In PLR 201652029 the IRS was asked to grant an organization a tax exemption under §501(c)(3). The organization was one formed to grant annual scholarships to graduating seniors of a particular high school who met certain criteria.

Initially this seems like a reasonable request since the organization’s purpose was to further education, and it was going to grant scholarships based on merit-based criteria. But it turns out that criteria caught the IRS’s attention when the IRS looked at applying those criteria to what had actually taken place in the past.

The governing board members were a husband and wife. The organization had two members of a selection committee who expected to spend about one hour per year operating the scholarship program—because it turns out it wouldn’t be that difficult to identify qualifying recipients.

The criteria for obtaining a scholarship from this organization were outlined as follows in the ruling:

To qualify for a scholarship, an applicant must be a graduating senior from B high school who has been selected as a National Merit Finalist and are newly admitted to C College. C College is approximately 3000 miles from B high school.

The scholarship may be awarded for four years of undergraduate studies or completion of baccalaureate degree requirements, whichever occurs first. Recipients must enter C College no later than the fall following graduation from B high school. Scholars must remain in good academic and disciplinary standing at C College. Transfer students are not eligible.

But the IRS took a look at how many graduating seniors from this high school would meet these criteria and discovered that they could only identify a single senior who would meet these criteria.

B high school has a graduating class which fluctuates yearly but is usually approximately 500 students. Two years ago there were four individuals graduating from B high school that were National Merit Finalists. You do not know if any attended C College. Last year there were two individuals graduating from B high school who were National Merit Finalists. One was F, the son of founders D and E. The other individual was not related to the founders. F went on to attend C College and was awarded your scholarship. The other individual did not attend C College and, therefore, did not meet the qualifications for your scholarship.

This year there was one individual graduating from B high school who was a National Merit Finalist. It is unknown if he will attend C College. If he attends C College, he will be awarded a scholarship.

Based on historical data, you said that between 1-4 students annually will be National Merit Finalists graduating from B high school, of which 0-1 will apply to C College. You said that C College historically admits about 10% of their applicants. Therefore, there will be between 0-1 eligible applicants annually.

The source of funding for the organization was also of interest to the IRS:

You are funded by your founders, D and E. You will only exist as long as the donors, in their discretion, fund the award; it is not a perpetual fund. As was indicated earlier all your funds were paid out last year for the scholarship awarded to F.

Looking at these facts, the IRS declined to grant a §501(c)(3) exemption status to this organization. The ruling concludes:

Based on the facts presented, you are operating for the substantial non-exempt purpose of operating a scholarship program with selection criteria which are too narrow to benefit the general public. Your scholarship program was set up to benefit the founders, as their son was the only recipient since your inception. Therefore, your earnings inure to the benefit of your founders and you do not qualify for exemption as an organization described in Section 501(c)(3) of the Code.