The IRS denied tax-exempt status under IRC Section 501(c)(3) in LTR 202504021 to an organization that planned to provide assistance, primarily to its members in need, if there is a death, marriage, or birthday.

The Foundational Tests for 501(c)(3) Exemption

To fully grasp why this organization failed, we must start with the core requirements for 501(c)(3) status, which involve both organizational and operational tests, as outlined in the regulations:

Treas. Reg. Section 1.501(c)(3)-1(a)(1) states: "In order to be exempt as an organization described in section 501(c)(3), an organization must be both organized and operated exclusively for one or more of the purposes specified in such section. If an organization fails to meet either the organizational test or the operational test, it is not exempt." This provision underscores that both the structure and the function of the organization must be geared towards an exempt purpose.
- Organizational Test: This test focuses on the organization’s governing documents (articles of organization). These must limit the organization’s purposes to one or more exempt purposes and not explicitly empower the organization to engage in substantial non-exempt activities.
- Operational Test: This test concerns the actual activities of the organization. It requires that the organization engage primarily in activities that accomplish one or more exempt purposes and not more than insubstantially in non-exempt activities.

In the case of LTR 202504021, the IRS focused on the operational test, finding the organization failed in this regard. While the organization’s documents may have stated an exempt purpose, the IRS determined that the organization’s actual operations did not align with that stated purpose.

The Operational Test and the “Exclusively” Requirement

The “exclusively” requirement of the operational test is quite strict and is a core reason the organization in LTR 202504021 failed to meet the requirements of 501(c)(3). The IRS emphasized this when it concluded that the organization was “not operated exclusively for exempt purposes”.

Treas. Reg. Section 1.501(c)(3)-1(c)(1) reinforces this: “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 Section 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.” This means the primary focus of the organization’s operations must be on exempt activities.

The IRS determined the organization’s primary activity was disbursing funds to members for personal events like deaths, marriages, and birthdays. This activity, while helpful to members, did not directly advance religious, charitable, scientific, educational, or other purposes listed as exempt under 501(c)(3). The IRS viewed these payments not as part of a broader charitable program, but as direct financial benefits to members, thus making this a substantial non-exempt activity. The fact that this activity constituted the primary operations and that no funds had been disbursed for other potential charitable activities, such as disaster relief, further supported this view.

The Private Benefit Doctrine: Public vs. Private Interest

A crucial element in determining exempt status is whether the organization serves a public rather than a private interest. This principle is central to the private benefit doctrine.

Treas. Reg. Section 1.501(c)(3)-1(d)(1)(ii) explains: “An organization is not organized or operated exclusively for one or more of the purposes specified in subdivision (i) of this subparagraph [exempt purposes] unless it serves a public rather than a private interest. Thus, to meet the requirement of this subdivision, 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.”

In the case of LTR 202504021, the IRS concluded that the organization was designed to provide direct and specific benefits to a select group – its members. The provision of funds was based on membership, and any member, including board members, could receive these distributions. The IRS did not see this as serving a broader public interest, but rather as a form of direct private benefit, which runs contrary to the requirements for a 501(c)(3) organization. The IRS noted “the payment of these types of benefits to pre-selected, specifically named individuals serves a private rather than a public interest. There is no charitable intent to these payments.” This is a strong statement indicating a lack of public purpose.

Application of Relevant Case Law and Revenue Rulings

The IRS did not base its decision solely on the regulations. It also relied on precedent set by case law and previous rulings:

Better Business Bureau of Washington, D.C., Inc. v. United States: This Supreme Court case emphasized the importance of an exclusively exempt purpose. The Court stated that “the presence of a single non-exempt purpose, if substantial in nature, will destroy a claim for exemption regardless of the number or importance of truly exempt purposes”. The court found the Better Business Bureau’s “important, if not the primary, pursuit” was to promote a profitable business community, not educational purposes.
- The IRS in LTR 202504021 directly applied this ruling: “As explained in Better Business Bureau of Washington, D.C., Inc., a single, substantial non-exempt purpose is sufficient to prevent exemption. You have a substantial non-exempt purpose of providing payments to your members for marriages, birthdays, funerals, or deaths which prevents you from qualifying for exemption under IRC Section 501(c)(3)”. This shows the IRS’s strict interpretation of the “exclusively” requirement and its application to the organization’s substantial non-exempt activity.
Rev. Rul. 67-367: This ruling involved an organization operating a “scholarship” plan where subscribers designated specific beneficiaries. The IRS denied exemption, stating the organization was “serving private interests rather than public charitable and educational interests”.
- The IRS in LTR 202504021 directly compared the two organizations: “You are similar to the organization described in Rev. Rul. 67-367 whose activities primarily serve its members rather than the public in general. You are providing payments to your members for marriages, birthdays, funerals, and deaths. The payment of these types of benefits to pre-selected, specifically named individuals serves a private rather than a public interest.” This ruling was a key piece of evidence that the payments to members were a non-exempt activity.
- Rev. Rul. 67-367 states: “Under these agreements, whereby the organization pays `scholarships’ to pre-selected, specifically named individuals designated by subscribers, the organization is serving private interests rather than public charitable and educational interests contemplated under section 501(c)(3) of the Code.” The ruling draws a parallel between the scholarship payments and the payments for personal events, indicating a lack of charitable intent in both cases.
Rev. Rul. 69-175: This ruling involved a parent-created organization providing transportation for children to private schools and was denied exemption because “they are serving a private interest.”
- The IRS drew this comparison: “Like the organization in Rev. Rul. 69-175, that a group of parents provided a cooperative service for themselves and served their own private interests, you were formed to provide benefits to your members. In your case, you are primarily providing payments to your members for marriages, birthdays, funerals or deaths. These payments serve a private rather than a public interest.”

These rulings show that organizations providing direct benefits to a defined private group, even if such benefits are for ostensibly good purposes, are generally not considered to be operating exclusively for exempt purposes. The emphasis is on serving the public good rather than specific private interests.

Inurement and its Relationship to Private Benefit

While the IRS did not explicitly state that the organization was in violation of the inurement prohibition, the case highlights how private benefit and inurement often intertwine.

Treas. Reg. Section 1.501(c)(3)-1(c)(2) notes 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”.

Inurement occurs when an organization’s net earnings are used for the benefit of insiders. This can take the form of excessive compensation, unreasonable payments for services or goods, or distributions of assets to individuals. In this case, even though the organization didn’t distribute profits, the payments to members for weddings, funerals, and birthdays could be seen as a form of inurement because they were providing a direct private benefit and not serving a charitable public good.

The Overall Deficiencies

The IRS identified key deficiencies that led to the denial of the organization’s tax-exempt status:

Substantial Non-Exempt Activity: The organization’s primary activity of providing funds for members’ personal events was deemed a substantial non-exempt activity, failing the operational test. This activity was not related to any of the specific exempt purposes listed under 501(c)(3).
Serving Private Interests: The organization primarily benefited its members, a defined private group, rather than the broader public. This violates the private benefit doctrine, a fundamental aspect of 501(c)(3) qualification.
Lack of Charitable Intent: The payments were viewed as serving individual member needs rather than promoting charitable goals. The IRS pointed out the lack of public purpose inherent in these payments.
Precedent and Consistency: The IRS applied established case law (Better Business Bureau case) and revenue rulings (Rev. Ruls. 67-367, 69-175) to support its determination, demonstrating consistency in interpreting and applying tax laws.
The organization had not engaged in disaster relief or other charitable programs, further weakening the argument for 501(c)(3) status.

Conclusion

The denial of tax-exempt status in LTR 202504021 highlights the strict requirements for qualification under Section 501(c)(3). The organization’s operations failed to demonstrate that its primary purpose was charitable, educational, religious, or any other exempt purpose under 501(c)(3). Instead, the IRS found that it was primarily operated for the private benefit of its members. The IRS’s analysis of the organization’s stated mission as compared to its operating activities showed a stark disconnect. To qualify, an organization must demonstrate that its purpose and operations align with a clear public benefit, and not primarily benefit a defined private group, while adhering to the specific requirements of the operational and organizational tests, and avoiding any form of private inurement.