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No Exemption for Organization Formed to Support One Individual

Background

Cousin Leroy is not entirely sure what happened. From what he can remember before he blacked out, he turned the corner around the large rock outcropping to see what all the ruckus was about while he was squirrel hunting. All he knows is that the lady moose ran away, and the bull moose charged Leroy and made quick work of exacting his revenge for interrupting their private moment.  Needless to say, Leroy was never the same. In fact, the medical bills and physical therapy costs were staggering, and his employer, Rapid Rays Burgers, did not, strictly speaking, provide him with insurance.

Nonetheless, the small town where Leroy lived rallied behind him and raised a substantial sum of money. In order to administer the largesse and to continue to raise funds, Uncle Bill created a corporation with the intent of having it qualify as an IRC § 501(c)(3) organization, so that all of the donors would be able to deduct their donations to Leroy’s Moose Fund.

Bill filed a Form 1023 (Application for Recognition of Exemption Under IRC § 501(c)(3)) and described the purpose and activities of the Moose Fund, which were primarily to raise and administer funds for the long-term care of Leroy to ensure that he received the supplemental financial help to assist with his extraordinary additional life expenses resulting from the debilitating bull moose attack. A secondary purpose—to educate the public on the dangers of interrupting moose loving—was also listed.

The Form 1023 noted that 85% of the gross proceeds would be used for Leroy, and that the Moose Fund existed primarily to raise funds for Leroy. The fundraising program was limited to Leroy, and the funds may not be used for any other purpose than to provide for the well-being of Leroy (and to hold an annual hour-long seminar on moose courtship habits).

The Law

IRC § 501(c)(3) provides for the recognition of exemption of organizations that are organized and operated 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.  Treas. Reg. § 1.501(c)(3)-1(a)(1) states that in order to be exempt as an organization described in IRC § 501(c)(3), the organization must be both organized and operated exclusively for one or more of the purposes specified in that section. If an organization fails to meet either the organizational test or the operational test, it is not exempt.

Treas. Reg. § 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 limit the purposes of such organization to one or more exempt purposes and do not expressly empower the organization to engage, otherwise than as an insubstantial part of its activities, in activities which in themselves are not in furtherance of one or more exempt purposes.

Treas. Reg. § 1.501(c)(3)-1(c)(1) provides that an organization will be regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in IRC § 501(c)(3). An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose. Further, Treas. Reg. § 1.501(c)(3)-1(c)(2) states that an organization is not operated exclusively for one or more exempt purposes if its net earnings inure in whole or in part to the benefit of private shareholders or individuals.

Treas. Reg. § 1.501 (c)(3)-1(d)(l)(ii) states that an organization is not organized or operated exclusively for exempt purposes unless it serves a public rather than a private interest. It is necessary for an organization to establish that it is not organized or operated for the benefit of private interests such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests.

Rev. Rul. 67-367 states that a nonprofit organization whose sole activity is the operation of a “scholarship” plan for making payments to pre-selected, specifically named individuals does not qualify for exemption from federal income tax under IRC § 501(c)(3), because it is serving private interests rather than public charitable and educational interests. Finally, in Wendy L. Parker Rehabilitation Foundation, Inc, v. Commissioner, T.C. Memo 1986-348, the Tax Court upheld the IRS’s position that a foundation formed to aid coma victims, including a family member of the founders, was not entitled to recognition of exemption. Approximately 30% of the organization’s net income was expected to be distributed to aid the family coma victim. The Court found that the family coma victim was a substantial beneficiary of the foundation’s funds. It also noted that such distributions relieved the family of the economic burden of providing medical and rehabilitation care for their family member.

Where the Moose Fund Fails

Leroy’s Moose Fund fails the organizational and operational tests pursuant to Treas. Reg. § 1.501(c)(3)-l(a)(l). Neither does it meet the requirements in Treas. Reg. § 1.501(c)(3)-1(b)(l)(i). Because the Fund’s Articles of Incorporation state that it will provide funding for the ongoing medical and life expenses of a specific named individual, Leroy, the Fund is not organized exclusively for purposes described in the regulations.

Further, the Fund does not meet the provisions in Treas. Reg. § 1.501 (c)(3)-l(c)(l), because it was formed and is solely operated to raise funds to pay for the medical and living expenses of Leroy. This illustrates that the fund was formed to further private purposes not public. As described in Treas. Reg. § 1.501(c)(3)-l(c)(2), the Moose Fund is not operated exclusively for exempt purposes because its net earnings inure to the benefit of private shareholders or individuals. This is evidenced by the fact that it was formed by Leroy’s dad, Bill, who is also the Fund’s president and treasurer. Finally, the Fund is not described in Treas. Reg. § 1.501 (c)(3)-1 (d)(1)(ii), as it operates for the private interests of Leroy.

The Fund is like the organization described in Rev. Rul. 67-367, as it was formed to benefit a preselected, designated individual, in this case Leroy, who was the only beneficiary of the Moose Fund’s fundraising. The fact that the Fund itself is named after Leroy illustrates that it serves private interests rather than public ones. Further, the Moose Fund is similar to the organization described in the Wendy L. Parker case, because it was formed to pay the medical and living expenses for a preselected individual. Like this organization, the Moose Fund serves the private benefit of an individual by paying his medical expenses and relieving him of their financial obligation.

The fact that the Moose Fund also puts on an annual seminar does not change the analysis. Pursuant to Treas. Reg. § 1.501(c)(3)-1(c)(1), an organization will be regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in IRC § 501(c)(3). An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose. Because the lion’s share of the Moose Fund goes to Leroy’s rehabilitation, it will not be regarded as being operated exclusively for one or more exempt purposes.

Takeaways

First, a charity formed to care for a single individual will always fail the operational and organizational tests of IRC § 501(c)(3) and its Treasury Regulations. Second, if you hear a ruckus in the woods of Maine, it’s either a bear or a moose—sometimes both—so don’t go to see what’s causing the kerfuffle, or you just may end up like Leroy.

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