serve sandwiches or any other meals it is adjoined members pay the same price as their guests the guests pay for their own beers and sodas department of the treasury - internal revenue page 20xx april explanation of items schedule or exhibit no year period ended form 886-a_ name of taxpayer org there are usually three bar managers at any given time the head bar manager handles all the sales proceeds purchases supplies and other direct expenses keeps a portion for commissions to himself and pays the sales_tax each month the head bar manager turns over the net_proceeds to the treasurer for around dollar_figure month organization in turn reported the net_proceeds as its gross_proceeds on its books and f-990 return organization did not report funds kept by the bar manager prior to the examination of the return for the following amounts bar manager ra-1 20xx dollar_figure dollar_figure 20xx dollar_figure dollar_figure 20kx dollar_figure 20xx dollar_figure dollar_figure auditorium or multi purpose hall the facility has an adjoining auditorium or multi purpose hall members the lease rate to members is dollar_figure and dollar_figuredollar_figure to non members this was recently increased from dollar_figure it is leased to members and non the lease does not cover clean up of the facility the rental_activity of the auditorium was reported on the f-990t as from unrelated_business_income with gross_receipts of dollar_figuredollar_figure and related expenses of dollar_figuredollar_figure for a net profit of dollar_figure this net profit along with investment_income of dollar_figuredollar_figure was reduced to dollar_figure unrelated_business_income before dollar_figure specific deduction by a net_operating_loss of dollar_figuredollar_figure the rental_activity is managed by ra-2 he handles the bookings rental receipts pays expenses and keeps a commission to himself before turning over the net_proceeds to the organization organization in turn records the net receipts as its gross rental receipts on its books_and_records and to the f-990 and f-990t return organization did not report funds kept by the rental manager prior to the examination of the return for the following amounts rental manager ra-2 20xx dollar_figure dollar_figure 20xkx dollar_figuredollar_figure 20xx dollar_figure dollar_figure 20xx dollar_figure dollar_figure additional audit procedures performed requested organization to reconstruct its rental income and a expenses per rev_proc and according to member and non member income organization did not keep adequate books_and_records it did not keep records per rev_proc as noted earlier it reported revenues net of expenses or commissions or payments made by the lease coordinator and bar managers to themselves department of the treasury -- internal revenue page form 886-a_ explanation of items schedule or exhibit no name of taxpayer org april 20xxx year period ended reviewed organization’s reconstruction of rental income and b expenses and verified to lease contracts and membership roster reviewed details of organization’s reconstruction of lease revenues and expenses as far as member and non member classification at the minimum reconstructed gross revenue is dollar_figure as compared to amount reported on f-990t for dollar_figuredollar_figure however non member expenses subject_to ubi dropped down to dollar_figure but had an increase in net_income to dollar_figure as opposed to dollar_figure on f-990t reviewed reclassification and noted that there were revenues classified as membership or rentals but the names of lessees on the contract are not listed on membership roster for 20xx-20xx that was the only available membership roster provided during the examination requested organization to provide documentation to prove membership on idr for a b ra-3 www ii veterans library unfortunately organization did not provide the requested documentation therefore the reconstructed revenues and expenses for member and non membership lease of the auditorium were adjusted per examination as follows leasing activity -- member and non member revenues and expenses as adjusted per examination non member non member revenue expense non member net_income reconstructed member non member use of rental facility rental income per rental contracts member member member revenues expense net_income 20xx 20xx quarterly quarterly quarterly quarterly rental income - revised may june july august sept oct nov dec jan feb mar apr subtotal wwii veterans library wwii veterans library wwii veterans library wwii veterans library allocation of operation exp-p r total department of the treasury - internal revenue page form 886-a_ name of taxpayer org explanation of items april 20xx schedule or exhibit no year period ended operational expense - p r ratio of member revenue ratio of nonmember revenue leases reclassified from member to non member for lack of documentation to show that lessees were members of the organization per organization roster of members and as required by revproc_71_17 for the following ra-3 ra-4 ra-5 ra-6 - co-1 other issues organization applied dollar_figuredollar_figure of net_operating_loss from prior years to offset taxable_income for fiscal_year ending 20xx copy of the f-990t for fy 20xx showed it was the originating year of the loss for dollar_figure had a allocation for indirect expenses such as utilities maintenance depreciation insurance supplies etc it the basis for the allocation was arrived at to arrive pincite of indirect_costs for the organization failed to provide substantiation to show a originating year of the net_operating_loss and b c substantiation for the basis of allocation used substantiation for the indirect expenses_incurred during the originating year in addition poa has agreed that the net_operating_loss cannot be substantiated and to forego the deduction gross_income_test the gross_receipts_test requires that gross_receipts of sec_501 organizations should not exceed the following a income cannot exceed and b gross_receipts from non members use of facility and services cannot exceed gross_receipts from non members use of facility and services including investment org did not exercise oversight on the rental revenues handled by the ra-2 the rental manager collected lease revenues and kept commissions and other expenses before turning over the net receipts to org treasurer organization in turn recorded the net receipts on its books as its gross rental income and is the amount reported on the f-990 and f-990t returns department of the treasury -- internal revenue page explanation of items form 886-a name of taxpayer org org reconstructed gross rental revenue the reconstructed gross rental revenue is adjusted per exam for organization’s inclusion of some member rental income whose names do not appear on the membership roster and failure to provide substantiation per revproc_71_17 schedule or exhibit no year period ended april 20xx performed gross_income_test based upon reconstructed amount of revenue per examination between member and non member rental_activity of organization’s auditorium result of the test is as follows 20x x04 per f-990t return 20x x04 per f-990t ubi gross revenue ubi per exam gross revenue investment_income nonmember income total review of prior year 20x x04 gross_income_test based on amounts reported on f-990t is as follows per f-990t investment_income nonmember income total 20xx04 ubi gross revenue sec_15 test no yes based upon the above gross_receipts_test it appears that the organization did not meet the test for gross_receipts from non member use of facility and services in the year under examination for the year ending 20xx pincite prior year return ending 20xx using the amounts reported on the f-990t return showed its gross_income_test pincite it showed that organization is engaged in more than a substantial amount of non exempt activity the findings were presented to the organization and representative in addition upon request trom the representative organization was offered an alternative to adopt corrective actions to meet the gross_income_test and exercise more control_over its bar and rental_activity organization agreed to the revocation of its tax exemption for failing to satisfy the gross_income_test however when it signed the f-6018 it changed the effective date to may 20xx informed organization that the effective date cannot be changed to a prospective date it requested that its revocation be reconsidered and will be willing to adopt changes to be in compliance with its exemption requirements it inquired what steps it needed to adopt to keep its tax exemption per advise of current gm organization has to adopt the following department of the treasury - internal revenue page 20xx april explanation of items schedule or exhibit no year period ended form 886-a name of taxpayer org if in case your organization decides to appeal the revocation of tax exempt status with the group manager at the minimum the board and officers will have to discuss vote and adopt changes effective immediately to correct the operation of the organization's activities a organization and officers are responsible to ensure that its assets such as cash and investment accounts are being protected it has to adopt tight internal controls in the operation cash handling recording of revenues with all aspects of its activities such as membership fees rental bar golf tournament and all other fundraising activities b organization has to take control of it gross revenues and deposit fully in its bank accounts c organization has to pay its expenses by issuing checks and not through cash payouts d organization has to deposit fundraising revenues allocated for charitable or community service to a separate bank account from its general fund it was also noted that organization deposits the net revenue from its golf and other fundraising activities with a number of expenses unaccounted for e net_operating_loss will be disallowed and taxes will be paid on f-990t for the year under audit and subsequent years it was noted that organization erroneously reported dollar_figure gross revenues on its f-990t for subsequent tax_year ending 20xx f bar and rental managers will be under the direct supervision and control of the officers of the organization there should be complete reporting of revenues and expenses expenses should be paid from the bank account and not from cash payouts g organization should maintain an inventory of cost_of_goods_sold and purchases related to the bar operations such as drinks snacks etc poa indicated on 20xx that organization decided to agree to the revocation of its tax exempt status it requested additional days to prepare converted f-1120 returns the board_of directors voted to agree with the proposed revocation on f-6018 it was signed and was received on 20xx a copy of the resolution adopted by the board_of directors was also provided unrelated_business_income ubd _ per sec_512 as noted earlier revenues and expenses from leasing of the auditorium or multi purpose hall to the public or non members were reported on the f-990t on a net of expenses basis reconstruction of member and non member revenues and expenses by the organization were further adjusted for examination purposes per guidelines of revproc_71_17 as follows leasing activity -- revenues and expenses as adjusted per examination reconstructed member non member use of rental facility rental income per rental contracts member member member rental income - revised revenues expense net_income 20xx may non member non member non member net revenue expense - income department of the treasury - internal revenue page form 886-a_ name of taxpayer org schedule or exhibit no explanation of items year period ended april 20xx 20xx quarterly quarterly quarterly quarterly june july august sept oct nov dec jan feb mar apr subtotal wwii veterans library wwii veterans library wwii veterans library wwii veterans library allocation of operation exp-p r total operational expense - p r ratio of member revenue ratio of nonmember revenue 20xx04 rent income rent expense net rental income investment_income net profit on f-990t net_operating_loss c o unrelated business tax inc specific deduction net taxable_income tax nol c o from prior year ded allowed in current yr c o to subs year law 20xx04 20xx04 20xx04 sec_501 exemption from tax on corporations certain trusts etc department of the treasury - internal revenue page form schedule or exhibit no 886-a explanation of items name of taxpayer org april 20xxx year period ended a exemption from taxation -an organization described in subsection c or d or sec_401 shall be exempt from taxation under this subtitle unless such exemption is denied under sec_502 or sec_503 c clubs organized for pleasure recreation and other nonprofitable purposes substantially_all of the activities of which are for such purposes and no part of the net_earnings of which inures to the benefit of any private shareholder tax-regs sec_1_501_c_7_-1 social clubs a the exemption provided by sec_501 for organizations described in sec_501 applies only to clubs which are organized and operated exclusively for pleasure recreation and other nonprofitable purposes but does not apply to any club if any part of its net_earnings inures to the benefit of any private shareholder in general this exemption extends to social and recreation clubs which are supported solely by membership fees dues and assessments however a club otherwise entitled to exemption will not be disqualified because it raises revenue from members through the use of club facilities or in connection with club activities b a club which engages in business such as making its social and recreational facilities available to the general_public or by selling real_estate timber or other products is not organized and operated exclusively for pleasure recreation and other nonprofitable purposes and is not exempt under sec_501 solicitation by advertisement or otherwise for public patronage of its facilities is prima facie evidence that the club is engaging in business and is not being operated exclusively for pleasure recreation or social purposes however an incidental sale of property will not deprive a club of its exemption reg sec_1_501_c_7_-1 sec_172 net_operating_loss_deduction a deduction allowed -there shall be allowed as a deduction for the taxable_year an amount equal to the aggregate of the net_operating_loss carryovers to such year plus the net_operating_loss carrybacks to such year for purposes of this subtitle the term net_operating_loss_deduction means the deduction allowed by this subsection irc code sec_511 imposition of tax on unrelated_business_income of charitable etc organizations a charitable etc organizations taxable at corporation rates - a imposition of tax -there is hereby imposed for each taxable_year on the unrelated_business_taxable_income as defined in sec_512 of every organization described in paragraph a tax computed as provided in sec_11 in making such computation for purposes of this section the term taxable_income as used in sec_11 shall be read as unrelated_business_taxable_income irc code sec_512 unrelated_business_taxable_income a definition -for purposes of this title - department of the treasury - internal revenue page explanation of items form 886-a_ name of taxpayer org a general_rule -except as otherwise provided in this subsection the term unrelated_business_taxable_income means the gross_income derived by any organization from any unrelated_trade_or_business as defined in sec_513 regularly carried on by it less the deductions allowed by this chapter which are directly connected with the carrying on of such trade_or_business both computed with the modifications provided in subsection b schedule or exhibit no year period ended april 20xxx a special rules applicable to organizations described in paragraph or of sec_501 - sec_512 - irc code sec_513 unrelated_trade_or_business a general_rule -the term unrelated_trade_or_business means in the case of any organization subject_to the tax imposed by sec_511 any trade_or_business the conduct of which is not substantially related aside from the need of such organization for income or funds or the use it makes of the profits derived to the exercise or performance by such organization of its charitable educational or other purpose or function constituting the basis for its exemption under sec_501 or in the case of an organization described in sec_511 to the exercise or performance of any purpose or function described in sec_501 except that such term does not include any trade_or_business - a in which substantially_all the work in carrying on such trade_or_business is performed for the organization without compensation or a which is the selling of merchandise substantially_all of which has been received by the organization as gifts or contributions irc code sec_172 net_operating_loss_deduction a deduction allowed -there shall be allowed as a deduction for the taxable_year an amount equal to the aggregate of the net_operating_loss carryovers to such year plus the net_operating_loss carrybacks to such year for purposes of this subtitle the term net_operating_loss_deduction means the deduction allowed by this subsection revproc_71_17 im 1971_1_cb_683 sec_1 scope and purpose this revenue_procedure sets forth guidelines for determining the effect gross_receipts derived from use of a social club’s facilities by the general_public have on the club’s exemption from federal_income_tax under sec_501 of the internal_revenue_code of these guidelines will be used in connection with the examination of annual returns on forms and 990-t filed by social clubs this revenue_procedure also describes the records required when nonmembers use a club’s facilities and the circumstances under which a host-guest relationship will be assumed which are relevant both for purposes of determining adherence to the exemption requirements and for computing exempt_function_income under sec_512 of the code however this revenue_procedure does not deal with other factors bearing on the exempt status of clubs department of the treasury -- internal revenue page form 886-a explanation of items schedule or exhibit no name of taxpayer year period ended org april 20xxx sec_2 background general statement --use of a club’s facilities by the general_public is significant for two reasons it may indicate the existence of a nonexempt purpose or if not of sufficient substantiality to result in loss of exemption it may make the club liable for unrelated_business_income_tax the term general_public as used in this revenue_procedure means persons other than members of a club or their dependents or guests the member’s spouse is treated as a member nonexempt purpose --in the examination of information returns of clubs the problem frequently is to determine under what circumstances and to what extent the fact that a club makes its facilities available to the general_public is to be relied upon by the service as indicating the existence of a nonexempt purpose where a club makes its facilities available to the general_public to a substantial degree the club is not operated exclusively for pleasure recreation or other nonprofitable purposes see revrul_60_324 c b and revrul_69_219 c b however this does not mean that all dealings with the general_public are necessarily inconsistent with the club’s purposes see revrul_58_589 c b revrul_68_119 c b and revrul_69_636 c b unrelated_business_income_tax --clubs have been made subject_to the tax on unrelated_business_income for taxable years beginning after date sec_511 of the code as amended by the tax reform act of public law c b and sec_512 of the code added by the tax reform act of the unrelated_business_taxable_income of a club is its gross_income excluding any exempt_function_income less the allowable deductions directly connected with the production of the gross_income excluding exempt_function_income both computed with the modifications specified sec_512 of the code taxpayer’s position board_of directors adopted a resolution to agree with the revocation of the organization’s tax exempt status per sec_501 it signed and submitted a f-6018 which was received on 20kx government’s position recordkeeping requirement per revproc_71_71 examination of f-990 and f-990t return of org org showed it did not keep records as required by revproc_71_17 for social_club to show revenues and expenses for member and non member from its rental_activity at the minimum it warrants an advisory net_operating_loss per sec_172 department of the treasury -- internal revenue page explanation of items form 886-a_ name of taxpayer org however the net_operating_loss nol that is carried forward to the year under examination is being disallowed per sec_172 for non substantiation of expenses and basis for allocation of expenses relating to the loss schedule or exhibit no year period ended april 20xxx the disallowance of the loss will result in tax_liability per irc however this issue is no longer pursued as organization decided to agree with the revocation of its tax exemption status by signing f-6018 organization will have a f-1120 filing requirement instead of a f-990 and f-990t revocation of tax exempt status per sec_501 audit procedures performed showed that org’s tax exemption status warrants a revocation based on the following private benefit inurement to members for funds paid_by the rental and bar manager to i themselves for operating the bar and rental_activity for the following amounts gross wages ra-2 ra-1 total 20xx dollar_figure dollar_figure dollar_figuredollar_figure dollar_figure dollar_figure dollar_figuredollar_figure dollar_figuredollar_figure dollar_figuredollar_figure dollar_figure dollar_figure 20xx 20kx 20xx dollar_figure dollar_figure the above funds were not turned over or reported to the organization and operated the rental and bar manager as if it were their own business these amounts represent net_earnings or inurement to the bar and rental manager who are also members of the organization more than an insubstantial non exempt activity from rental of facilities to non members gross_income_test showed organization had or more than of gross_income from its rental of its facility to non members it is reconstructed as follows 20xx04 per f-990t return 20xx04 per f-990t ubi gross revenue ubi per exam gross revenue investment_income nonmember income total prior year f-990t 20x x04 was not examined however the amounts reported on the f-990t showed gross_income_test pincite and supports the finding in the year under examination that there is more than an insubstantial non exempt activity from non members as follows per f-990t investment_income nonmember income total 20xx04 ubi gross revenue sec_15 test no yes department of the treasury - internal revenue page i1 form 886-a name of taxpayer org explanation of items april 20xx schedule or exhibit no year period ended the results showed that the organization was not operated exclusively for the benefit of its members and warrants the revocation of its tax exempt status per sec_501 the proposal for revocation was presented along with an option to adopt changes in its operation to correct deficiencies noted above and operate within the requirements of its tax exempt status the board_of directors have adopted a resolution dated 20xx to consent to the revocation of its tax exempt status and signing the f-6018 which was received on 20xx revocation is effective as of 20xx and organization agreed to prepare and file converted f- returns unrelated_business_income ubt per sec_512 in case the tax exemption status of the organization is revoked for failing to satisfy the gross_income_test the f-990 and f-990t returns will be converted to a f-1120 return therefore there is no longer a need to raise the additional tax per irc for ubi on leasing rental_activity of its facility to non members however in the event that organization’s tax exempt status is not revoked for whatever reason even though it failed to satisfy the gross_income_test an alternative proposal is made for adjustment to non member revenue and expenses which will result in additional tax per irc as follows 20xx04 rent income rent expense net rental income investment_income net profit on f-990t net_operating_loss c o unrelated business tax inc specific deduction per sec_512 net taxable_income tax 20x04 20xx04 20xx04 nol c o from prior year ded allowed in current yr c o to subs year deduction for net_operating_loss carried over to the year under examination is disallowed in full for dollar_figure for non substantiation per sec_172 as noted above department of the treasury - internal revenue page form 886-a_ name of taxpayer org explanation of items april 20xx schedule or exhibit no year period ended conclusion examination procedures performed showed that org did not keep records as required by rev for social clubs net_operating_loss carried over from prior years for dollar_figure is being disallowed for non substantiation of expenses and basis for allocation of its expenses from member and non member use of the facility disallowance is made per sec_172 examination of org’s operation cash handling and recording of the rental and bar activity showed that a portion of the receipts were retained and not turned over by the bar and rental managers these funds were not reported on the organization’s books f-990 f-990t and payroll returns the proceeds kept by the rental and bar managers represent inurement private benefit which is prohibited for organizations exempt per sec_501 as described per sec_501 for social clubs it warrants a revocation of its tax exempt status per sec_501 gross_income_test performed showed that the revenues from the rental_activity of the multipurpose hall to non members greatly exceeded of its gross revenues in the year under examination pincite review of f-990t for prior year which was not audited nor adjusted showed gross_income from rental_activity greatly exceeded as well pincite facts showed that rental_activity to non members represent a more than insubstantial amount of non exempt activity as a social organization it warrants a revocation of its tax exempt status per sec_501 as described per sec_501 above findings were presented to organization and its representatives on file organization was offered an unagreed conference with group manager and to adopt corrective actions organization decided to agree with the proposed revocation of its tax exempt status by signing f- which was received on 20xx supporting schedule of non member income adjusted per exam for period may 20xx through april 20xx is as follows reconstruction of non member income per exam rental expenses per tp's reconstruction may member expense member expense non totexp member revenue non member revenue tot rev ra-3-co-4 ra-7 ra-8 total 20xx 20xx 20xx 20xx 20xx 20xx june ra-9 ra-9 department of the treasury - internal revenue page form 886-a name of taxpayer org explanation of items japril 20xxx schedule or exhibit no year period ended 20xx 20kx ra-10 ra-11 total 20xx 20xx wns 20xx 20xx tn 20kx 20xx 20xx 20xx 20xx 20xx 20xx 20xx 20xx july ra-12 ra-13 ra-14 ra-15 ra-16 total august ra-3-co-4 ra-17 ra-19 total september ra-20 ra-3 hpc ra-21 ra-22 co-2 total 20xx 20xx 20xx 20xx 20xx 20xx 20xx october co-3 c o ra-23 ra-4 ra-3-co-4 ra-24 co-5 ra-25 ra-26 c o co-7 ra-27 c o ra-28 total 20xx li 20xx 20xx november ra-3 ra-29 ra-30 total 20xx 20xx 20xx 20xx 20xx december ra-3-co-4 co-1 c o ra-6 co-4 ra-5 ra-3 ra-1 department of the treasury - internal revenue page form 886-a name of taxpayer org schedule or exhibit no year period ended explanation of items april 20xx total entity rep for co-5 is ra-7 who is a club member 20xx 20xx january co-7 no rental_activity in jan 20xx but there are deposits to the rental bank account 20xx 20xx 20xx 20xx 20xx 20xx 20xx 20xx 20xx february ra-18 ra-3 co-1 total march ra-3 co-5 ra-22 ra-28 total april ra-30 ra-12 ra-3 co-5 co-2 department of the treasury - internal revenue page


internal_revenue_service number release date index number ---------------------------------------- ------------------------------------------- ------------------------------------------------------ ----------------------------- legend x department of the treasury washington dc third party communication none date of communication not applicable_person to contact ----------- id no ------------- telephone number -------------------- refer reply to cc psi b01 plr-156940-06 date june ------------------------------------------ ---------------------- ------------------ ------------ -------------------------- d1 state d2 dear -------------- this responds to the letter dated date and related correspondence submitted on behalf of x requesting relief under ' b of the internal_revenue_code facts x was organized as a limited_liability_company on d1 under the laws of state x intended to be treated as an s_corporation for federal tax purposes however x inadvertently failed to timely file a form_2553 election by a small_business_corporation effective d2 law and analysis sec_1362 provides that a small_business_corporation may elect to be an s_corporation plr-156940-06 sec_1362 provides the rule on when an s election will be effective if an s election is made within the first two and one-half months of a corporation s taxable_year then the corporation will be treated as an s_corporation for the year in which the election is made if the election is made after the first two and one-half months of a corporation s taxable_year then the corporation will not be treated as an s_corporation until the taxable_year after the year in which the s election is made sec_1362 provides that if no election is made pursuant to ' a or if made the election is made after the date prescribed for making such an election and the secretary determines there was reasonable_cause for the failure to timely make the election then the secretary may treat such an election as timely made for such taxable_year and effective as of the first day of that tax_year conclusion based solely on the facts and representations submitted we conclude that x has established reasonable_cause for failing to make a timely election to be an s_corporation effective d2 accordingly provided that x makes an election to be an s_corporation by filing a completed form_2553 effective d2 along with a copy of this letter with the appropriate service_center within days from the date of this letter then such election will be treated as timely made for d2 except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent sincerely audrey w ellis senior counsel branch office of the associate chief_counsel passthroughs and special industries enclosures copy of this letter copy for ' purposes cc


office_of_chief_counsel internal_revenue_service memorandum number release date cc corp b04 postu-111611-05 uilc date september to case coordinator large mid-size business from senior technician reviewer branch associate chief_counsel corporate subject application of sec_332 of the internal_revenue_code to a deemed liquidation this chief_counsel_advice responds to your request for assistance in accordance with sec_6110 this advice may not be used or cited as precedent legend -------------- ------------------------ parent --------------------------------------------------------------------------- sub --------------------------------------------------------------------------- sub --------------------------------------------------------------------------- fsub ------------------------------------------------------------------------------- month a month b ---------------------- ------------------ ---------------------------------------- -------------------------------------------- ---------------------- ------------------ ------------ ------------------------------------ ---------------------------------- ------------------------ ----------------------------------------- ------------------------------------- ------------------------------------- --------------------------------------- ----------------------------------------- postu-111611-05 date c month d country x appraiser a b c d e f issue whether sec_332 of the internal_revenue_code applies to the deemed liquidation of fsub upon a change in entity classification under sec_301_7701-3 of the procedure and administration regulations resulting in the disallowance to the taxpayer of a worthless_security deduction under sec_165 and a bad_debt deduction under sec_166 conclusion based on the information provided to us sec_332 does not apply to the deemed liquidation of fsub because fsub was insolvent at the time of the deemed liquidation thus the taxpayer is allowed a worthless_security deduction under sec_165 and a bad_debt deduction under sec_166 facts parent is the common parent of a consolidated_group that includes sub and sub in month a sub formed fsub to operate a business in country x and fsub issued i one share of common_stock to sub in exchange for dollar_figurea and ii one share of common_stock to sub as nominee for sub in exchange for dollar_figurea postu-111611-05 sub filed a valid form_8832 entity classification election changing the classification of fsub from a corporation to a disregarded_entity for federal tax purposes effective date c the taxpayer represents that on date c the fair_market_value of fsub’s assets was less than zero the taxpayer also represents that as of date c fsub was indebted to sub in the amount of dollar_figureb the sub debt and was indebted to a local bank in the amount of dollar_figurec the bank debt which debt was guaranteed by parent in month d on a date after date c parent transferred funds in the amount of dollar_figured to fsub which fsub used along with other funds to pay off the bank debt sub hired appraiser to determine the fair_market_value of fsub in early month b appraiser indicated that fsub’s assets had a negative liquidation value and that fsub’s business had a negative going_concern_value the audit team has determined that as of date c the business_enterprise value of fsub was in the range of dollar_figuree to dollar_figuref for the group’s taxable_year that included date c the taxpayer claimed under sec_166 a bad_debt deduction for both the sub debt and for the portion of the bank debt satisfied with the funds transferred by parent to fsub in month d the group also claimed under sec_165 a worthless_security deduction for sub 1’s investment in fsub law and analysis a legal authority sec_301_7701-3 allows an eligible_entity to elect its classification for federal tax purposes an eligible_entity with a single owner can elect to be classified as an association taxed as a corporation or to be disregarded as an entity separate from its owner sec_301_7701-3 if an eligible_entity classified as an association elects to be disregarded as an entity separate from its owner the association is deemed to distribute all of its assets and liabilities to its single owner in liquidation of the association sec_301_7701-3 the tax treatment of a change in entity classification is determined under all relevant provisions of the internal_revenue_code and general principles of tax law including the step_transaction_doctrine sec_301 g sec_331 provides that amounts received by a shareholder in a distribution in complete_liquidation of a corporation shall be treated as in full payment in exchange we assume for purposes of this memorandum that fsub was an eligible_entity within the meaning of sec_301_7701-3 and that prior to date c fsub was treated as a corporation for federal tax purposes postu-111611-05 for the stock sec_331 cites sec_1001 for the determination of the amount of gain_or_loss recognized on such exchange sec_332 provides that a corporation recognizes no gain_or_loss on the receipt of property distributed in complete_liquidation of another corporation provided the distributee owns stock of the liquidating corporation meeting the requirements of sec_1504 the distribution results in the complete cancellation or redemption of all of the liquidating corporation’s stock and the property transfers occur within a prescribed period of time sec_1_332-2 of the income_tax regulations provides that sec_332 does not apply to a liquidating_distribution unless the percent shareholder receives at least partial payment for the stock it owns in the liquidating corporation a shareholder receives no payment for its stock of a liquidating corporation if that corporation is insolvent on the date of the liquidation ie the corporation’s liabilities exceed the fair_market_value of its assets revrul_2003_125 2003_2_cb_1243 if sec_332 does not apply to a liquidating_distribution then the shareholder may deduct its loss on the worthless_security provided that the requirements of sec_165 are met sec_1_332-2 furthermore if a shareholder owns both common and preferred shares of a liquidating corporation’s stock sec_332 applies only if the 80-percent shareholder receives property in exchange for its common_stock after the corporation has transferred property to its creditors in satisfaction of any indebtedness and to its preferred shareholders in satisfaction of the liquidation preference of such stock 252_f2d_693 2nd cir aff’g 27_tc_684 and 87_tc_689 sec_165 allows a deduction for any loss sustained during the taxable_year and not_compensated_for_by_insurance_or_otherwise under sec_165 a worthless_stock loss is generally treated as a capital_loss however sec_165 provides that a loss on worthless_stock of a corporation that is affiliated with a taxpayer which is a domestic_corporation is treated as an ordinary_loss affiliation for this purpose means the ownership of stock meeting the requirements of sec_1504 and the satisfaction of a gross_receipts_test sec_165 and b sec_166 allows a deduction for any debt that becomes worthless within the taxable_year in addition payments made by a guarantor in discharge of part or all of its obligation as a guarantor are allowed as bad_debt losses under sec_166 sec_1_166-9 sec_1_166-9 provides that a payment made in discharge of part or all of a taxpayer’s obligation as a guarantor is treated as a business debt becoming worthless in the taxable_year in which the payment is made or where the agreement provides for a right of subrogation against the issuer in the taxable_year in which the subrogation postu-111611-05 right becomes totally worthless sec_1_166-9 and e however such a payment is treated as a worthless_debt only if the guarantee agreement was entered into in the course of the taxpayer’s trade_or_business or a transaction for profit there was an enforceable legal duty upon the taxpayer to make the payment except that legal action need not have been brought against the taxpayer and the agreement was entered into before the obligation became worthless for this purpose an agreement is considered as entered into before the obligation became worthless if the taxpayer at the time the agreement was made had a reasonable expectation that it would not be required to pay the debt without full reimbursement from the issuer sec_1_166-9 in addition sec_1_166-9 requires a guarantor of an obligation to have received reasonable consideration for entering into the guarantee agreement a guarantor can demonstrate that it received reasonable consideration if it can demonstrate that the agreement was given in accordance with normal business practice or for a good_faith business_purpose sec_1_166-9 b analysis the change in fsub’s entity classification from a corporation to a disregarded_entity is treated as a deemed liquidation of fsub for federal tax purposes see sec_301_7701-3 the taxpayer took the position that fsub was insolvent at the time of the deemed liquidation and therefore claimed a bad_debt deduction under sec_166 for the sub debt and a worthless_security deduction under sec_165 for sub 1’s investment in the stock of fsub in addition the taxpayer claimed under sec_166 a bad_debt deduction for the dollar_figured amount transferred in month d by parent to fsub and by fsub to the local bank in satisfaction of the bank debt the audit team questioned the taxpayer’s valuation of fsub on date c the audit team has determined that as of date c the business_enterprise value of fsub was in the range of dollar_figuree to dollar_figuref however even under the audit team’s valuation fsub would have had insufficient assets to satisfy its obligations because fsub was insolvent at the time of the deemed liquidation sec_332 does not apply and the taxpayer is allowed under sec_165 a worthless_security deduction with respect to the common_stock of fsub held by sub in addition the taxpayer is allowed a bad_debt deduction under sec_166 in an amount equal to the total outstanding indebtedness of fsub minus the fair_market_value of fsub in sum fsub’s insolvency the audit team’s highest valuation for fsub was dollar_figuref which is less than the amount of fsub’s liabilities ie the sub debt of dollar_figureb plus the bank debt of dollar_figurec this memorandum assumes that fsub meets the gross_receipts_test described in sec_165 this analysis assumes that the payment made by parent in satisfaction of its guaranty of the bank debt meets the requirements of sec_1_166-9 if those requirements are not met the payment made by parent on the guaranty would be treated as a contribution to the capital of fsub and give rise to a worthless_security deduction under sec_165 thus whether or not the guaranty payment satisfies the requirements of sec_1_166-9 a loss results either under sec_166 or sec_165 postu-111611-05 precludes the deemed liquidation from qualifying as a complete_liquidation under sec_332 and allows the taxpayer to claim a worthless_security and bad_debt deductions the audit team has proposed as one way to make sec_332 applicable to the deemed liquidation to recharacterize some or all of the sub debt as an equity_investment in fsub for federal tax purposes treating a threshold_amount of sub debt as equity rather than debt would make fsub solvent at the time of the deemed liquidation however for the reasons discussed below sec_332 would still not apply to the deemed liquidation because fsub would not be treated as distributing property in complete cancellation or redemption of all its stock on its deemed liquidation see sec_332 a liquidating corporation is deemed to distribute its property in the following order to creditors in satisfaction of indebtedness to preferred_stock shareholders and to common_stock shareholders 252_f2d_693 2nd cir aff’g 27_tc_684 and 87_tc_689 sec_332 applies to a liquidation only if the liquidating corporation has property remaining for distribution on its common_stock after satisfying its indebtedness and the prior claim of its preferred_stock id in this case if the sub debt were recharacterized as equity of fsub it would be treated as a preferred class of fsub stock on the date of the deemed liquidation the total amount of the bank debt and the sub debt exceeded the audit team’s highest estimate of fsub’s business_enterprise value therefore treating the sub debt as equity would not make sec_332 applicable to the deemed liquidation because fsub would have no assets to distribute on its common_stock the taxpayer would be allowed a worthless_security deduction under sec_165 for the common_stock of fsub held by sub and a capital_loss under sec_331 and sec_1001 for the portion of the sub debt recharacterized as equity in addition to treating a portion of the sub debt as equity of fsub the audit team has also proposed to treat the bank debt as debt of parent and then as a capital_contribution by parent to fsub for the reasons that follow such recharacterization in determining the true substance of an intercompany advance the legal rights and obligations of the parties must be considered see 398_f2d_694 3rd cir 464_f2d_394 5th cir and 748_f2d_1365 9th cir therefore where it is determined that the substance of the advances are equity the specific rights attached to the investment must be respected in characterizing the equity the intercompany advances that constitute the sub debt were in form term loans embodied in promissory notes that bore fixed rates of interest and were treated by the parties as debt for tax and accounting purposes because the sub debt had all the formal indicia of indebtedness and because interest payments were made on the obligation the sub debt if recharacterized as equity should be treated as preferred_stock postu-111611-05 would not cause the deemed liquidation to qualify as a complete_liquidation under sec_332 as discussed above in the deemed liquidation fsub is treated as paying off its indebtedness and the prior claims of its preferred_stock before distributing property with respect to its common_stock sec_332 will apply to the deemed liquidation only if fsub has property remaining for distribution on its common_stock treating the bank debt as a contribution by parent to the capital of fsub would not make sec_332 applicable even if parent’s equity_interest in fsub were treated as common_stock because fsub would have insufficient assets to satisfy the sub debt whether respected as debt or treated as preferred_stock and thus would have nothing to distribute to its common_stock shareholders thus the taxpayer would be allowed a worthless_security deduction under sec_165 for sub 1’s investment in the common_stock of fsub and a capital_loss under sec_331 for the portion of the sub debt treated as preferred_stock of fsub that is not satisfied in the liquidation the character of the loss recognized on the bank debt would depend on whether that amount was recast as preferred or common_stock of fsub the exact deduction and loss amounts depend on the final valuation of fsub this writing may contain privileged information any unauthorized disclosure of this writing may undermine our ability to protect the privileged information if disclosure is determined to be necessary please contact this office for our views please call --------------------- if you have any further questions