The private inurement prohibition applies to an exempt organization, even if that organization is clearly serving an individual that would otherwise been a reasonable recipient of benefits from a charity. The IRS pointed that out in denying an application for tax exempt status in PLR 201637017.

Private inurement is an issue for many potential organizations that a client may be motivated to form, as often a personal experience and a problem of a specific individual will be the genesis of the idea to form the organization. But the regulations under §501(c)(3) provide a strict prohibition on “private inurement” as the IRS points out in the ruling:

Treas. Reg. Section 1.501(c)(3)-1(c)(2) states regarding the distribution of earnings 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.

In this case the organization in its application for exempt status stated it was formed “to assist adolescent children and families in coping with undiagnosed and/or debilitating diseases.” On the surface that would seem a worthy charitable purpose.

But the problem was how the organization actually operated. As the IRS notes:

You were formed by D and E and named after their minor son, who suffers from an unidentified illness. Your activities consist primarily of conducting various fundraising events to provide financial support to designated recipients. Your fundraising material specifically requests funds to help D and E's son. The funds are made available to recipients to assist with unexpected and unreimbursed medical, travel and other related expenses. Since your inception the only individual that has received funds from you is the minor child of D and E.

The organization claimed that it planned to serve other beneficiaries. But, as the IRS noted, this process hadn’t yet found any other appropriate beneficiary:

You indicated that selected recipients will be required to provide a detailed explanation of the needy recipients' medical condition. Your governing body or designated committee will review the request for assistance submitted by any needy individual, organization and/or the family of a needy individual to determine if the distribution meets your qualification as a charitable purpose. However, to date no individual has been a recipient other than D and E's child.

As the IRS notes, the statute and case law does not allow for such private charity to be given tax preferred treatment.

In Carrie A. Maxwell Trust, Pasadena Methodist Foundation v. Commissioner, 2 TCM 905 (1943) a trust established for the benefit of an aged clergyman and his wife was a private trust and not an exempt activity despite the fact that the two individuals served were needy.

As well, even using less than 100% of the organization’s fund for a “preferred” individual will cause a denial of exempt status.

In Wendy Parker Rehabilitation Foundation, Inc. v. Commissioner, 52 T.C.M. (CCH) 51 (1986), the organization was created by the Parker family to aid an open-ended class of "victims of coma." However, the organization stated that it anticipated spending 30 percent of its income for the benefit of Wendy Parker, significant contributions were made to the organization by the Parker family, and the Parker family controlled the organization. Wendy's selection as a substantial recipient of funds substantially benefited the Parker family by assisting with the economic burden of caring for her. The benefit did not flow primarily to the general public as required under Treas. Reg. Section 1.501(c)(3)-1(d)(1)(ii). Therefore, the Foundation was not exempt from federal income tax under Section 501(c)(3) of the Code.

In denying the request for exempt status, the IRS points out:

Since your inception, the only individual that has received funds has been the minor child of D and E. As described in Treas. Reg. Section 1.501(c)(3)-1(c)(2), you are not operated exclusively for one or more exempt purposes because your net earnings have inured to private shareholders or individuals. The payments made for the benefit of the minor child of D and E inures to their benefit. The prohibition on inurement under Section 501(c)(3) of the Code is absolute, precluding you from exemption.