1.501(c)(3)-1. Organizations organized and operated
for religious, charitable, scientific, testing for public safety,
literary, or educational purposes, or for the prevention of
cruelty to children or animals, REG-111257-05, 9/9/2005.
Par. 3. In §1.501(c)(3)-1, paragraphs (d)(1)(iii)
and (g) are added to read as follows:
(d) * * *
(1) * * *
(iii) Examples. --The following examples illustrate
the requirement of paragraph (d)(1)(ii) of this section that
an organization serve a public rather than a private interest:
Example 1. (i) O is an educational organization
the purpose of which is to study history and immigration. The
focus of O's historical studies is the genealogy of one family,
tracing the descent of its present members. O actively solicits
for membership only individuals who are members of that one
family. O's research is directed toward publishing a history
of that family that will document the pedigrees of family members.
A major objective of O's research is to identify and locate
living descendants of that family to enable those descendants
to become acquainted with each other.
(ii) O's educational activities primarily serve
the private interests of members of a single family rather than
a public interest. Therefore, O is operated for the benefit
of private interests in violation of the restriction on private
benefit in §1.501(c)(3)-1(d)(1)(ii). Based on these facts
and circumstances, O is not operated exclusively for exempt
purposes and, therefore, is not described in section 501(c)(3).
Example 2. (i) O is an art museum. O's sole
activity is exhibiting art created by a group of unknown but
promising local artists. O is governed by a board of trustees
unrelated to the artists whose work O exhibits. All of the art
exhibited is offered for sale at prices set by the artist. Each
artist whose work is exhibited has a consignment arrangement
with O. Under this arrangement, when art is sold, the museum
retains 10 percent of the selling price to cover the costs of
operating the museum and gives the artist 90 percent.
(ii) The artists in this situation directly
benefit from the exhibition and sale of their art. As a result,
the sole activity of O serves the private interests of these
artists. Because O gives 90 percent of the proceeds from its
sole activity to the individual artists, the direct benefits
to the artists are substantial and O's provision of these benefits
to the artists is more than incidental to its other purposes
and activities. This arrangement causes O to be operated for
the benefit of private interests in violation of the restriction
on private benefit in §1.501(c)(3)-1(d)(1)(ii). Based on
these facts and circumstances, O is not operated exclusively
for exempt purposes and, therefore, is not described in section
501(c)(3).
Example 3. (i) O is an educational organization
the purpose of which is to train individuals in a program developed
by P, O's president. All of the rights to the program are owned
by Company K, a for-profit corporation owned by P. Prior to
the existence of O, the teaching of the program was conducted
by Company K. O licenses, from Company K, the right to use a
reference to the program in O's name and the right to teach
the program, in exchange for specified royalty payments. Under
the license agreement, Company K provides O with the services
of trainers and with course materials on the program. O may
develop and copyright new course materials on the program but
all such materials must be assigned to Company K without consideration
if the license agreement is terminated. Company K sets the tuition
for the seminars and lectures on the program conducted by O.
O has agreed not to become involved in any activity resembling
the program or its implementation for 2 years after the termination
of O's license agreement.
(ii) O's sole activity is conducting seminars
and lectures on the program. This arrangement causes O to be
operated for the benefit of P and Company K in violation of
the restriction on private benefit in §1.501(c)(3)-1(d)(1)(ii),
regardless of whether the royalty payments from O to Company
K for the right to teach the program are reasonable. Based on
these facts and circumstances, O is not operated exclusively
for exempt purposes and, therefore, is not described in section
501(c)(3).
***
(g) Interaction with section 4958
(1) Application process. --An organization that
applies for recognition of exemption under section 501(a) as
an organization described in section 501(c)(3) must establish
its eligibility under this section. The Commissioner may deny
an application for exemption for failure to establish any of
this section's requirements for exemption. Section 4958 does
not apply to transactions with an organization that has failed
to establish that it satisfies all of the requirements for exemption
under section 501(c)(3). See §53.4958-2 of this chapter.
(2) Substantive requirements for exemption still
apply to applicable tax-exempt organizations described in section
501(c)(3)
(i) In general. --Regardless of whether a particular
transaction is subject to excise taxes under section 4958, the
substantive requirements for tax exemption under section 501(c)(3)
still apply to an applicable tax-exempt organization (as defined
in section 4958(e) and §53.4958-2 of this chapter) described
in section 501(c)(3) whose disqualified persons or organization
managers are subject to excise taxes under section 4958. Accordingly,
an organization may no longer meet the requirements for tax-exempt
status under section 501(c)(3) because the organization fails
to satisfy the requirements of paragraph (b), (c) or (d) of
this section. See §53.4958-8(a) of this chapter.
(ii) Determining whether revocation of tax-exempt
status is appropriate when section 4958 excise taxes also apply.
--In determining whether to continue to recognize the tax-exempt
status of an applicable tax-exempt organization (as defined
in section 4958(e) and §53.4958-2 of this chapter) described
in section 501(c)(3) that engages in one or more excess benefit
transactions (as defined in section 4958(c) and §53.4958-4
of this chapter) that violate the prohibition on inurement under
this section, the Commissioner will consider all relevant facts
and circumstances, including, but not limited to, the following
--
(A) The size and scope of the organization's
regular and ongoing activities that further exempt purposes
before and after the excess benefit transaction or transactions
occurred;
(B) The size and scope of the excess benefit
transaction or transactions (collectively, if more than one)
in relation to the size and scope of the organization's regular
and ongoing activities that further exempt purposes;
(C) Whether the organization has been involved
in repeated excess benefit transactions;
(D) Whether the organization has implemented
safeguards that are reasonably calculated to prevent future
violations; and
(E) Whether the excess benefit transaction has
been corrected (within the meaning of section 4958(f)(6) and
§53.4958-7 of this chapter), or the organization has made
good faith efforts to seek correction from the disqualified
persons who benefited from the excess benefit transaction.
(iii) All factors will be considered in combination
with each other. Depending on the particular situation, the
Commissioner may assign greater or lesser weight to some factors
than to others. The factors listed in paragraphs (g)(2)(ii)(D)
and (E) of this section will weigh more strongly in favor of
continuing to recognize exemption where the organization discovers
the excess benefit transaction or transactions and takes action
before the Commissioner discovers the excess benefit transaction
or transactions. Further, with respect to the factor listed
in paragraph (g)(2)(ii)(E) of this section, correction after
the excess benefit transaction or transactions are discovered
by the Commissioner, by itself, is never a sufficient basis
for continuing to recognize exemption.
(iv) Examples. --The following examples illustrate
the principles of paragraph (g)(2)(ii) of this section. For
purposes of each example, assume that O is an applicable tax-exempt
organization (as defined in section 4958(e) and §53.4958-2
of this chapter) described in section 501(c)(3) for all relevant
periods. The examples are as follows:
Example 1. (i) O was created as a museum for
the purpose of exhibiting art to the general public. In Years
1 and 2, O engages in fundraising and in selecting, leasing,
and preparing an appropriate facility for a museum. In Year
3, a new board of trustees is elected. All of the new trustees
are local art dealers. Beginning in Year 3 and continuing to
the present, O uses almost all of its revenues to purchase art
solely from its trustees at prices that exceed fair market value.
O exhibits and offers for sale all of the art it purchases.
O's Form 1023, "Application for Recognition of Exemption,"
did not disclose the possibility that O's trustees would be
selling art to O.
(ii) O's purchases of art from its trustees
at more than fair market value constitute excess benefit transactions
between an applicable tax-exempt organization and disqualified
persons under section 4958. Therefore, these transactions are
subject to the appropriate excise taxes provided in that section.
In addition, O's purchases of art from its trustees at more
than fair market value violate the proscription against inurement
under section 501(c)(3) and §1.501(c)(3)-1(c)(2).
(iii) The application of the factors in §1.501(c)(3)-1(g)(2)(ii)
to these facts is as follows. Beginning in Year 3, O does not
engage in any regular and ongoing activities that further exempt
purposes because almost all of O's activities consist of purchasing
art from its trustees and exhibiting and offering for sale all
of the art it purchases. The size and scope of the excess benefit
transactions collectively are significant in relation to the
size and scope of any of O's ongoing activities that further
exempt purposes. O has been involved in repeated excess benefit
transactions, namely, purchases of art from its trustees at
more than fair market value. O has not implemented safeguards
that are reasonably calculated to prevent such improper purchases
in the future. The excess benefit transactions have not been
corrected, nor has O made good faith efforts to seek correction
from the disqualified persons who benefited from the excess
benefit transactions (the trustees). The trustees continue to
control O's Board. Based on the application of the factors to
these facts, O is no longer described in section 501(c)(3) effective
in Year 3.
Example 2. (i) The facts are the same as in
Example 1, except that in Year 4, O's entire board of trustees
resigns, and O no longer offers all exhibited art for sale.
The former board is replaced with members of the community who
are not in the business of buying or selling art and who have
skills and experience running educational programs and institutions.
O promptly discontinues the practice of purchasing art from
current or former trustees, adopts a written conflicts of interest
policy, adopts written art valuation guidelines, hires legal
counsel to recover the excess amounts O had paid its former
trustees, and implements a new program of educational activities.
(ii) O's purchases of art from its former trustees
at more than fair market value constitute excess benefit transactions
between an applicable tax-exempt organization and disqualified
persons under section 4958. Therefore, these transactions are
subject to the appropriate excise taxes provided in that section.
In addition, O's purchases of art from its trustees at more
than fair market value violate the proscription against inurement
under section 501(c)(3) and §1.501(c)(3)-1(c)(2).
(iii) The application of the factors in §1.501(c)(3)-1(g)(2)(ii)
to these facts is as follows. In Year 3, O does not engage in
any regular and ongoing activities that further exempt purposes.
However, in Year 4, O elects a new board of trustees comprised
of individuals who have skills and experience running educational
programs and implements a new program of educational activities.
As a result of these actions, beginning in Year 4, O engages
in regular and ongoing activities that further exempt purposes.
The size and scope of the excess benefit transactions that occurred
in Year 3, taken collectively, are significant in relation to
the size and scope of O's regular and ongoing exempt function
activities that were conducted in Year 3. Beginning in Year
4, however, as O's exempt function activities are established
and grow, the size and scope of the excess benefit transactions
that occurred in Year 3 become less and less significant as
compared to the size and extent of O's regular and ongoing exempt
function activities that began in Year 4 and continued thereafter.
O was involved in repeated excess benefit transactions in Year
3. However, by discontinuing its practice of purchasing art
from its current and former trustees, by replacing its former
board with independent members of the community, and by adopting
a conflicts of interest policy and art valuation guidelines,
O has implemented safeguards that are reasonably calculated
to prevent future violations. In addition, O has made a good
faith effort to seek correction from the disqualified persons
who benefited from the excess benefit transactions (its former
trustees). Based on the application of the factors to these
facts, O continues to meet the requirements for tax exemption
under section 501(c)(3).
Example 3. (i) O conducts educational programs
for the benefit of the general public. Since its formation,
O has employed its founder, C, as its Chief Executive Officer.
Beginning in Year 5 of O's operations and continuing to the
present, C caused O to divert significant portions of O's funds
to pay C's personal expenses. The diversions by C significantly
reduced the funds available to conduct O's ongoing educational
programs. The board of trustees never authorized C to cause
O to pay C's personal expenses from O's funds. Certain members
of the board were aware that O was paying C's personal expenses.
However, the board did not terminate C's employment and did
not take any action to seek repayment from C or to prevent C
from continuing to divert O's funds to pay C's personal expenses.
C claimed that O's payments of C's personal expenses represented
loans from O to C. However, no contemporaneous loan documentation
exists, and C never made any payments of principal or interest.
(ii) The diversions of O's funds to pay C's
personal expenses constituted excess benefit transactions between
an applicable tax-exempt organization and a disqualified person
under section 4958. Therefore, these transactions are subject
to the appropriate excise taxes provided in that section. In
addition, these transactions violate the proscription against
inurement under section 501(c)(3) and §1.501(c)(3)-1(c)(2).
(iii) The application of the factors in §1.501(c)(3)-1(g)(2)(ii)
to these facts is as follows. O has engaged in regular and ongoing
activities that further exempt purposes both before and after
the excess benefit transactions occurred. However, the size
and scope of the excess benefit transactions engaged in by O
beginning in Year 5, collectively, are significant in relation
to the size and scope of O's activities that further exempt
purposes. Moreover, O has been involved in repeated excess benefit
transactions. O has not implemented any safeguards that are
reasonably calculated to prevent future diversions. The excess
benefit transactions have not been corrected, nor has O made
good faith efforts to seek correction from C, the disqualified
person who benefited from the excess benefit transactions. Based
on the application of the factors to these facts, O is no longer
described in section 501(c)(3) effective in Year 5.
Example 4. (i) O conducts activities that further
exempt purposes. O employs C as its Chief Executive Officer.
C, on behalf of O, entered into a contract with Company K to
construct an addition to O's existing building. The addition
to O's building is a significant undertaking in relation to
O's other activities. C owns all of the voting stock of Company
K. Under the contract, O paid Company K an amount that substantially
exceeded the fair market value of the services Company K provided.
When O's board of trustees approved the contract with Company
K, the board did not perform due diligence that could have made
it aware that the contract price for Company K's services was
excessive. Subsequently, but before the IRS commences an examination
of O, O's board of trustees determines that the contract price
was excessive. Thus, O concludes that an excess benefit transaction
has occurred. After the board makes this determination, it promptly
removes C as Chief Executive Officer, terminates C's employment
with O, and hires legal counsel to recover the excess payments
to Company K. In addition, O promptly adopts a conflicts of
interest policy and significant new contract review procedures
designed to prevent future recurrences of this problem.
(ii) The purchase of services by O from Company
K at more than fair market value constitutes an excess benefit
transaction between an applicable tax-exempt organization and
disqualified persons under section 4958. Therefore, this transaction
is subject to the appropriate excise taxes provided in that
section. In addition, this transaction violates the proscription
against inurement under section 501(c)(3) and §1.501(c)(3)-1(c)(2).
(iii) The application of the factors in §1.501(c)(3)-1(g)(2)(ii)
to these facts is as follows. O has engaged in regular and ongoing
activities that further exempt purposes both before and after
the excess benefit transaction occurred. Although the size and
scope of the excess benefit transaction were significant in
relation to the size and scope of O's activities that further
exempt purposes, the transaction with Company K was a one-time
occurrence. By adopting a conflicts of interest policy and significant
new contract review procedures and by terminating C, O has implemented
safeguards that are reasonably calculated to prevent future
violations. Moreover, O took corrective actions before the IRS
commenced an examination of O. In addition, O has made a good
faith effort to seek correction from Company K, the disqualified
person who benefited from the excess benefit transaction. Based
on the application of the factors to these facts, O continues
to be described in section 501(c)(3).
Example 5. (i) O is a large organization with
substantial assets and revenues. O conducts activities that
further exempt purposes. O employs C as its Chief Financial
Officer. During Year 1, O pays $2,500 of C's personal expenses.
O does not make these payments under an accountable plan under
§53.4958-4(a)(4) of this chapter. In addition, O does not
report any of these payments on C's Form W-2, "Wage and
Tax Statement," or on a Form 1099-MISC, "Miscellaneous
Income," for C for Year 1, and O does not report these
payments as compensation on its Form 990, "Return of Organization
Exempt From Income Tax," for Year 1. Moreover, none of
these payments can be disregarded under section 4958 as nontaxable
fringe benefits and none consisted of fixed payments under an
initial contract under §53.4958-4(a)(3) of this chapter.
C does not report the $2,500 of payments as income on his individual
federal income tax return for Year 1. O does not repeat this
reporting omission in subsequent years and, instead, reports
all payments of C's personal expenses not made under an accountable
plan as income to C.
(ii) O's payment in Year 1 of $2,500 of C's
personal expenses constitutes an excess benefit transaction
between an applicable tax-exempt organization and a disqualified
person under section 4958. Therefore, this transaction is subject
to the appropriate excise taxes provided in that section. In
addition, this transaction violates the proscription against
inurement in section 501(c)(3) and §1.501(c)(3)-1(c)(2).
(iii) The application of the factors in §1.501(c)(3)-1(g)(2)(ii)
to these facts is as follows. O engages in regular and ongoing
activities that further exempt purposes. The payment of $2,500
of C's personal expenses represented only a de minimis portion
of O's assets and revenues; thus, the size and scope of the
excess benefit transaction were not significant in relation
to the size and scope of O's activities that further exempt
purposes. The reporting omission that resulted in the excess
benefit transaction in Year 1 is not repeated in subsequent
years. Based on the application of the factors to these facts,
O continues to be described in section 501(c)(3).
(3) Effective date. --The rules in paragraph
(g) of this section will apply with respect to excess benefit
transactions occurring after the date of publication in the
Federal Register of a Treasury Decision adopting these rules
as final regulations.
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