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Full Opinion
T.C. Memo. 1997-424
UNITED STATES TAX COURT
KJ'S FUND RAISERS, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 10279-96X. Filed September 22, 1997.
Stephen S. Ankuda, for petitioner.
Ronald B. Weinstock, for respondent.
MEMORANDUM OPINION
RAUM, Judge: The Commissioner determined that petitioner
did not meet the section 501(c)(3)1 requirements for
qualification as an exempt organization, with the consequence
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years at issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
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that it is not exempt from income tax under section 501(a).
Specifically, the Commissioner determined that petitioner failed
to establish that it operated exclusively for exempt purposes
under section 501(c)(3). This case is before us on a petition
for declaratory judgment pursuant to section 7428. The parties
filed a joint stipulation as to the completeness and correctness
of the administrative record and submitted this case for
determination under Rule 122.
Kristine Hurd and James Gould are the sole owners of KJ's
Place, a lounge where alcoholic beverages are served. The term
KJ is obviously derived from the first initials of the first
names of the owners, Kristine and James. In 1992, Kristine and
James created petitioner, KJ's Fund Raisers, Inc. They had
petitioner incorporated as a Vermont Non-Profit Corporation on
October 12, 1992. They also had petitioner file a Form 1023,
Application for Recognition of Exemption Under Section 501(c)(3)
of the Internal Revenue Code on November 11, 1992.
Petitioner's business is selling Lucky 7 or other break-open
(or lottery or rip) tickets. The lottery tickets are sold
exclusively at KJ's Place; no other locations were considered.
The tickets are sold during regular business hours by the owners
and employees of KJ's Place.
Petitioner was organized purportedly to "raise funds for
distribution to charitable causes". Petitioner expects the
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majority of its funds to come from the sale of lottery tickets
and does not plan to solicit public donations, but will accept
any donations offered. There is no evidence in the record that
any such donations were ever offered or received.
When petitioner was organized, Hurd and Gould were both
officers and directors. She was president; he was vice
president, secretary, and treasurer. The third member of the
board of directors was Karen Gould, a relative of James Gould.
In April 1993, petitioner replaced its board of directors.
Of the three new members, two were related to Hurd or Gould. The
board has been altered since then. The current board has two
members unrelated to Hurd or Gould; the third is Kristine Hurd's
sister. In a letter to the IRS, petitioner indicated that it
would further revise its board so that none of the members were
related to the officers of KJ's Place. However, that change has
never been implemented.
In 1993, petitioner paid Hurd and Gould compensation of
$6,000 each for bookkeeping, accounting and managerial services.
Petitioner also paid $6,000 in rent to KJ's Place. The measure
of compensation was determined by Hurd and Gould. On July 1,
1994, changes in Vermont's gambling laws took effect. In
accordance with these changes, petitioner stopped paying rent to
KJ's Place and stopped paying wages to Hurd and Gould.
Currently, there are no business dealings between petitioner's
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directors and the owners of KJ's Place, and petitioner's books
are kept separate from the accounts of KJ's Place.
From the proceeds of the sales of the lottery tickets,
petitioner has made grants to a variety of organizations. Some
of these grants have been memorialized in local newspapers. Of
six clippings sent to the IRS by petitioner, two have a photo of
Hurd or Gould in front of KJ's Place handing out a check on
behalf of petitioner. One clipping notes that KJ's Fund Raisers
is a new corporation located at KJ's Place. Another shows a
director of petitioner presenting a check and identifies the
proceeds as arising from rip-ticket sales at KJ's Place.
In its preliminary adverse determination letter, issued on
June 7, 1994, the IRS indicated that the identity of the lounge
owners and the officers of petitioner put Hurd and Gould in a
position to control petitioner. Petitioner responded as follows:
With respect to control of the organizations, it
may appear that all of KJ's Fundraisers, Inc.,
fundraising activities can be controlled by the owners
of the lounge due to the relationship between officers
and directors of each. It is our opinion, however,
that KJ's Fund Raisers, Inc. would fold without the
original founders of the organization as officers and
local charities would go unfunded. Therefore we do not
view the appointment of the present officers as a
function of control but more as a function of going
concern.
The IRS issued its final adverse determination letter on
February 27, 1996. It stated:
You have failed to establish that you are operated
exclusively for exempt purposes under section
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501(c)(3). You have failed to establish that your
operation will not result in more than incidental
private benefit. Furthermore, for the period prior to
July 1, 1994, you have failed to establish that your
net earnings will not inure to the benefit of private
individuals.
Petitioner seeks a declaratory ruling that, as of July 1, 1994,
petitioner is exempt from taxation under section 501(c)(3).
Section 501(a) provides that "An organization described in
subsection (c) * * * shall be exempt from taxation under this
subtitle". Subsection (c)(3) includes "Corporations * * *
organized and operated exclusively for * * * charitable * * *
purposes * * * no part of the net earnings of which inures to the
benefit of any private shareholder or individual".
Section 1.501(c)(3)-1(a)(1), Income Tax Regs., requires that
for an entity to have exempt status it "must be both organized
and operated exclusively for one or more of the purposes
specified" in section 501(c)(3). Respondent has conceded that
petitioner meets the organizational test. Petitioner must
demonstrate that it operates exclusively for exempt purposes.
Sec. 1.501(c)(3)-1(c)(1), Income Tax Regs., provides:
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 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.
An organization is not operated exclusively for exempt purposes
unless it serves "a public rather than a private interest."
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Sec. 1.501(c)(3)-1(d)(1)(ii), Income Tax Regs. To meet this
requirement, the organization must demonstrate
that it is not * * * 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.
Id.
Under the operational test, the organization's purpose,
rather than the nature of its activities, determines whether the
organization is entitled to tax-exempt status. B.S.W. Group,
Inc. v. Commissioner, 70 T.C. 352, 356-357 (1978). Even an
organization engaged in only one activity may have multiple
purposes for that activity. Copyright Clearance Center, Inc. v.
Commissioner, 79 T.C. 793, 803 (1982). A single nonexempt
purpose, if substantial in nature, will disqualify an
organization from qualification under section 501(c)(3). Better
Business Bureau v. United States, 326 U.S. 279, 283 (1945).
Determining the purpose of the organization is a factual question
which concerns "both the actual as well as the stated purposes
for the existence of the organization and the activities it
engages in to accomplish those purposes." Christian Manner
International, Inc. v. Commissioner, 71 T.C. 661, 668 (1979).
Petitioner's case is factually similar to P.L.L. Scholarship
Fund v. Commissioner, 82 T.C. 196 (1984). In that case, the
taxpayer was a nonprofit corporation formed to raise money for
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college scholarships. It planned to raise money through the
operation of bingo games held at the Pastime Lounge, a lounge
owned by two members of the board of directors. The other board
members consisted of an accountant and director of the lounge and
two "bingo players." The board was self-perpetuating, with the
existing directors selecting future directors. Id. at 197.
The owners of the Pastime Lounge ran the bingo games during
regular business hours. Employees of the Pastime Lounge
solicited orders for food and drink from the bingo players.
However, the accounts of the Pastime Lounge were kept separate
and distinct from those of the taxpayer. Id. at 197-198.
This Court held that the taxpayer had a nonexempt purpose
which was "substantial in nature"; i.e., to promote business at
the Pastime Lounge through the medium of the bingo games. Id. at
199-200. The Court based this conclusion in part on the identity
of the taxpayer's board of directors with the owners and
associates of the Pastime Lounge. Since the owners controlled
the board and appointed its future directors, the Court reasoned,
the taxpayer's activities could be used to the advantage of the
Lounge. Id. at 200.
The taxpayer argued that the separate accounts and the fact
that the Lounge received nothing from the taxpayer for wages or
rent demonstrated that it was operated exclusively for an exempt
purpose. The Court held otherwise:
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A realistic look at the operations of these two entities,
however, shows that the activities of * * * [the taxpayer]
and the Pastime Lounge were so interrelated as to be
functionally inseparable. Separate accountings of receipts
and disbursements does not change that fact.
* * * Since the record in this case does not show that
the * * * [taxpayer] was operated exclusively for exempt
purposes, but rather indicates that it benefited private
interests, exemption was properly denied. [Fn. ref.
omitted.]
Id.
The manner in which petitioner is operated benefits private
interests, KJ's Place and its owners. Like P.L.L. Scholarship
Fund v. Commissioner, supra, petitioner's lottery tickets are
sold at a single location, KJ's Place. As in P.L.L. Scholarship
Fund v. Commissioner, supra, the lottery tickets are sold during
KJ's Place's regular business hours, their sale overseen by the
owners of KJ's Place, Hurd and Gould. While in KJ's Place,
lottery ticket purchasers are solicited for beverages. As in
P.L.L. Scholarship Fund v. Commissioner, supra, the accounts of
petitioner and KJ's Place are kept separate and apart.
Despite these similarities, petitioner contends that two
factors distinguish it from P.L.L. Scholarship Fund v.
Commissioner, supra. First, the board of directors is
responsible for running petitioner, and the majority of the board
members are not related to the owners of KJ's Place. Second,
KJ's Place has allegedly lost money as patrons prefer to purchase
lottery tickets rather than beverages.
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Petitioner stresses that the board of directors, independent
of Hurd and Gould, controls the distribution of proceeds raised
by the sale of the lottery tickets. While the board does decide
which charities will receive funds, it is clear from the record
that Kristine Hurd and James Gould control sales of the lottery
tickets as they relate to KJ's Place. It is also clear that
their control is realistically independent of the board. In a
protest letter to the IRS dated July 18, 1994, petitioner
concedes that the officers of KJ's Place appear able to control
petitioner but defend it as necessary.
It is our opinion, however, that KJ's Fundraisers, Inc.
would fold without the original founders of the organization
as officers and local charities would go unfunded. * * *
[Emphasis added.]
Before July 1, 1994, Hurd and Gould received wages and KJ's
Place received rent from petitioner. Although those practices
ceased and are not in issue here, the current board of directors
is composed of at least the majority of the same members who
allowed those amounts to be paid. This strongly suggests that
Hurd and Gould are free to set policy for their own benefit
without objection from the board. Nothing in the record since
July 1, 1994, indicates otherwise.
Petitioner also contends that KJ's Place actually lost
money, since patrons preferred to buy lottery tickets rather than
use their money to purchase beverages. Thus, petitioner argues,
there was no actual benefit. While all facts must be accepted as
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true for purposes of a declaratory judgment, Rule 217,
conjectural statements such as the one above are entitled to no
such consideration. Petitioner has presented no evidence that
KJ's Place lost money. More important, KJ's Place has benefitted
from the publicity surrounding donations given by petitioner. In
four of six newspaper articles or picture captions in evidence,
KJ's Place is pictured or mentioned, along with Hurd or Gould,
who are identified as the owners of KJ's Place rather than
officers of petitioner.
Petitioner argues that the clippings are not paid
advertising and do not indicate the receipt of an actual benefit
by KJ's Place. We find, however, that the publicity, which KJ's
Place would not have received but for petitioner's exclusive
association with the lounge, is a significant benefit. Moreover,
the record discloses that there were other "clubs" or lounges in
the area where comparable gambling took place. It is thus a fair
inference that one of the real purposes of establishing
petitioner in the first place was to induce customers with a
proclivity for this type of gambling not to desert KJ's Place in
favor of other clubs or lounges. As a result of petitioner's
formation, KJ's Place, far from losing revenue, may indeed have
prevented at least a portion of its business from being taken
elsewhere.
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Petitioner engaged in the exempt activity of raising money
for charitable purposes. Petitioner also operated for the
substantial private benefit of KJ's Place and its owners. A
substantial nonexempt purpose thus characterizes its operation,
disqualifying it from exemption under sections 501(a) and
501(c)(3). Better Business Bureau v. United States, 326 U.S. at
283; Copyright Clearance Center, Inc. v. Commissioner, 79 T.C. at
803.
Decision will be entered
for respondent.