Tuesday October 20, 2020
Private Letter Ruling
Exempt Status Denied for Failure to Establish Charitable Purpose
Organization was formed and controlled by a 501(c)(3) public charity as a Professional Service Corporation to practice medicine. Organization’s document of incorporation fails to state the disposition of assets in the event of dissolution. Organization submitted an unfiled Certificate of Amendment to incorporation document which included a statement that Organization is organized for a charitable purpose and in the event of dissolution, assets will be distributed to qualifying 501(c)(3) organizations. The Service requested proof of filing the Amendment on two separate dates. Organization did not provide proof of filing and no reason for delay was given.
Under Sec. 501(c)(3), in order for an organization to be exempt from tax it must be organized and operated exclusively for an exempt purpose. No part of net earnings may inure to the benefit of any private shareholder or individual. An organization is organized exclusively for an exempt purpose if its articles of organization limit its purpose to exempt purposes and its assets are dedicated to an exempt purpose. Sec. 1.501(c)(3)-1(b)(1)(i); Reg. 1.501(c)(3)-1(b)(4). In Universal Life Church v. United States, the court concluded that an organization seeking tax exemption has the burden of establishing the right to tax-exempt status. In New Dynamics Foundation v. United States, the court stated, “gaps in the administrative record are resolved against the applicant.” Here, the Service found that Organization failed to provide supporting documentation to establish that it had met the requirements of Sec. 501(c)(3). The Service found that Organization failed to meet the organizational test because its Articles did not limit its purpose to an exempt purpose as described in Sec. 501(c)(3) and the incorporation documents lacked a dissolution provision for its assets. Thus, because Organization failed to provide evidence establishing that it is organized for exempt purposes under Sec. 501(c)(3), the Service denied Organization's application for exemption.
Dear * * *:
We considered your application for recognition of exemption from federal income tax under Section 501(a) of the Internal Revenue Code (the Code). Based on the information provided, we determined that you don't qualify for exemption under Section 501(c)(3) of the Code. This letter explains the basis for our conclusion. Please keep it for your records.
Do you qualify for exemption under Section 501(c)(3) of the Code? No, for the reasons stated below.
You were formed on B in the State of C. Your incorporation document states that you are a Professional Service Corporation formed to practice the profession of medicine and you have the authority to issue shares of stock. You were formed and are controlled by D, a Section 501(c)(3) public charity. Your incorporation document is silent regarding the disposition of your assets upon your dissolution.
You submitted an unfiled Certificate of Amendment to your incorporation document signed by your sole shareholder. This proposed amendment includes a statement that you are organized exclusively for 501(c)(3) purposes and that upon your dissolution your assets will be distributed to organizations that are qualified under Section 501(c)(3). You also indicated that the Certificate of Amendment had been submitted to be filed with the licensing authority for all professional corporations that engage in the practice of medicine in the State of C. We requested a copy of the Certificate of Amendment that shows proof of filing from you twice. You stated you are still working on the filing of the amendment and you expect to have the proof of filing by E. You did not provide any specific reason why it takes an extended period of time to obtain an approval for the Certificate of Amendment from State of C.
You have a sole shareholder, an individual employed and selected by D. The relationship between you and the sole shareholder is subject to a Shareholders' Agreement. The Agreement provides that the sole shareholder shall ho d the shares solely for the benefit of D and exclusively in furtherance of the charitable purposes of D. D shall retain ultimate control over your activities and finances and shall retain sole power and discretion.
Section 501(c)(3) of the Code provides for the recognition of exemption of organizations that are organized and operate exclusively for religious, charitable or other purposes as specified in the statute. No part of the net earnings may inure to the benefit of any private shareholder or individual.
Treasury Regulation Section 1.501(c)(3)-1(a)(1) states that, in order to be exempt as an organization described in Section 501(c)(3) of the Code, an organization must be both organized and operated exclusively for one or more of the purposes specified in such section. If an organization fails to meet either the organizational test or the operational test, it is not exempt.
Treas. Beg. Section 1.501(c)(3)-1(b)(1)(i) provides that an organization is organized exclusively for one or more exempt purposes only if its articles of organization:
(a) Limit the purposes of such organization to one or more exempt purposes; and
(b) Do not expressly empower the organization engage, otherwise than as an insubstantial part of its activities, in activities that in themselves are not in furtherance of one or more exempt purposes.
Treas. Reg. Section 1.501(c)(3)-1(b)(4) holds that an organization is not organized exclusively for one or more exempt purposes unless its assets are dedicated to an exempt purpose. An organization's assets will be considered dedicated to an exempt purpose, for example, if, upon dissolution, such assets would, by reason of a provision in the organization's articles or operation of law, be distributed for one or more exempt purposes.
Revenue Procedure 2018-5, 2018-1 I.R.B. 233, Section 3 states that a determination letter or ruling on exempt status is issued based solely upon the facts and representations contained in the administrative record. The applicant is responsible for the accuracy of any factual representations contained in the application. Section 6 (and its predecessors) provides that a favorable determination letter or ruling will be issued to an organization only if is application and supporting documents establish that it meets the particular requirements of the section under which exemption from federal income tax is claimed.
In Universal Life Church v. United States, 372 F. Supp. 770 (E.D. Cal. 1974), the court concluded that “one seeking a tax exemption has the burden of establishing his right to a tax-exempt status.”
New Dynamics Foundation v. United States, 70 Fed. Cl. 782 (2006), was an action for declaratory judgment that the petitioner brought to challenge the denial of his application for exempt status. The court, in finding that the actual purposes displayed in the administrative record supported the Service's denial, stated “It is well-accepted that, in initial qualification cases such as this, gaps in the administrative record are resolved against the applicant.” The court noted that if the petitioner had evidence that contradicted these findings, it should have submitted it as part of the administrative process. The court also highlighted the principle that exemptions from income :ax are matters of legislative grace.
Application of law
As stated in Treas. Reg. 1.501(c)(3)-1(a)(1), to qualify for exemption under Section 501(c)(3) of the Code an organization must be both organized and operated exclusively for purposes described in Section 501(c)(3). Your incorporation document states that you were formed for the business purpose of practicing medicine. Your formation document does not limit your purposes to one or more exempt purposes, as required by Treas. Reg. Section 1.501(c)(3)-1(b)(1)(i), causing you to fail the organizational test. Additionally, your incorporation document does not have a dissolution provision as required by Treas. Reg. Section 1.501(c)(3)-1(b)(4), which also causes you to fail the organizational test.
Your Certificate of Amendment does not show proof of filing with State of C, leaving us to rely on the original incorporation document. Your original incorporation document lacks a purpose and dissolution clause that meets the requirements under Section 501(c)(3) of the Code. As in Universal Life Church, you have the burden of establishing that you qualify for tax exemption. As explained in New Dynamics Foundation, an organization must establish, through its administrative record, that it meets the requirements for exemption You have failed to provide sufficient documentation to establish that you are exempt from taxation as required by Rev. Proc. 2018-5.
Based on the information submitted, you have failed to establish that you are organized exclusively for exempt purpose s within the meaning of Section 501(c)(3) of the Code and the related income tax regulations. Therefore, based on the administrative record, you fail to qualify for exemption under Section 501(c)(3).
If you don't agree
You have a right to file a protest if you don't agree with our proposed adverse determination. To do so, you must send a statement to us within 30 days of the date of this letter. The statement must include:
Your name, address, employer identification number (EIN), and a daytime phone number
A copy of this letter highlighting the findings you disagree with
An explanation of why you disagree, including any supporting documents
The law or authority, if any, you are relying on
The signature of an officer, director, trustee, or other official who is authorized to sign for the organization, or your authorized representative
One of the following declarations:
For an officer, director, trustee, or other official who is authorized to sign for the organization:
Under penalties of perjury, I declare that I examined this protest statement, including accompanying documents, and to the best of my knowledge and belief, the statement contains all relevant facts and such facts are true, correct, and complete.
For authorized representatives:
Under penalties of perjury, I declare that I prepared this protest statement, including accompanying documents, and to the best of my knowledge and belief, the statement contains all relevant facts and such facts are true, correct, and complete.
Your representative (attorney, certified public accountant, or other individual enrolled to practice before the IRS) must file a Form 2848, Power of Attorney and Declaration of Representative, with us if he or she hasn't already lone so. You can find more information about representation in Publication 947, Practice Before the IRS and Power of Attorney.
We'll review your protest statement and decide if you provided a basis for us to reconsider our determination. If so, we'll continue to process your case considering the information you provided. If you haven't provided a basis for reconsideration, we'll forward your case to the Office of Appeals and notify you. You can find more information about the role of the Appeals Office in Publication 892, How to Appeal an IRS Decision on Tax-Exempt Status.
If you don't file a protest within 30 days, you can't seek a declaratory judgment in court at a later date because the law requires that you use the IRS administrative process first (Section 7428(b)(2) of the Code).
Where to send your protest
Please send your protest statement, Form 2848, if needed, and any supporting documents to the applicable address:
Internal Revenue Service
EO Determinations Quality Assurance
P.O. Box 2508
Cincinnati, OH 45201
Street address for delivery service:
Internal Revenue Service
EO Determinations Quality Assurance
550 Main Street, Room 7-008
Cincinnati, OH 45202
You car also fax your statement and supporting documents to the fax number listed at the top of this letter. If you fax your statement, please contact the person listed at the top of this letter to confirm that he or she received it.
If you agree
If you agree with our proposed adverse determination, you don't need to do anything. If we don't hear from you within 30 days, we'll issue a final adverse determination letter. That letter will provide information on your income tax filing requirements.
You can find all forms and publications mentioned in this letter on our website at www.irs.gov/formspubs. If you have questions, you can contact the person listed at the top of this letter.
We sent a copy of this letter to your representative as indicated in your power of attorney.
Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements