On May 6, 2021, the Tax Court issued a Memorandum Opinion in the case of Tikar Inc. v. Commissioner (T.C. Memo. 2021-53). The primary issue presented in Tikar Inc. v. Commissioner was whether Tikar (organized to present exposition of African art owned by a corporation and to promote African art, generally) was operated exclusively for one or more exempt purposes pursuant to IRC § 501(c)(3).

The Blessed Rains Down in Africa in Tikar Inc. v. Commissioner

In 1993, Dr. Seghers, developed a keen interest in the culture of the Tikar tribe after a short stay in Cameroon, in particular with Tikar artifacts, especially bronze ones.  He imported a number of such artifacts, and others were shipped from Cameroon to Belgium (purportedly) for the good doctor.  Seghers engaged a Cameroonian attorney, but the attorney he chose took a liking to the artifacts and refused to part with them.  In 2005, Seghers “reclaimed” the items and “transferred” the items to the basement of the National Museum of Cameroon.

Tikar Inc.’s Circle of Life

The petitioner was organized as a Texas nonprofit corporation in 1999. Its initial directors were Seghers, his father, and a man named Linzy. According to the petitioner’s articles of incorporation, the petitioner was organized to present expositions of objects belonging to the corporation, to negotiate contracts with museums and other organizations to organize expositions, to promote African Art by exhibits through the corporation itself or through museums, and to do any and all necessary and incidental to the stated purpose, and to do this all without ever violating the sanctity of IRC § 501(c)(3). The petitioner sent a Form 1023 (Application for Recognition of Exemption Under IRC § 501(c)(3)) to the IRS around the same time as the incorporation. The activities were identical to those listed on the articles of incorporation.

The Initial Determination of Exemption

Late in 199, the IRS issued a determination letter stating that on the basis of the information supplied, and assuming its operations would be as stated in the application for recognition of exemption, the IRS had determined that the petitioner was exempt from Federal income tax under IRC § 501(a) as an organization described in IRC § 501(c)(3).

Shift to Private Foundation

Between 1999 and 2004, the petitioner was not as active.  The authenticity of some of the artifacts were in question, and the petitioner was working with experts around the world to determine their provenance. The petitioner reported that it had received zero in financial support for the past five years.  In early 2004, the IRS informed the petitioner that on the basis of it not receiving any public support during the advance ruling period, it no longer qualified as a public charity and instead would be classified as a private foundation under IRC § 509(a). The letter stated, however, that the petitioner’s exemption under IRC § 501(c)(3) remained in effect.

The Audit and Revocation

In 2016, the IRS sent a letter to the petitioner proposing to revoke its IRC § 501(c)(3) status, because “[i]n excess of 20 years of operation the foundation claims to have had only one exhibition of 2 to 3 years in duration …. One exhibit of 2 to 3 years does not qualify as carrying out an exempt purpose for 20 plus years of operations.” The petitioner appealed timely. Appeals issued a final adverse determination in 2017, determining that the petitioner was not operated exclusively for exempt purposes.

Tax Court Jurisdiction

IRC § 7428(a)(1)(A) confers jurisdiction on the Tax Court to make a declaration in a case of actual controversy involving a determination by the IRS with respect to the initial qualification or continuing qualification of an IRC § 501(c)(3) organization, including a revocation of or other change in a qualification. See IRC § 7428(a) (flush language). The petitioner bears the burden of establishing that respondent’s determination is erroneous. See Tax Court Rule 142(a); Partners in Charity, Inc. v. Commissioner, 141 T.C. 151, 162 (2013).

Exempt Status

In order to be exempt under IRC § 501(c)(3), an organization must be both organized exclusively for one or more of the exempt purposes specified in the section, known as the organizational test, and operated exclusively for such purposes, known as the operational test. See Treas. Reg. § 1.501(c)(3)-1(a)(1). Failure to satisfy either test forecloses a IRC § 501(c)(3) exemption. Id. The IRS did not challenge the petitioner’s organization, just its operation.

The Operational Test

In application of the operational test, “exclusively” does not mean “solely” or “absolutely without exception.” Nationalist Movement v. Commissioner, 102 T.C. 558, 576 (1994) (quoting Church in Bos. v. Commissioner, 71 T.C. 102, 107 (1978)), aff’d, 37 F.3d 216 (5th Cir. 1994); see also Copyright Clearance Ctr., Inc. v. Commissioner, 79 T.C. 793, 803-804 (1982). Nonetheless, the presence of a single nonexempt purpose, if substantial, precludes exempt status regardless of the number or importance of truly exempt purposes. Better Bus. Bureau of Wash., D.C. v. United States, 326 U.S. 279, 283 (1945); Redlands Surgical Servs. v. Commissioner, 113 T.C. 47, 71-72 (1999), aff’d, 242 F.3d 904 (9th Cir. 2001); Nationalist Movement v. Commissioner, 102 T.C. at 576; Am. Campaign Acad. v. Commissioner, 92 T.C. 1053, 1065 (1989).

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. Treas. Reg. § 1.501(c)(3)-1(c)(1). An entity is deemed not to operate exclusively for exempt purposes if net earnings are distributed or otherwise inure to the benefit of private individuals. Treas. Reg. § 1.501(c)(3)-1(c)(2), (3). Additionally, although an organization may be engaged in only a single activity directed toward multiple purposes, both exempt and nonexempt, failure to satisfy the operational test will result if any nonexempt purpose is substantial. Redlands Surgical, 113 T.C. at 71; Copyright Clearance, 79 T.C. at 803-804. Exempt purposes are those specified in IRC § 501(c)(3) – religious, charitable, scientific, and educational. Treas. Reg. § 1.501(c)(3)-1(d)(1)(I).

Serving a Higher (Exempt) Purpose Required

However, regardless of the presence of what might otherwise be proper exempt purposes, an explicit exception to IRC § 501(c)(3) status exists in that an organization must serve a public rather than a private interest. Thus, 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. See Treas. Reg. § 1.501(c)(3)-1(d)(1)(ii).

If the IRS shows that an organization benefits private interests, a limitation substantially overlapping but encompassing more than simply the inurement of earnings to insiders, it will be deemed to further a nonexempt purpose. Am. Campaign Acad., 92 T.C. at 1066, 1068-1069; Church of the Transfiguring Spirit, Inc. v. Commissioner, 76 T.C. 1, 5, n.5 (1981). Private benefits within the scope of the prohibition may include an advantage, profit, fruit, privilege, gain, or interest. Am. Campaign Acad., 92 T.C. at 1065-1066. A substantial body of caselaw has explored the concept of private benefit within the framework of the relationship between an organization claiming tax-exempt status and its founder (or small group of related insiders).[1]

Factors Indicative of Prohibited Inurement

Several factors are red flags of prohibited inurement and private benefit:[2]

• control by the founder over the entity’s funds, assets, and disbursements;
• use of entity money for personal expenses;
• payment of salary or rent to the founder without any accompanying evidence or analysis of the reasonableness of the amounts; and
• purported loans to the founder showing a ready private source of credit.

Such circumstances provide an “obvious opportunity for abuse” of the claimed tax-exempt status.  Disclosure and substantiation, therefore, is critical; otherwise the Tax Court will make the “logical inference” that the facts, if disclosed, would show that the taxpayer fails to meet the requirements of IRC § 501(c)(3). Bubbling Well Church of Universal Love, 74 T.C. at 535; see also, e.g., Founding Church of Scientology, 412 F.2d at 1201; Basic Bible Church, 74 T.C. at 858. Thus, the organization will not qualify as operating primarily for exempt purposes absent an affirmative showing that no more than an insubstantial part of its activities further the private interests or any other nonexempt purposes. Am. Campaign Acad., 92 T.C. at 1066.

The Takeaways

Storing artifacts in a warehouse in Texas and in the basement of a museum in Cameroon is not enough to cross the exempt purpose line.  Had the petitioner actually displayed a couple of items in its collection, then, perhaps the Tax Court would have been more willing to ignore the other red flags.  But not today.

(T.C. Memo. 2021-53) Tikar, Inc. v. Commissioner

Footnotes

[1] See, e.g., Founding Church of Scientology v. United States, 412 F.2d 1197, 1199-1202 (Ct. Cl. 1969); Church of Eternal Life & Liberty, Inc. v. Commissioner, 86 T.C. 916, [*31] 927-928 (1986); Church of the Transfiguring Spirit, Inc., 76 T.C. at 5-6; Basic Bible Church v. Commissioner, 74 T.C. 846, 856-858 (1980), aff’d per curiam sub nom. Kile v. Commissioner, 739 F.2d 265 (7th Cir. 1984); Bubbling Well Church of Universal Love, Inc. v. Commissioner, 74 T.C. 531, 534-538 (1980), aff’d, 670 F.2d 104 (9th Cir. 1981); Unitary Mission Church of Long Island v. Commissioner, 74 T.C. 507, 512-515 (1980), aff’d without published opinion, 647 F.2d 163 (2d Cir. 1981).

[2] See, e.g., Founding Church of Scientology, 412 F.2d at 1200-1202; Church of Eternal Life & Liberty, Inc., 86 T.C. at 927-928; Church of the Transfiguring Spirit, 76 T.C. at 5-6; Basic Bible Church, 74 T.C. at 857-858; Bubbling Well Church of Universal Love, 74 T.C. at 534-538; Unitary Mission Church, 74 T.C. at 513-515.

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