Petition — Western Catholic Church v. Commissioner

60-1049

Dereme Court, U.S,

' FILED

No. . 17 1980

MICHAEL RODAK, JR., CLERK

In Tue

Supreme Court of the Anited States

Ocroser TERM, 1980

WESTERN CATHOLIC CHURCH,

Petitioner,

Vv.

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE SEVENTH CIRCUIT

EDWARD J. KIONKA

632 North Main Street

Columbia, Illinois 62236

(618) 281-7186

JOHN J. VASSEN

PATRICK B. MATHIS

JOHN J. VASSEN P.C.

1801 North Belt West

Belleville, Illinois 62223

(618) 277-8700

Attorneys for Petitioner

Western CaTHoLic CHURCH

Midwest Law Printing Co., Chicago 60601, Financial 6-3988

i

QUESTIONS PRESENTED FOR REVIEW

1. The principal issue is whether the Tax Court and

the Court of Appeals erred in determining that the

Western Catholic Church was not being “operated” for a

religious purpose when its principal activity was ac-

cumulating and investing funds in a budding fund for

the purpose of constructing a church building, one of the

purposes for which it was organized and for which its

exemption was initially approved.

2. A secondary issue is whether the Tax Court and

the Court of Appeals erred in determining that a part of

the “net earnings” of the Western Catholic Church in-

ured to the benefit of a private individual.

1 The parties to this promeoning in the Court of Appeals were

the same as those listed in the caption here.

ili

TABLE OF CONTENTS

QUESTIONS PRESENTED FOR REVIEW ................ i

LIST OF AUTHORITIES CITED ......WW 2... iv

REPORTS OF OPINIONS 1

GROUNDS FOR JURISDICTION OF UNITED

STATES SUPREME COURT W000. 2

STATUTES AND REGULATIONS INVOLVED ...... 2

STATEMENT OF THE CASE oe eeeeeeeeneceeeeeeeeee 3

REASONS FOR GRANTING THE WRIT:

1

The Decision Below Conflicts With The Majority

Of The Courts Of Appeals That Have Considered

This Question, And Also With The Decisions Of

This Court 9

2

The Decision Below Impermissibly Burdens New

Charities And Discriminates In Favor Of Those

Which Have Already Succeeded In Establishing

Their Programs 22

3

The Decision Below Erroneously Concluded That

Some Part Of The Net Earnings Of The Church

Inured To The Benefit Of A Private Individual .... 24

CONCLUSION 26

| PREVIOUS PAGE WAS BLANK \

iv

APPENDIX:

Section 501, Internal Revenue Code of 1954 (26

U.S.C. § 501) as

Section 504, Internal Sevieni Code of 1954 (re-

pealed 1969)

Section 511, Internal Revenue Code of 1954 (26

U.S.C. § 511)

Section 512, Internal Revenue Cude of 1954 (26

US.C. § 512)

Section 513, Internal Revenue Code of 1954 (26

—US.C. § 513)

45a

48a

58a

Excerpts from Treas. Reg. § 1.501(c)(3)-1 (1959) 63a

Architect’s Drawing

LIST OF AUTHORITIES CITED

Cases

Better Business Bureau v. United States, 326 U.S. 279

67a

(1945) - 12, 18, 17

Bomen v. Commissioner, 240 F.2d 767 (8th Cir. 1957)

C. F. Mueller Co. v. Contanlasiones: 190 F.2d 120 (3d Cir

13, 25

1951) 13, 14

Curt Teich Foundation v. Commissioner, 48 T.C. 963

(1967), aff’d per curiam, 407 F.2d 815 (7th Cir. 1969)

Danforth Foundation v. United States, 222 F. Supp.

761 (E.D. Mo. 1963)

Erie Endowment v. United States, 316 F.2d 151 (3d

Cir. 1963)

Golden Rule Church Association v. Commissioner, 41

20, 26

20

T.C. 719 (1964) 23, 24

Hulman Foundation, Ine. v. United States, 217 F.

Supp. 423 (S.D. Ind. 1962)

20

|

Vv

Huron Clinic Foundation v. United States, 212 F.

Supp. 847 (D.S.D. 1962), remanded by stipulation,

324 F.2d 43 (8th Cir. 1963) 9, 20, 25

Lichter Foundation v. Welch, 247 F.2d 431 (6th Cir.

RIE i datiaiinesbensedbanccnamtediedes 13

Ralph H. Eaton Foundation v. Commissioner, 219 F.

2d 527 (9th Cir. 1955) 13

Randall Foundation v. Riddell, 244 F.2d 803 (9th Cir.

TONED Nechsiniichebnyitiacentipcasia 11, 16, 17, 18, 19

Roche’s Beach, Ine. v. Commissioner, 96 F.2d 776 (2d

UUs RNUIED cajelelisecsiiceiodiadeane lca ticintnismspadiaiwecs 13, 14

Samuel Friedland Foundation v. United States, 144 F.

Supp. 74 (D.N.J. 1954) ........... 20

Stevens Bros. Foundation, Inc. v. Commissioner, 324

F.2d 633 (8th Cir. 1963) 20

Travis Smith v. Commissioner, 60 T.C. 988 (1973) ........ 10

Trinidad v. Sagrada Orden, 263 U.S. 578 (1924) .... 12,14, 17

United States v. Community Services, Inc., 189 F.2d 421

(4th Cir. 1961) ................. 13

Willingham v. Home Oil Mill, 181 F.2d 9 — Cir,

MU is hcilasik teieeiedaedaseasact

Other Authorities

Excerpts from Treas. Reg. § 1.501(¢)(3)-1 (1959) ....

ASSET NB DNASE Deen RICA DADA! DT oa .. 9, 10, 63a

Section 501, Internal Revenue Code of 1954 (26 U.S.C.

Lt BURT ST ot eRe AO 3, 9, 10, 11, 16, 18, 29a

Section 504, Internal Revenue Code of 1954 (repealed

TT Katinas wencekarisisdb chicane .... 16, 18, 20, 44a

Section 511, Internal Revenue Code of 1954 (26 U.S.C.

§ 511) skit sa hoa nals henibeecadses wapepaipiennalamhcadeoasereeaiatealadan pied 45a

§ 512) RRL CAN Ree ON eo Be SDN ER BEEN WES BO a I OE - 48a

“Do BEREAN ARATE OE Sa RE MEE _ 58a

7%

vi

Section 3814(3), Internal Revenue Code of 1939 ........ 16, 19

Corporate Excise Tax Act of 1909, 36 Stat. 112 (1909) .. 11

Income Tax Act of October 3, 1913, 38 Stat. 172 -....... 11, 12

26 U.S.C. § 7428(a) 3

28 U.S.C. § 1254 2

96 Cong. Rec. 13273 (1950) 14

Rev. Rul. 66-219, 1966-2 C.B. 208 ; 25, 26

Rev. Rul. 75-282 22, 23

Eliasberg, Charity and Commerce: I.R.C. §501(c)(3)—

How Much Unrelated Business Activity?, 21 Tax L.

Rev. 53 (1965) 14, 17, 18

Strong and Fields, Profitable Related Business Activ-

ities and Charitable Exemptions Under §501(c)(3),

44 Gro. Wasu. L. Rev. 270 (1976)

S. Rep. No. 2375, 81st Cong. 2d Sess. 28-9 (1950) ...... 14, 15

In Tue

Supreme Court of the Anited States

Ocroser Term, 1980

WESTERN CATHOLIC CHURCH,

Petitioner,

Vv.

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE SEVENTH CIRCUIT

The petitioner Western Catholic Church respectfully

prays that a writ of certiorari issue to review the

judgment of the United States Court of Appeals for

the Seventh Circuit entered in this proceeding on

September 19, 1980.

REPORTS OF OPINIONS

The opinion of the Tax Court below is reported at 73

T.C. 196. The order of the United States Court of

Appeals for the Seventh Circuit, which merely adopted

the opinion of the Tax Court, is unreported.

jellies

GROUNDS FOR JURISDICTION

OF UNITED STATES SUPREME COURT

The order of the United States Court of Appeals for

the Seventh Circuit, affirming the decision of the Tax

Court, was entered September 19, 1980. No petition for

rehearing was filed.

This Court has jurisdiction to issue a writ of certiorari

in this case pursuant to 28 U.S.C. § 1254.

STATUTES AND REGULATIONS INVOLVED

The statutes and regulations involved are set forth in

the Appendix. They are:

Section 501, Internal Revenue Code of 1954 (26

U.S.C. § 501).

Section 504, Internal Revenue Code of 1954

(repealed 1969).

Section 511, Internal Revenue Code of 1954 (26

U.S.C. § 511).

Section 512, Internal Revenue Code of 1954 (26

U.S.C. § 512).

Section 513, Internal Revenue Code of 1954 (26

U.S.C. § 518).

Excerpts from Treas. Reg. § 1.501(cX3)-1 (1959).

mr an

STATEMENT OF THE CASE

The Western Catholic Church was incorporated for

religious purposes under the Illinois General Not For

Profit Corporation Act in 1971. That same year, it

applied for and was issued a determination by the Inter-

nal Revenue Service that it was exempt from federal in-

come tax under § 501(cX3) of the Internal Revenue Code.

me. 2%

The Internal Revenue Service conducted an audit of

the Church’s activities for the years 1972, 1973 and

1974. Following this audit, the Church was notified by

letter dated April 25, 1978 that the IRS had determined

to revoke its tax exempt status, retroactive to April 23,

1971, the date the Church was organized. The grounds

for the revocation were that (1) the Church was not, nor

had it ever been, “operated exclusively for religious. . .

purposes” and (2) a portion of the Church’s net earnings

had “inured to the benefit of private individuals,” both

in contravention of I.R.C. § 501(cX3).

Pursuant to 26 U.S.C. § 7428(aX1\A), the Church filed

a Petition for Declaratory Judgment in the United

States Tax Court, seeking its determination that the IRS

had erred in its determination. Following a hearing

before a judge of the Tax Court, the Court on October

31, 1979 issued its Order and Decision finding that the

Church did not qualify as a § 501(cX3) organization and

sustaining the IRS retroactive revocation of the Church’s

tax exempt status.

Pursuant to 26 U.S.C. § 7428(a), the Church appealed

to the United States Court of Appeals for the Seventh

Circuit. In a brief order entered September 19, 1980, the

a om

Court of Appeals affirmed the decision of the Tax Court

and adopted its opinion.

The Western Catholic Church was formed and incor-

porated by S. Dean Slough, his wife Laura, and his

daughter, Deana L. Hron. It is located in Quincy, Ii-

linois.

The purpose or purposes for which the Church was

organized were set forth in the By-Laws (Ad.Rec.Ex.6-

F) and stated in Article V of the Articles of Incorpora-

tion as follows:

To establish a church to embrace persons of all

faith, color and creed. To join for a common cause

the betterment of man, by helping God in spreading

the Gospel. To recruit evangalists, to build, operate

and maintain churches, hospitals, nursing homes,

schools and to establish missionarys and missions

wherever they are needed in the World. We believed

the Bible to be the verbally inspired Word of God;

the only infallible rule of faith and practice. We

believe in the eternal Deity of our Lord Jesus

Christ; in his virgin birth; in his substitutionary

death on Calvary for our sins; in His bearing of our

afflictions and in His bodily reserrection from the

grave. We believed in salvation by faith through the

shed blood of Jesus Christ. We believe that the true

church is com of all those who have been born

again. We believe in the present working and mov-

ing of the Holy Spirit in the lives of men, women,

children; we believe in carrying out the Great Com-

mission. To evangelize is a vital part of our Chris-

tian responsibility. We believe all men are lost

apart from the saving grace of Jesus Christ. We

believe in the return of Jesus Christ, God’s only

begotten, Son, to this earth. A.7. |

The Articles of Incorporation also provided that the

Church, as a means of accomplishing the stated pur-

poses of the organization, had among other powers, the

following:

i

ae

3. To borrow money, and, from time to time, to

make, accept, endorse, execute and issue bonds,

debentures, promissory notes, bills of exchange, and

other obligations of the Corporation for moneys

borrowed or in payment for property acquired or

for any of the other purposes of the Corporation,

and to secure the payment of any such obligations

4. To invest and reinvest its funds in such stock,

common or preferred, bonds, debentures, mort-

gages, or in such other securities and property,

real and personal, as it shall deem advisable, sub-

ject to the limitations and conditions contained in

any bequest, devise, grant or gift, provided such

limitation and conditions are not in conflict with the

provisions of Section 501(c\3) of the Internal

Revenue Code and applicable Regulations, as they

re exist or as they may hereafter be amended.

8.

During the period in question, 1972-74—the formative

years of the Church’s existence—Dean Slough, its

founder, served as its president, general superintendent,

and only minister. He also was its principal donor. Dur-

ing those three years, he made cash contributions to the

Church totalling almost $100,000. A. 49-51. (Two other

donors contributed $1,000. Tr. 69-70.)

The main focus of this case is the activities of Dean

Slough, which represent the activities of the Church.

The primary issue is whether those activities were in

furtherance of the religious purposes for which the ex-

emption was granted.

There was some activity that was not related to the

building fund. As would be expected, it was develop-

mental. It consisted primarily of “one-on-one” prose-

lytizing or “missionary” work by Dean Slough in

which he sought new members and counseled them. He

ie

estimated that this took ten to twelve hours per month.

These efforts had resulted in obtaining about forty

members for the Church. (Slough declined to disclose

the names of the members, other than his wife and

daughter, for privacy reasons. However, the government

has so far never contended that no such members ex-

isted.) The Church, through Slough, made minor cash

gifts to needy converts or potential converts totalling ap-

priximately $5,000. Slough testified that he considered

the practice of his faith to be a twenty-four hour per day

project, limited by the time requirements of his

businesses.”

The principal activity of the Church was the creation

of a building fund for the purpose of constructing a

church building.

In 1971, an architect designed a building for the

Church. See Appendix for a drawing. The projected cost

for the entire complex was estimated at four to five

million dollars, but it was not contemplated that the en-

tire complex would be constructed at once. Slough

believed that the primary function of the Church was to

obtain more members, and he felt that the construction

of a church building would be important to this end. It

was agreed that at least $500,000 should be raised

before initiating any construction. At the time of trial,

March 14, 1979, the Church had accumulated assets of

approximately $190,000 towards this goal. Slough es-

timated that it would take approximately ten to fifteen

years to put the Church into full operation.

2 During the years in question Slough owned 100% of the

stock and was president of Credit Control Services (a collec-

tion service) and Business Management Corporation, which

managed real estate.

‘esis

To accumulate the required capital for the building

fund, Slough undertook an investment program, using

the contributions to the Church and bank loans obtained

by the Church on its own credit. The Church thus ac-

quired certificates of deposit, bought and sold common

stocks, and purchased a parcel of real estate. This was a

commercial building which the Church leased to Credit

Control Services. It was undisputed that this lease was

favorable to the Church, was at least at full market

value, and provided the Church with a 25% return on its

investment. (All maintenance, repair, and other costs

and taxes were to be paid by Credit Control Services.)

The Church also purchased two automobiles that were

to be used as compensation for two fund raisers who

were to be employed by the Church to raise money.

When the Church later decided not to employ these in-

dividuals, the automobiles were sold to Credit Control

Services for an amount in excess of the purchase price,

so that the Church netted approximately $3,000 on this

transaction.

As noted, the Church borrowed money on bank loans

to help finance its investments. As the bank had a

$75,0C -per-borrower loan limit, it was sometimes

necessary for Slough or his Business Management Cor-

poration to borrow additional funds which were then in

turn loaned to the Church. However, Slough was careful

to insure that the terms of these re-loans were such that

their benefit inured entirely to the Church, and neither

Slough nor his corporation benefited in any way from

them.

A question was raised concerning a check from the

Church to Deana Hron (Slough’s daughter) issued in

May, 1974, in the amount of $1,600. However, the

evidence demonstrated that this represented funds from

~ a

the sale of Mrs. Hron’s mobile home which had been

used to purchase Colt Industries stock, and that stock

had been inadvertently comingled with the Church’s

stock holdings in the same company. When this error

was discovered, upon the sale of such stock, the proceeds

attributable to Mrs. Hron’s investment were returned to

her by that check.

In January, 1975, the Church became a creditor of

Slough when it paid his $12,000 bank loan and took his

note in that amount at the same rate of interest.

No wages or other compensation were ever received

by Slough, his wife or daughter, or any of his businesses

from the Church.

<i

REASONS FOR GRANTING THE WRIT

1

THE DECISION BELOW CONFLICTS WITH THE

MAJORITY OF THE COURTS OF APPEALS THAT

HAVE CONSIDERED THIS QUESTION, AND ALSO

WITH THE DECISIONS OF THIS COURT.

Generally, in order for an organization to be entitled

to exemption from federal income taxation under the

provisions of I.R.C. §50l(a) and §501(cX3), [all

references are to the Internal Revenue Code of 1954, un-

less otherwise indicated], the organization must show

“(1) that it was organized exclusively for charitable pur-

poses, (2) that it is operated exclusively for charitable

purposes, (3) that no part of its net earnings inured to

the benefit of any private shareholder or individual, and

(4) that no substantial part of its activities consist of

carrying on propaganda or otherwise attempting to in-

fluence legislation . . .” Huron Clinic Foundation v. Un-

ited States, 212 F. Supp. 847, 850 (D.S.D. 1962), remand-

ed by stipulation, 324 F.2d 43 (8th Cir. 1963).

In the instant case, it is undisputed that the Church

was “organized” for religious purposes. The primary

issue is whether, during its first three years of operation

(1972-74), it was “operated” exclusively for religious pur-

poses.

Treas. Reg. § 1.501(cX3)-1(a) provides that in order to

be exempt as an organization described in § 501(cX3), an

organization must be “operated exclusively for one or

more of the purposes specified in such section.” Tres.

Reg. § 1.501(cX3)-1(cX1) elaborates on this by providing

“an organization will be regarded as ‘operated exclusive-

ly’ for one or more exempt purposes only if it engages

—10—

primarily in activities which accomplish one or more

such exempt purposes specified in § 501(cX3). An

organization will not be so regarded if more than an in-

substantial part of its activities is not in furtherance of

an exempt purpose.” Treas. Reg. § 1.501(cX3)-1(dX1Xi)

specifies “An organization may be exempt... if it is

organized and operated exclusively for one or more of

the following purposes: (a) Religious, (b) charitable. . .”

The definition of “charitable” found in Treas. Reg.

§ 1.501(cX3)-1(d\(2) specifically includes “advancement of

religion,” “erection or maintenance of public buildings”

and “relief of the poor and distressed.”

The Tax Court and the Court of Appeals concluded

that the Church was not operated exclusively for exempt

purposes because “No activities were conducted ...

which accomplished the petitioner’s stated purpose.”

This overlooks entirely the fact that the Church engaged

in no activities except activities that were directed

toward the primary purposes of any new church—the

acquisition of members and the creation of a building

fund leading to the erection of a church building.

The Tax Court and the Court of Appeals apparently

discounted Slough’s one-to-one missionary work, despite

the fact that it resulted in some forty converts to

membership. It is manifest that such activity relates

directly to an exempt purpose. Cf. Travis Smith v. Com-

missioner, 60 T.C. 988 (1973). At the very least, it cannot

support a finding of operation for non-religious pur-

poses, as the statute requires to deny an exemption.

Aside from this, however, it appears that the Tax

Court (and therefore the Court of Appeals) based its

determination to deny the exemption primarily on its

view that the investment activity of the Church was not

in furtherance of an exempt purpose. While this might

per ee

be true if the investment activity was an end in itself,

that is not the case here. It was beyond dispute that the

accumulation and investment of funds was for the pur-

pose of a building fund for a church building. Clearly,

the erection of a church building is a proper exempt

purpose. How, then, can the Church be denied the only

means available to it to accomplish that purpose? The

holding of the Tax Court takes an impermissibly narrow

view of the Church’s activity, and if generalized to other

exempt organizations, could destroy these organizations

before they had a chance to get off the ground.

The Tax Court relied on Randall Foundation v.

Riddell, 244 F.2d 803 (9th Cir. 1957), as the sole authori-

ty for its conclusion. But apart from factual distinctions,

the Randall Foundation case must be rejected because

(1) it does not consider present statutory provisions for

dealing with business income of exempt organizations,

and (2) it reflects the minority view of the Ninth Circuit

Court of Appeals rejecting the “destination of income”

test applied in other circuits and derived from the deci-

sion of this Court.

A partial review of the history of the tax exempt

provisions now embodied in § 501 is useful in under-

standing the statutory scheme for dealing with the issues

raised in this case and why Randall Foundation should

not be deemed applicable.

The exemption for charitable organizations originated

in the Corporate Excise Tax Act of 1909 which ex-

empted “. .. any corporation or association organized

and operated exclusively for religious, charitable, or

educational purposes, no part of the net income of which

inures to the benefit of any private stockholder or in-

dividual.” § 38, 36 Stat. 112 (1909). This language was

carried over as part of the Income Tax Act of October 3,

pan,

1913, 38 Stat. 172, 180. This Court considered the effect

of business and investment income on an organization’s

tax exempt status in Trinidad v. Sagrada Orden, 263

U.S. 578 (1924). That case involved a religious order

that derived approximately 35% of its income from rents

and 59% from dividends and interest on investments.

The Court rejected the contention that the organization

was not operated exclusively for exempt purposes

because of its investment and business activities observ-

ing:

“Whether the contention is well taken turns

oe ae geed on the meaning of the excepting clause,

fore quoted from the taxing act. Two matters ap-

parent on the face of the clause go far towards settl-

ing its meaning. First, it recognizes that a corpora-

tion may be organized and operated exclusively for

religious, charitable, scientific or educational pur-

poses, and yet have a net income. Next, it says

nothing about the source of the income, but makes

the destination the ultimate test of exception.

“Evidently the exception is made in recognition of

the benefit which the public derives from corporate

activities of the class named, and it intended to aid

them when not conducted for private gain. Such ac-

tivities cannot be carried on without money; and it

is common knowledge that they are largely carried

on with income received from properties dedicated

to their pursuit. This is particularly true of many

charitable, scientific and educational corporations

and is measurably true of some religious cor-

porations. Making such properties productive to the

end that the income may be thus used does not alter

or enlarge the purpose for which the corporation is

created and conducted.” 263 U.S. at 581.

This Court again applied the destination of income

test in Better Business Bureau v. United States, 326 U.S.

279 (1945), where, in considering the exemption of the

BBB from social security taxes under an identical

a)

statutory provision, the Court focused not on the nature

of the organization’s income but upon the ultimate non-

exempt purpose of promoting private business interests.

Following the Supreme Court’s decision in Trinidad, a

split developed among the Circuit Courts of Appeals

concerning the proper meaning of the language quoted

above. The majority of the courts adopted what is

referred to as the “destination of income” test and held

that there was virtually no limit on the permissible in-

come producing activities of tax exempt organizations so

long as the income would ultimately be used for a tax

exempt purpose. See, e.g., Roche’s Beach, Inc. v. Com-

missioner, 96 F.2d 776 (2d Cir. 1938); C. F. Mueller Co.

v. Commissioner, 190 F.2d 120 (3d Cir. 1951);

Willingham v. Home Oil Mill, 181 F.2d 9 (5th Cir. 1950);

Lichter Foundation v. Welch, 247 F.2d 481 (6th Cir.

1957); Bomen v. Commissioner, 240 F.2d 767 (8th Cir.

1957).

On the other hand, the Ninth and Fourth Circuits

adopted a much more restrictive view of the effect of

business income upon the ability of an organization to

meet the requirement that it be operated exclusively for

exempt purposes. Those courts indicated that tax ex-

emption should not be allowed for an organization all of

whose income arose from conduct of a trade or business

and which arrried on no active charitable activities. See,

e.g., United States v. Community Services, Inc., 189 F.2d

421 (4th Cir. 1951); Rolph H. Eaton Foundation v. Com-

missioner, 219 F.2d 527 (9th Cir. 1955).

Commentators who have considered the issue have

almost universally reached the conclusion that the ma-

jority destination of income test is the correct view

because it correctly interprets the opinion of the

Supreme Court in Trinidad and Better Business Bureau,

-*

=i

it is consistent with the wording of § 501, and it is more

realistic. See, e.g., Eliasberg, Charity and Commerce:

ILR.C. § 501(c)(3)-. How Much Unrelated Business Ac-

tivity?, 21 Tax L. Rev. 53, 73-4 (1965); Strong and

Fields, Profitable Related Business Activities and

Charitable Exemption Under I.R.C. § 501(c)(3), 44 Geo.

Wash. L. Rev. 270, 275-76 (1976).

In the wake of this Court’s decision in Trinidad and

adoption of the “destination of income” test by a majori-

ty of the Circuit Court of Appeals, numerous exempt

organizations began operating trades and businesses in

direct competition with private enterprise. See e.g.

Roche’s Beach, Inc. v. Commissioner, supra (operation of

public bathing beach and related concessions); C. F.

Mueller Co. v. Commissioner, supra, (operation of food

manufacturer). By 1950, the business activities of

charitable organizations had reached such proportions

that Congress felt it was necessary to amend the Inter-

nal Revenue Code to “eliminate the unfair competition

which exists when a tax-exempt organization engages in

competition with taxpaying business.” Remarks of

Senator George at 96 Cong. Rec. 13273 (1950), S. Rep.

No. 2375, 81st Cong. 2d Sess. 28-9 (1950).

The Revenue Act of 1950 included two changes that

are relevant to the present case. First, the predecessors

of §§ 511-513 were added to the Code to provide for

a tax on “unrelated business income” of exempt organi-

zations. Second, a provision was added denying tax

exempt status to § 502(cX3) organizations for, among

other things, unreasonably accumulating income. These

changes provided a statutory system to deai with

business activities of exempt organizations.

The primary means by which Congress chose to

eliminate the unfair advantage enjoyed by tax exempt

—~1§—

organizations in competition with private business is by

taxing income resulting from an exempt organization’s

conduct of a trade or business unless such business ac-

tivity directly accomplishes an exempt purpose. I.R.C.

§§ 511-518 provide a detailed explanation of when an ex-

empt organization’s income producing activities will be

subject to the tax. There has been no allegation that the

Church’s income from investments in securities falls

within the statutory definition of unrelated business in-

come. Also, it is extremely important to note that when

Congress considered the problems arising from the

destination of income test which allowed tax exempt

organizations to engage in trades and businesses un-

related to their charitable goals, the solution it provided

was not the denial of an organization’s status as a tax

exempt organization but merely to impose a tax upon in-

come from the conduct of an unrelated business. As

noted in the Senate Report on §§ 511-513:

“In neither the House bill nor your committee’s

bill does the provision deny the exemption where

the organizations are carrying on related active

business enterprises, nor require that they dispose

of such business. Both provisions merely impose the

same tax on income derived from an unrelated

trade or business as is borne by their competitors.

In fact it is not intended that the tax imposed on

unrelated business income will have any effect on

the tax-exempt status of any organization. An

organization which is exempt prior to the enact-

ment of this bill, if continuing the same activities,

would still be exempt after this bill becomes law.”

S. Rep. No. 2375, 81st Cong., 2d Sess. 28-29 (1950).

In spite of lengthy Code sections dealing with the tax

on unrelated business income, no provision was included

that prohibits an exempt organization from engaging in

business activities or that attempts to limit the scope of

74%

~10~-

those activities. Taxation, not prohibition of business ac-

tivities, was the remedy provided by Congress.

In the Revenue Act of 1950, Congress also provided a

means for dealing with unreasonable accumulations of

income by organizations exempt from tax under the

predecessor of § 501(cX3). Here, however, Congress

chose the harsher remedy of denial of exemption rather

than merely providing for a tax on the prohibited ac-

cumulations. Section 3814 was added to the Internal

Revenue Code of 1939. That section provided that an ex-

empt organization would be denied exempt status for

any taxable year in which it had accumulated income

that 1) was unreasonable in amount or duration in order

to carry out the organization’s exempt purpose, 2) was

used to substantial degree to carry out a nonexempt pur-

pose or 3) was invested in a manner that jeopardized the

carrying out of the organization’s exempt purposes. Sec-

tion 3814 was carried over in the Internal Revenue Code

of 1954 as § 504. However, the section was repealed by

the Tax Reform Act of 1969.

Against this background it can be seen that the

holding of Randall Foundation v. Ridell, supra, is in-

applicable to this case. In the Randall Foundatwn case,

Paul Randall formed the Foundation in 1950 as a

California non-profit corporation. The corporate articles

provided its purpose was “the promotion and advance-

ment of charitable, religious and educational projects on

a non-profit basis.” 244 F.2d at 805. Randal! donated ap-

proximately $20,000 worth of stock to the Foundation

and loaned it an additional $155,200 at 2% per cent in-

terest. During 1950 and 1951, the Foundation used these

funds to engage in short term trading of highly

speculative oil stocks. On September 12, 1951, the Foun-

dation was notified that its application for tax exempt

a ae

status had been denied. Over one year later, the Founda-

tion amended its articles to provide a specific charitable

purpose of establishing a home for underprivileged boys.

Income taxes were collected from the Foundation for its

1951 and 1952 tax years and the Foundation sued for a

refund. The Randall Foundation opinion affirms the

District Court’s judgment in favor of the District Direc-

tor of Revenue.

The Ninth Circuit Court of Appeals in Randall Foun-

dation chose to adhere to its minority view and express-

ly rejected the “destination of income” test favored by

the majority of the Circuit Courts of Appeals. 244 F.2d

at 807. As discussed supra, the minority view fails to

reflect the decisions of this Court in the Trinidad and

Better Business Bureau cases and is not supported by

any statutory language. In addition, language used by

the Court points up the unrealistic nature of the minori-

ty test. The Court observes:

“An individual who engages in business and in-

tends to give all his gains to charity receives ex-

emption only upon certain gifts in a taxable year. If

he continues in the same business but incorporates

as Paul Randall did here, he should have not better

standing .. .” 244 F.2d at 808.

However, as one commentator has noted regarding

this aspect of the minority test:

“On reflection, the majority approach to this

problem appears more realistic. In a situation

where X voluntarily obligated himself to pay his en-

tire salary to Y, the minority would say that X has

two purposes—to earn his salary, and to turn it over

to Y. The majority would say that X’s purpose is to

confer a benefit upon Y, and his labors are the

vehicle through which he accomplished his Fol

pose. The minority would break the thought off too

abruptly. It is not a realistic view of human nature

—19—

to say that a man works to work and then pursuant

to a completely separate intellectual mandate, turns

over his work product to someone else. The two ac-

tions are part and parcel of the continuous pur-

pose.” Eliasberg, supra at 74.

Perhaps more importantly, when Congress considered

the problems caused by the business activities of exempt

organizations its solution was not a limitation or prohibi-

tion on the activities but was only to tax unrelated

business income while allowing the organization to re-

tain its exempt status.

Thus, the view of the Ninth Circuit expressed in Ran-

dall Foundation should not be applied to deny exempt

status to the Church because it engaged in investment

activities to raise money to build a church building. The

correct view is the majority’s “destination of income”

test which would allow income producing activities so

long as the ultimate destination of the income was an ex-

empt purpose. The Church’s members had clearly in-

dicated their intent to use the funds for a church, and

the Church’s corporate articles and by-laws unequivocal-

ly commit all funds to charitable purposes. Even if the

Church should prove unsuccessful and be forced to liq-

uidate, the articles require all assets to be distributed

to another § 501(cX3) organization where they will be

used for an exempt purpose.

Although it seems the reasonableness of accumulations

should not be a factor in determining an organization’s

exempt status subsequent to repeal of § 504, the Tax

Court seemed concerned with what it viewed as the

remote prospect of the Church accumulating the funds it

needs to construct a church in the foreseeable future.

Preliminarily it must be noted that the Tax Court based

its evaluation of the Church’s prospects on faulty

assumptions. It apparently considered the entire four to

—19-—

five million dollars as the goal of the accumulations.

However, the Church’s voting members on two occasions

indicated their intent to start construction as soon as at

least $500,000 was accumulated. A glance at the

architect’s drawing reveals that the $4-5 million dollar

estimate covered the eventual cost of a multibuilding

complex. Secondly, the Tax Court refers to the fact that

the Church raised only about $190,000 after seven years

of existence. However, it must be remembered that the

great bulk of this sum was accumulated in 1973 and

1974. The uncertainty surrounding the Church’s tax ex-

empt status made fundraising impractical in subsequent

years.

Randall Foundation also involved the accumulation

issue. The Revenue Act of 1950 was effective for only the

second of the two years involved in that case and the

court did not refer to § 3814 of the Internal Revenue

Code of 1939 in its opinion. However, the tests applied

closely parallel those found in the statute. Thus, the

court stressed the highly speculative nature of the Foun-

dation’s investments which endangered the charitable

purpose. Compare § 3814(3), Internal Revenue Code of

1939. More in point, the court held that:

“It is not our intention to say that a case can

never be made out on the facts of a particular situa-

tion for aggregation of funds by a corporation for

ultimate disposition to a charitable purpose. But a

corporation which in its inception engages in trade,

business or s lation, and only has a vague

charitable design, does not in our opinion come

within the terms of the statute.” 244 F.2d 808.

The Church does not contend that the decision of the

Randall Foundation case on this issue was based on an

erroneous view of the law as it existed between the

Revenue Act of 1950 and the Tax Reform Act of 1969.

— =

The Foundation in that case had no specific use for its

funds at the time they were accumulated. Its charter

stated its exempt purposes only in broad, vague terms.

It was not until a subsequent year, after denial of ex-

empt status that the Foundation’s articles were amended

to provide a specific charitable purpose. A number of

other cases also concluded that accumulation of funds

without some program for their use was an un-

reasonable accumulation within the meaning of § 504

and thus fatal to the organization’s exempt status for

taxable years in which it held such accumulations. E.g.,

Curt Teich Foundation v. Commissioner, 48 T.C. 963

(1967), affd per curiam, 407 F.2d 815 (7th Cir. 1969);

Stevens Bros. Foundation, Inc. v. Commissioner, 324

F.2d 633 (8th Cir. 1963); Danforth Foundation v. United

States, 222 F. Supp. 761 (E.D. Mo. 1963). It was also

held that “the program must be prospective and not oc-

cur to the organization only after the Commissioner’s

shadow becomes visible. ‘After-thoughts will not suf-

fice.” Erie Endowment v. United States, 316 F.2d 151

(8d Cir. 1968).

On the other hand, it seems equally clear that even

before repeal of § 504, an organization was allowed to

accumulate income for a specific project without losing

its exempt status. E.g., Huron Clinic Foundation v. Un-

ited States, 212 F. Supp. 847 (D.J.D. 1962), remanded by

stipulation, 324 F.2d 43 (8th Cir. 1963) (income ac-

cumulated to construct medical clinic building); Hulman

Foundation, Inc. v. United States, 217 F. Supp. 423 (S.D.

Ind. 1962) (accumulation of over $1-1% million over 14

year period to finance construction of civic center);

Samuel Friedland Foundation v. United States, 144 F.

Supp. 74 (D.N.J. 1954) (accumulation of income to con-

struct medical research facility). In this case, the

Church accumulated income to accomplish a specific ex-

=

empt purpose, construction of a church building. The

evidence clearly indicates this plan was adopted well

before the Commissioner’s shadow became visible. Thus,

even under the pre-1969 Tax Reform Act Standards, the

Church’s accumulation of funds to construct a church

building would not have affected its tax exempt status.

More importantly, repeal of § 504 by the Tax Reform

Act of 1969 indicates a decision by Congress that ac-

cumulation of income should no longer cause the loss of

an organization’s tax exempt status.

The position urged by the government and adopted by

the Tax Court takes far too narrow of view of the ac-

tivities in question, and arbitrarily and unreasonably ig-

nores the ultimate purpose of those activities. It also

overlooks the fact that there was no activity that was

shown not to be for a proper tax exempt purpose. Could

the Tax Court’s conclusion be justified if the Church’s

charter had stated as one of its purposes, “the accumula-

tion of funds for the purpose of constructing a church

building”? Yet is not that implicit in the stated purpose

to construct such a building?

The decision below, in effect, prevents the vital ac-

quisition of funds for the stated purpose, since without

a tax exemption contributions will be impossible to obtain

and accumulations, burdened by income taxes, will be

slowed to a pace which cannot even hope to match the

inflationary spiral.

In short, the decision below cannot be justified under

the existing tax laws, the decisions of this Court and the

better-reasoned decisions of the Courts of Appeals, or

the policies underlying the tax exemption. While the ex-

emption may be a matter of legislative grace, it cannot

be arbitrarily and discriminatorily applied by the

courts.

—22—

It will be time enough to revoke, retroactively, the

Church’s tax exemption if it ever happens that the funds

in question are improperly used, or are used for a non-

exempt purpose. Until that time, the Church ought to be

entitled to pursue its purposes in the manner dictated by

the good faith exercise of its own judgment.

2.

THE DECISION BELOW IMPERMISSIBLY BUR-

DENS NEW CHARITIES AND DISCRIMINATES IN

FAVOR OF THOSE WHICH HAVE ALREADY SUC-

CEEDED IN ESTABLISHING THEIR PROGRAMS.

The decision below amounts to a determination that a

new charity must proceed with its activities in accord-

ance with the preconceived ideas of the particular

courts that review those activities, and must have

succeeded according to the standards of those courts,

upon penalty of losing its tax exemption—which

amounts to capital punishment. Apart from the manifest

injustice of this approach, it raises serious issues concern-

ing, and impinges upon, the rights guaranteed to its

members by the First Amendment to the United States

Constitution.

There seems to be no doubt that an established

religious organization could have engaged in exactly the

same activities as the Church without endangering its

tax exempt status. See Rev. Rul. 75-282 and discussion

supra. However, here the Tax Court looked to the

number of members and the absence of regular religious

services as “relevant factors” in deciding whether the

Church would be afforded tax exempt status. This ap-

proach focuses not upon the fact of whether the Church

is organized and operated to accomplish genuine

religious purposes but upon the methods by which the

Church seeks to accomplish its purposes and by the ease

_

with which others can be persuaded to accept its tenets.

If the Church was under the control of an established

church, if it had adopted tenets that would rapidly at-

tract large numbers of followers or if it had chosen to

conduct services prior to construction of a church

building, the Tax Court’s opinion and Rev. Rul. 75-282

indicate the Church would more likely have been allow-

ed to retain its tax exempt status.

Here, the Tax Court did not base its opinion on the use

planned for the Church’s funds or the exclusive purposes

of the Church’s existence, but instead relied on its sub-

jective appraisal of the methods by which the Church

undertook accomplishment of its admittedly exempt

goals and the court’s subjective appraisal of whether its

stated goals were realistic. Such insistence upon conform-

ing to its views of the proper mode of operating a

religious organization effectively discriminates against

new organizations and favors established religious

organizations. The Tax Court’s approach would force the

Church to prematurely undertake activities which would

dissipate the funds necessary to construct the church

building, which the Church believes is essential to its

ability to compete with established religious sects for

members, while allowing those associated with an es-

tablished sect free rein in accumulating funds with

which to expand and build new churches.

In Golden Rule Church Association v. Commissioner,

41 T.C. 719 (1964) the Tax Court considered the

problems inherent in denying tax exempt status to

religious organizations that engaged extensively in

business activities. The Tax Court observed:

“As we stated in United School of Christianity, [4

B.T.A. 61 (1926)] at 70:

—24—

In considering whether a corporation is

religious, charitable or educational we must

always be guided by the character of the

organization and its activities. Religion is not

confined to a sect or a ritual. The symbols of

religion to one are anathema to another. What

one may regard as charity another may scorn

as foolish waste, and even education today is

not free from divergence of view as to its

validity. Congress left open the door of tax ex-

emption to all corporations meeting the test,

the restriction being not as to the species of

religion, charity, science or education under

which they may operate, but as to the use of its

profits and the exclusive purpose of its exemp-

tion.

We have grave doubts that a contrary decision

would be permissible under the Constitution of

the United States. It is a violation of the first

amendment to discrimate between religious organi-

zations. Although tax benefits such as exemptions

may be matters of legislative grace, nevertheless, a

denial of such benefits granted to others of essenti-

ally the same class may well rise to the level of an

unconstitutional discrimination.” [Citations omitted]

41 T.C. at 729.

3.

THE DECISION BELOW ERRONEOUSLY CON-

CLUDED THAT SOME PART OF THE NET EARN-

INGS OF THE CHURCH INURED TO THE BENEFIT

OF A PRIVATE INDIVIDUAL.

As an alternative ground for its decision, the Tax

Court concluded that the Church had failed to show that

it was not operated for the private benefit of Slough and

that no net earnings had inured to private individuals.

The court expressly stated: “No single factor or com-

bination thereof controls our conclusion. Rather, these

~i5~

factors, taken in the aggregate, require the conclusion

we reach.”

We believe that a detailed analysis of these factors is

beyond the scope of this petition. However, we submit

that this conclusion was essentially makeweight and is

manifestly not supported by the record. All of the

evidence was that in the transactions between Slough

and his businesses and the Church, scrupulous care was

taken to insure that no benefit inured to Slough or his

businesses and that the advantage, if any, was the

Church’s. If this record demonstrates a private benefit,

then no charity’s tax exemption is safe. Every charity

must engage in business transactions with “private in-

dividuals,” including its own officers and members at

times. Presumably, these transactions will usually in-

volve some mutual benefit. If that part of the benefit

that inures to the private person results in the loss of the

charity’s tax exemption, how can the charity function

and still retain its exemption? Any such rule would be

absurd, and yet this very rule is implicit in the decision

below. That decision is without precedent. Huron Clinic

Foundation v. United States, 212 F. Supp. 847 (D.S.D.

1962), remanded by stipulation, 324 F.2d 48 (8th Cir.

1963); Bomen v. Commissioner, 240 F.2d 767 (8th Cir.

1957).

The government’s position is not aided by the fact that

the Church is predominately the vehicle of its founder,

Dean Slough. The same may be said of the vast majority

of churches during their formative years. They have,

historically, been the result of the vision and views of

some founder. Indeed, even the Internal Revenue Ser-

vice has indicated that personal control of an organiza-

tion by its founder will not alone constitute grounds for

denial of tax exempt status. Rev. Rul. 66-219, 1966-2

_— =

C.B. 208; see also, Curt Teich Foundation v. Com-

missioner, 48 T.C. 963 (1967), aff'd per curiam, 407 F.2d

815 (7th Cir. 1969). ~

The record in the instant case will demonstrate that

the benefit that flowed from Slough to the Church far

outweighed any incidental benefit to Slough or his

businesses, or to any other private individual. It will also

demonstrate that that benefit was no different from the

benefit that normally accrues to anyone who deals with

a charity. The “facts” relied upon by the court will not

support any rational analysis based upon the meaning

and purpose of this part of the exemption requirements.

CONCLUSION

For these reasons, a writ of certiorari should issue to

review the judgment of the United States Court of

Appeals for the Seventh Circuit.

Respectfully submitted,

EDWARD J. KIONKA

632 North Main Street

Columbia, Illinois 62236

(618) 2&1-7186

JOHN J. VASSEN

PATRICK B. MATHIS

JOHN J. VASSEN P.C.

1801 North Belt West

Belleville, Illinois 62223

(618) 277-8700

Attorneys for Petitioner

Western Catuouric CourcH

—jla—

APPENDIX

UNITED STATES COURT OF APPEALS

For the Seventh Circuit

Chicago, Illinois 60604

Argued: September 15, 1980

September 19, 1980

Before

Hon. Harlington Wood, Jr., Circuit Judge

Hon. Richard D. Cudahy, Circuit Judge

Hon. William J. Campbell,* Senior Judge

Western Catholic Church,

Petitioner-Appellant.

No. 80-1083 vs.

Commissioner of Internal Revenue,

Respondent-Appellee.

Appeal from the United States Tax Court

No. 8709-78X—Judge William M. Drennen

ORDER

(Unpublished Order Not To Be Cited Per Circuit Rule 35]

After having reviewed the briefs and heard

arguments from the Appellant, the Court is of the opin-

ion that the judgment of the Tax Court should be AF-

FIRMED. The opinion of the Tax Court is adopted as the

opinion of this Court.

* Honorable William J. ama. Senior United States Dis-

vie Judge for the Northern District of Illinois is sitting by

esignation. )

—2Ja—

UNITED STATES TAX COURT

Washington

WESTERN CATHOLIC CHURCH,

Petitioner,

No. 8709-78X v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

ORDER AND DECISION

Pursuant to the determination of this Court, as set

forth in its Findings of Fact and Opinion filed October

31, 1979, it is

DECLARED, ADJUDGED and DECIDED: That petitioner

does not qualify as an organization described in section

501(cX3), I.R.C. 1954, as amended. Respondent’s retroac-

tive revocation of his ruling that petitioner was exempt

under section 501(cX3), I.R.C. 1954, is hereby sustained.

/s/ WILLIAM M. DRENNEN

JUDGE

Entered: October 31, 1979

aliltinse

73 T.C. No. 19

UNITED STATES TAX COURT

WESTERN CATHOLIC CHURCH, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 8709-78X Filed October 31, 1979

Petitioner was organized in 1971 for religious pur-

poses. However, it had no place of worship and con-

ducted no public religious services during the years

1972-74. Its only activities, aside from investment ac-

tivities, were some one-to-one ministry conducted by its

founder with individuals who had problems, and dis-

tribution of a few grants to needy individuals chosen by

the founder. Petitioner’s capital was derived primarily

from contributions by its founder who, with his wife and

daughter, constituted the board of directors of

petitioner. Petitioner’s primary activity during 1972-74

was the passive investment of its funds, which it ac-

cumulated to build a church when it had at least $500,-

000. Held: Petitioner was not operated exclusively for

an exempt purpose and it has not shown that no part of

its net earnings inured to the benefit of private in-

dividuals. Respondent’s retroactive revocation of his rul-

ing that petitioner was exempt under sec. 501(cX3) is

sustained

John J. Vassen and James R. Kalish, for the petitioner.

Judith M. Picken, for respondent.

DENNEN, Judge: This is an action for declaratory

judgment pursuant to section 7428(a), I.R.C. 1954.1

Respondent issued a final adverse determination to

petitioner on April 25, 1978, in which petitioner’s

previously granted tax-exempt status under section

1_ All section references are to the Internal Revenue Code of

1954, as amended and in effect in the years in issue, unless

otherwise specified.

—4da—

501(cX3) was retroactively revoked. The revocation was

effective as of April 23, 1971, the date petitioner was

organized. Based upon an examination of petitioner’s ac-

tivities during the 1972, 1973, and 1974 calendar years,

pat gps determined that (1) petitioner was not, nor

had it ever been, operated exclusively for any of the pur-

poses enumerated in section 501(cX3); and (2) a portion

of petitioner’s net earnings had inured to the benefit of

private individuals. Petitioner challenges respondent’s

determination and it has properly invoked the jurisdic-

tion of this Court for a declaratory judgment relating to

its qualification as an organization described in section

501(cX3).?

The issues presented are whether petitioner was

operated exclusively for a religious purpose’ and

whether a portion of petitioner’s net earnings inured to

the benefit of private individuals.

FINDINGS OF FACT

Some of the facts were stipulated and are so found.

The stipulation of facts and the exhibits attached thereto

are incorporated herein by this reference.‘

Western Catholic Church’ (hereinafter referred to as

petitioner), was incorporated on April 23, 1971, pur-

2 Petitioner has satisfied the following prerequisites for a

declaratory judgment: It exhausted its administrative

remedies, sec. 7428(b\2); it filed the petition and_ its

qualifications are at issue, sec. 742&(b\1); and it mailed its

petition before the 91st day after respondent mailed his

adverse determination in this matter, sec. 7428(b\3). See also

Rule 210(c), Tax Court Rules of Practice and Procedure.

8 Petitioner does not claim that it was operated for any of the

other purposes mentioned in sec. 501(cX3).

* In a declaratory judgment action concerning a revocation

of a tax-exempt status, the Court may make findings of fact

which differ from the administrative record. Rule B17(bX 1),

Tax Court Rules of Practice and Procedure.

5 The term “Catholic” was used in petitioner’s name to mean

“universal,” rather than any affiliation with the Roman

ew Church or any other organization which uses the

rm

sii

suant to the General Not for Profit Corporation Act of

Illinois by S. Dean Slough (hereinafter referred to as

Slough), Laura R. Slough, and Deana L. Hron. Laura R.

Slough and Deana L. Hron are, respectively, the wife

and daughter of Slough. These three individuals also

comprised petitioner’s board of directors. Petitioner’s

principal office, at all times relevant herein, was located

in Quincy, IIl.

In its articles of incorporation and its by-laws, the

following is set forth as the purpose of petitioner:

To establish a church to embrace persons of all

faith[s], color{s], and creed[s], to join for a common

cause the betterment of man, by helping God in

spreading the Gospel. To recuit [sic] evangalists

[sic], to build, operate and maintain churches,

hospitals, nursing homes, schools and to establish

missionarys [sic] and missions whereever [sic] they

are needed in the World. We believed [sic] the Bible

to be the verbally inspired Word of God; the only in-

fallible rule of faith and practice. We believe in the

eternal Deity of Our Lord Jesus Chirst; in His

virgin birth; in His substitutionary death on

Calvary for our sins; in His bearing of our afflic-

tions and in His bodily reserrection [sic] from the

grave. We believed in salvation by faith through the

shed blood of Jesus Christ. We believe that the true

church is composed of all those who have been born

again. We believe in the present working and mov-

ing of the Holy Spirit in the lives of men, women,

children; we believe in carry{ing] out the Great

Commission. To evangelize is a vital part of our

Christian responsibility. We believe all men are lost

apart from the saving grace of Jesus Christ. We

believe in the return of Jesus Christ, God’s only

begotten, Son, to this earth.

It was also provided that upon petitioner’s dissolution,

all assets would be paid to an organization exempt un-

der section 501(cX3). To accomplish its stated purposes,

the articles of incorporation provided that petitioner had

the power, inter ala, to buy, sell, mortgage, and lease

cecil

real and personal property, to borrow money, and to in-

vest in stocks and bonds.

On or about May 18, 1971, petitioner filed an applica-

tion for recognition as a religious organization described

in section 501(cX3) and as exempt from taxation under

section 501(a). Petitioner’s stated purpose was “to

further religion and benefit mankind.” In the applica-

tion petitioner described its proposed activities as in-

cluding the building of churches, colleges, nursing

homes, and a hospital. Petitioner noted that it had not

engaged in any of these activities as of the time it filed

its application. Funds were to be raised by donations.

Following an interchange of letters between petitioner

and the District Director, St. Louis, Mo., in which it was

suggested to petitioner that it amend its articles of in-

corporation and its by-laws in certain respects,® which

suggestions petitioner adopted, the District Director

determined by letter dated October 31, 1971, that

petitioner was exempt from Federal income tax under

section 501(cX3). The exemption was based on informa-

tion supplied by petitioner and it was conditioned on the

assumption that petitioner’s operations would be as

stated in the application for exemption. Petitioner was

also informed that it had to report any change in its

purposes, character, or method of operation. The letter

also specifically stated that no determination was made

as to whether any of petitioner’s proposed activities

would give rise to unrelated business income subject to

tax under section 511.

By letter dated July 10, 1974, the Regional Com-

missioner notified petitioner that an examination would

be conducted in order to establish petitioner’s continuing

qualification as an exempt organization. The examina-

tion was commenced on August 20, 1974, and it covered

the calendar years 1972, 1973, and 1974. As a result of

8 One letter advised petitioner that its pro activities of

“building additional churches, a college, a hospita! and nur-

sing homes” would aa separate exemption applications

inasmuch as each would be considered separate entities.

—T7a—

this examination respondent revoked petitioner’s tax-

exempt status.

Prior to petitioner’s incorporation and during the

years in question, Slough was president and owned 100

percent of the stock of both Credit Control Services, Inc.,

and Business Management Corp. Credit Control Services

was in the business of collecting bad accounts. Business

Management Corp. had some real estate holdings.

Slough was also involved in a number of other business

enterprises. Slough devoted full time to his business

enterprises.

Slough decided to organize petitioner for two reasons:

(1) In order to help other people; and (2) to have an

organization in which Slough could be active and dictate

some of the policies. Slough estimated it would take 10

to 15 years to get the program into operation.

During the years under examination, petitioner

neither conducted religious services nor performed

religious functions on a group basis.’ Slough was

petitioner’s only minister, having been ordained by ac-

tion of the voting members at the annual meeting held

on May 15, 1972.8 He had no theological training prior

to that time or between then and the time of trial. No

other minister was hired by petitioner, Slough prefer-

ring to retain petitioner’s money in its building fund.

7 In 1975 7 made arrangements with a church in

Ohatchee, Ala., hold group services for petitioner. The

piston. of this church was a former business partner of

8 At the same meeting the members of the board of directors

present were Slough, his wife, and his daughter. These in-

ividuals voted themselves into the following offices:

Slough — _ president

Diana Hron — vice-president

Laura Slough — secretary

Slough — treasurer

_In its application for recognition as a tax-exempt organiza-

tion, petitioner stated that no proposed member of the be

or officers would be related, inter alia, by blood or marriage.

—8a—

Although petitioner did not conduct services, Slough

claimed he met on a one-to-one basis with individuals he

knew in Quincy, IIl., and he attempted to get these in-

dividuals to commit themselves to become members of

petitioner. He also counselled individuals with personal

problems.’ Slough believed that the growth of petitioner

could be better accomplished by talking to people on a

one-to-one basis than by holding religious services which

were not well attended. Only Slough engaged in this

one-to-one activity. He spent approximately 10-12 hours

od month engaged in petitioner’s activities. Although

lough claimed that there were 40 members of

petitioner, only Slough, his wife and daughter, and two

other individuals, one of whom was a former employee

of Slough and the other of whom knew Slough prior to

the incorporation of petitioner, have been identified as

members. All it took to become a member was to accept

the principles of petitioner and to agree to attend ser-

vices when held in the future. Slough refused to divulge

any list of petitioner’s members, claiming such a divul-

sion would be an invasion of privacy. With the exception

of Slough’s wife’s and daughter’s participation in

petitioner’s annual meetings, evidence was not in-

troduced to indicate that any individual other than

Slough performed any activity for petitioner.

Slough has never received any salary or other form of

compensation from petitioner and neither has Slough’s

wife, daughter, or businesses.

During 1972 Slough wrote checks to cash totaling $5,-

200 on petitioner’s checking account. The principal

evidence of the disposition of this money was Slough’s

testimony that the money was donated to individuals

known to Slough and whom Slough personally deter-

mined to be in need of money. The individuals to whom

the payments were made did not apply to petitioner for

® Slough also testified that he performed wedding

ceremonies. Altho it is not clear when these ceremonies

were conducted, it not been established that they were

conducted during 1972-1974.

a

money. Slough considered these payments as a function

of petitioner. The revenue agent who conducted the ex-

amination of petitioner was able to contact only one of

the identified recipients. This individual verified that he

received money from petitioner.

Petitioner stopped donating money following the ad-

vice of a certified public accountant to the effect that

petitioner’s inability to document what happened to the

money would be troublesome if petitioner was audited.

Slough chose to discontinue making payments rather

than set up a bookkeeping procedure which he con-

sidered unnecessary for an organization that was not re-

quired to file tax returns.

For the taxable year ending December 31, 1972,

Slough filed a joint return with his wife on which ad-

justed gross income of $61,258 was reported. From this

amount itemized deductions of $34,536 were subtracted,

of which amount $29,975 represented contributions to

petitioner. For the taxable year ending December 31,

1973, a joint return was filed on which was reported ad-

justed gross income of $126,990.17. From this amount

itemized deductions of $73,064.37 were subtracted, of

which amount $63,495 represented contributions to

petitioner."° For the taxable year ending December 31,

1974, a joint return was filed on which was reported ad-

justed Dy - income of $64,945. From this amount

itemi deductions of $18,006 were subtracted, of

which amount $6,370 represented charitable con-

tributions."

The parties stipulated that during 1972, 1973, and

1974, petitioner received the following amounts from

Slough in the form of cash or checks deposited to

petitioner’s checking account:

0 Although contributions totaled $69,705, the sec. 170(bX1)

rcentage limitation reduced the allowable charitable con-

ibution deduction to $63,495.

Of the charitable contribution deduction, $6,210 is the

carryover of excess contributions from the preceding taxable

year.

—10a—

Year Amount

1972 $7,000

1973 78,830

1974 12,150

Total for 3 years $97,980

No explanation was provided concerning the

difference between the amounts deducted on the joint

returns as charitable contributions to petitioner and the

amounts which the parties stipulated were given by

Slough to petitioner. Only two other individuals were

identified as having contributed to petitioner, each hav-

ing contributed $500. One of these individuals was a

previous recipient of funds from petitioner.

It was represented in petitioner’s application for ex-

emption that petitioner would not receive 10 percent or

more of its assets from any single organization or group

of affiliated organizations or from any individual or

members of a family group. Of petitioner’s accumulated

assets, estimated at approximately $190,000 as of the

time of trial, Slough’s contributions for the years under

examination totaled $97,980.

In 1971 petitioner requested John A _ Benya, an

architect, to design a church building. Mr. Benya work-

ed without charge in his spare time and he completed a

preliminary drawing of an elaborate church. The cost of

the building, as conceptualized by Mr. Benya, was es-

timated to be $4-$5 million. As of the time of trial,!* this

estimate was considered low due to inflation. Plans to

build a church never went beyond this preliminary

drawing stage. The minutes of petitioner’s annual

meeting of voting members on May 15, 1973, reflect that

it was agreed that at least $500,000 should be collected

before any building project was started. This decision

12 No evidence was introduced concerning Slough’s con-

tributions to petitioner for years subsequent to those under ex-

amination. Apparently a part of the accumulated assets

represented gain on petitioner’s securities transactions and

dividends and interest received on its investments.

18 Trial was held in this case on Mar. 14, 1979.

—lla—

was reaffirmed at the annual meeting held on May 15,

1974.4 Slough thought the overall success of the

organization would come more quickly if a large church

building was constructed.

During the years under examination, petitioner’s

primary activity has been one of making passive in-

vestments in order to accumulate money for the building

fund. These investments were principally in certificates

of deposit, stocks, and real estate. Petitioner borrowed

considerable amounts of money from banks in order to

finance its investment activity. At times either Slough

individually or one of his businesses would borrow

money for petitioner. Slough or one of his businesses also

provided the collateral for some of petitioner’s bank

loans. There was conflicting testimony as to whether

petitioner repaid all amounts borrowed on its behalf,

and it cannot be determined from the documentary

evidence whether all repayments were made. Neither

Slough nor his businesses charged petitioner for any

amount in excess of what the bank charged them when

loans were obtained for petitioner’s benefit.

Petitioner had no assets at the time of filing its

application for exemption. The only records maintained

by petitioner for the period 1972 through 1974 were

check stubs and minutes of annual meetings.'® Initial

contributions to petitioner were made by Slough. At the

beginning of 1972, petitioner’s only assets were the

following three certificates of deposit:

Certificate of Issuance Market

deposit number date value

5330 Oct. 15, 1971 $ 5,000

5348 Nov. 26, 1971 6,000

5354 Dec. 21, 1971 10,000

14 The minutes do not identify an r “voting members” as be-

ing present other than the three directors.

6 As a result, it was often difficult to retrace petitioner’s

financial dealings. This difficulty was compounded b

aie one ay practice of applying checks received from its stoc

rokerage account directly against outstanding loans without

first depositing the checks into petitioner’s checking account.

—12a—

Said certificates had 12-month maturity periods and 5%

percent interest rates.

During the period under examination petitioner ac-

quired four certificates of deposit and a single time-

savings certificate with a total market value of $42,500.

Two of the certificates of deposit, with a total market

value of $15,000, were transferred to petitioner from

Credit Control Services.

During 1972, 1973, and 1974, petitioner transacted the

following loans at 7%-percent and 8-percent interest

rates:

Loan No Date Amount Type

1 Oct. 12, 1972 $7,000 Commercial

2 Dec. 15, 1972 7,000 Commercial

3 Dec. 15, 1972 7.500 Commercial

4 May 2, 1973 20,000 Business

5 May 3, 1973 §2,000 Commercial

6 Aug. 17, 1973 32,500 Commercial

7 Oct. 9, 1973 13,000 Commercial

& Nov. 16, 1973 32,000 Commercial

9 Dec. 3, 1973 20,500 Commercial

10 Feb. 8, 1974 7,150 Commercial

11 Feb. 26, 1974 28,600 Commercial

12 Mar. 15, 1974 32,500 Real Estate

6 For purposes of clarity, se uential numbers were sub-

stituted for the actual loan numbers.

Loan No. Actual No.

—_

COOAIMOS CON

rr"

2

iw)

—_

Be

tr)

SS

—13a—

With the exception of Loan number 4, petitioner ob-

tained the loans from the South Side Bank of Quincy,

Ill. (subsequently the Town & Country Bank). Loan

number 4 was obtained from Lewistown State Bank,

Lewistown, Mo.

With the exception of the proceeds from loan numbers

1, 2, 7, and 12, the ultimate use of the loan proceeds was

not disclosed. Most of these loan proceeds were deposited

in petitioner’s checking account.’

The proceeds of loan number 1 were used by

petitioner to purchase a new 1973 Lincoln Continental 2-

door coupe for a total sales price of $7,080.49 on October

12, 1972. No sales tax was paid. Two of petitioner’s cer-

tificates of deposit were assigned as security for the

loan. This loan was repaid by petitioner on December

11, 1972.

The proceeds of loan number 2 were used by

petitioner to purchase a new 1973 Lincoln Tour Car 4-

door sedan for a total sales price of $7,556.92 on

December 14, 1972. No sales tax was paid.

The two automobiles were purchased in anticipation of

two fund raisers being hired to work for petitioner. The

automobiles were to be a part of the fund raisers’ com-

pensation. Subsequent to the purchase of the

automobiles, however, Slough decided not to hire the

two individuals. Both automobiles were then sold to

Credit Control Services on January 5, 1973, for a total

price of $17,749.66.18 The terms of the sale required

Credit Control Services to assume petitioner’s $14,500

7 Evidence was also introduced that an employee of Credit

Control Services, Ben Fresno, without authorization, secured

a loan and opened a stock brokerage account in _petitioner’s

name. Fresno was not connected with petitioner in any way,

and he did not have authority to use petitioner’s name.

Petitioner did not repay the loan nor did it benefit from the

loan proceeds or the stock brokerage account.

18 No evidence was introduced as to petitioner’s use of the

automobiles between the time of their purchase and their sale.

—l4a—

liability under loan numbers 2 and 39 and to execute a

demand note at 7% percent interest for the $3,249.66

balance. Loan numbers 2 and 8 were repaid in 1973 by

Credit Control Services. As of December 31, 1974,

neither the demand note nor any interest thereon had

been paid. Credit Control Service claimed depreciation

deductions for the two automobiles as a business ex-

pense.

Slough obtained a loan of $55,000 which was applied

to petitioner’s loan number 5 ($62,000), and Business

Management Corp. obtained a loan of $10,000 of which

$7,000 was applied to petitioner’s loan number 5.

The proceeds from petitioner’s loan number 7 were

used to repay Slough and Business Management Corp.

in part for their payments on petitioner’s loan number 5.

Of the $13,000 loan proceeds, $10,000 was paid to

Business Management Corp., which was $3,000 more

than petitioner owed Business Management Corp. The

remaining $3,000 was applied against Slough’s personal

loan of $55,000. Slough thereafter paid off the balance of

his personal loan as follows: (1) Petitioner’s interest in-

come check of $3,333.60; (2) petitioner’s check of $44,-

154.98 received from its stock brokerage account at

Lamson Bros. & Co. on October 2, 1973, infra; and (8) a

$4,511.47 check written on petitioner’s checking account.

Proceeds from loan number 12 were used in March

1974 to purchase an office building for $45,000.29 The

difference between the purchase price and the $32,500

loan was given to petitioner by Credit Control Services

and treated as advance rentals by Credit Control Ser-

vices. The building was purchased because of its invest-

19 Evidence was not presented concerning petitioner’s use of

the proceeds of loan number 3.

20 The purchase price of the building was stipulated by the

parties to be $45,000. Other evidence was introduced which

indicates that the purchase price was $45,500. This latter

amount was also the sum of the loan and the advanced rentals

received by ge panes The $500 difference is not important to

resolution of this case, however.

—15a—

ment potential and because Credit Control Services

needed more office space. Under the terms of the lease,

Credit Control Services leased the entire building, ex-

cept for two rooms, at a monthly rental of $1,000. Credit

Control Services was also required to pay all real estate

taxes, maintenance, and insurance. The rent paid by

Credit Control Services was reasonable. One of the

rooms in the building could have been used for religious

services.

On or about January 29, 1974, petitioner made a pay-

ment of $12,000 to Town & Country Bank (formerly the

South Side Bank of Quincy) which was applied to

Slough’s loan account at the bank. Slough signed a note

payable to petitioner evidencing the $10,000 loan.

In May 1973 petitioner opened an account with Lam-

son Bros. & Co. stock brokerage firm. A second account

was opened in October 1974. Slough made the invest-

ment decisions for petitioner. Neither Slough, his fami-

ly, nor any of his businesses had a stock brokerage ac-

count with Lamson Bros. & Co. During 1973 petitioner

purchased 21,300 shares of stock in 24 separate transac-

tions for a total cost of $379,361.69. In 9 transactions

petitioner sold 11,000 shares of stock for a profit of $25,-

569.59. As of December 31, 1973, petitioner had 10,300

shares in its account at a total cost of $182,812.30. Dur-

ing 1974 petitioner purchased 30,800 shares of stock in

20 separate transactions for a total cost of $239,845. In

20 transactions petitioner sold 14,500 share of stock for a

og of $25,885.18. As of December 31, 1974, petitioner

ad 27,9007! shares of its accounts at a total cost of

$175,670.01.

In May 1974 a cashier’s check in the amount of $1,600

was issued to Deana Hron. The source of the funds for

21 The parties stipulated to the number of shares vine

solc, and retained by petitioner. No explanation is provi ed

for the difference between the number of shares stipulated as

being held by petitioner as of Dec. 31, 1974, and the

remainder arrived at by subtracting the total shares sold

from the total shares purchased.

—16a—

this check was a check from Lamson Bros. & Co.

payable to petitioner.

By letter dated June 9, 1976, petitioner was informed

by the District Director, St. Louis, Mo., that respondent

proposed to revoke petitioner’s tax-exempt status. A

copy of the revenue agent’s examination report was at-

tached to the letter and it set forth the reasons for the

proposed revocation, including the failure of petitioner

to meet the operational test and the inurement of net

earnings to the benefit of private individuals. As

previously noted, respondent issued a final adverse

determination on April 25, 1978.

OPINION

Section 7428(a) permits this Court under certain cir-

cumstances to make a declaration with respect to a final

determination by respondent that a corporation is not an

organization described in section 501(c\3) and therefore,

not exempt from tax under section 501(a).% The term

“determination” includes a_ revocation of an

organization’s tax-exempt status. Sec. 7428(a). The

burden of proof is on petitioner to overcome the grounds

for revocation of the exemption set forth in respondent’s

2 Sec. 7428(a) provides in pertinent part:

(a) Creation of Remedy.—In a case of actual controver-

sy involving—

(1) a determination by the Secretary—

(A) with respect to the initial qualification or con-

tinuing qualification of an organization as an organiza-

tion described in section 501(cX3) which is exempt from

tax under section 50l(a)* ** .

** *

upon the filing of an appropriate pleading, the United

States Tax Court * * * may make a declaration with

respect to such initial qualification or continuing

Fcc war * * * Any such declaration shall have the

orce and effect of a decision of the Tax Court * * * and

shall be reviewable as such. * * *

—17a—

determination. Rule 217(cX2\i), Tax Court Rules of

Practice and Procedure.”

Section 501(a) and section 501(cX3)* provide an ex-

emption from Federal income tax for an organization

if three conjunctive requirements are met: (1) The or-

mayne must be organized and operated exclusively

or an exempt purpose; (2) no part of the net earnings of

the organization can inure to the benefit of any private

shareholder or individual; and (3) no substantial part of

the activities of the organization includes carrying on

propaganda, otherwise attempting to influence legisla-

tion, or participating or intervening in any political

campaign. Failure to satisfy any of these requirements

results in a denial of tax-exempt status. Hancock

Academy of Savannah, Inc. v. Commissioner, 69 T.C.

488, 492 (1977); Harding Hospital, Inc. v. United States,

505 F. 2d 1068 (6th Cir. 1974). Respondent based his

23 Hancock Academy of Savannah, Inc. v. Commissioner, 69

T.C. 488, 492 (1977).

% Sec. 501. Exemption From Tax on Corporations, Certain

Trusts, Etc.

(a) Exemption From Taxation—An organization

described in subsection (c) * * * shall be exempt from tax-

ation under this subtitle unless such exemption is denied

under section 502 or 503.

** *

(c) List of Exempt Organizations.—The following

organizations are referred to in subsection (a):

** *

(3) Corporations * * * organized and operated ex-

clusively for religious, charitable, scientific, testing for

public safety, literary, or educational purposes, * * * no

part of the net earnings of which inures to the benefit of

any private shareholder or individual, no substantial

part of the activities of which is carrying on propagan-

a, or otherwise attempting, to influence legislation

(except as otherwise provided in subsection | ), and

which does not oe in, or intervene in (including

the publishing or distributing of statements), any

2 mg campaign on behalf of any candidate for public

office.

—18a—

determination on the grounds that petitioner failed to

satisfy requirements (1) and (2) above.

Respondent concluded that petitioner failed the

“operated exclusively for a religious purpose” test

because (1) petitioner did not actively engage in any

religious-type functions in furtherance of its stated pur-

pose; (2) petitioner’s primary activity was the making of

passive investments and accumulating income

therefrom, which activity was not in furtherance of an

exempt purpose and did not qualify it for tax-exempt

status; and (3) some of petitioner’s financial activities

were for the benefit of private interests. Respondent’s

conclusion that petitioner had also failed the “inurement

of net earnings” test is based on the assertion that

petitioner has failed to establish that net earnings did

not inure to the benefit of a private shareholder. In sup-

port of this assertion respondent principally points to

petitioner’s inability to definitively document its finan-

cial dealings due to petitioner’s inadequate records.

Petitioner asserts that its primary activities were the

conversion of members through one-to-one missionary

work by Slough and the accumulation of a fund for the

construction of a church building, both of which were in

furtherance of an exempt purpose. Petitioner further

argues that the absence of any statutory or regulatory

guidelines concerning minimum religious functions

pec the denial of exempt status on those grounds.

etitioner further contends that, in the absence of any

statutory guidelines as to minimum activities, the main

thrust of section 501(cX3) is to prohibit organizations

whose activities inure to the private benefit of

shareholders from attaining tax-exempt status.

Petitioner attempts to establish that it has factually

satisfied the “inurement of net earnings” test by showing

that all the transactions entered into by petitioner were

for the financial benefit of petitioner.

Section 1.501(cX3)-1(cX1), Income Tax Regs., provides

that an organization is not operated exclusively for an

exempt purpose if more than an insubstantial part of its

—19a—

activities is not in furtherance of an exempt purpose.”

Section 1.501(cX3)-1(dX1), Income Tax Regs., further

—— that an organization is not operated exclusively

or an exempt purpose if it serves a private rather than

a public interest.% Section 1.501(cX3)-1(cX2), Income

Tax Regs., provides that an organization is not operated

exclusively for an exempt purpose if its net earnings in

whole or in part inure to the benefit of a private in-

dividual.?’

2% Sec. 1.501(cX3)-1(cX1), Income Tax Regs., states:

An organization will be regarded as “operated exclusive-

ly” 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(cX3). An

——r will not be so regarded if more than an in-

substantial part of its activities is not in furtherance of an

exempt purpose.

2% Sec. 1.501(cX3)-1(dX1Xi) and (ii), Income Tax Regs., states:

i) An organization a? be exempt as an organization

escribed in section 1(cX3) if it is organized and

operated exclusively for one or more of the following pur-

poses:

a) Religious

b) Charitable,

Scientific,

) Testing for public safety,

e) Literary,

Educational, or

) Prevention of cruelty to children or animals.

(ii) An organization is not organized or operated ex-

clusively for one or more of the pur 3 specified in sub-

division (i) of this subparagraph unless it serves a public

rather than a private interest. Thus, to meet the require-

ment of this subdivision, it is necessary for an i aye

tion 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 indirectiy, by such

private interests.

27 Sec. 1.501(cX3)-1(cX2) states:

An organization is not operated exclusively for one or

more exempt purposes if its net earnings inure in whole

(Footnote continued on following page)

—20a—

The Supreme Court, in interpreting section 811(bX8)

of the Social Security Act, 49 Stat. 620, 639 (1935),

which provided an exemption for corporations organized

and operated exclusively for educational purposes, said

~ oo Bureau v. United States, 326 U.S. 279,

83 (1 :

[Ijn order to fall within the claimed exemption, an

organization must be devoted to educational pur-

poses exclusively. This plainly means that the

presence of a single non-educational purpose, if sub-

stantial in nature, will destroy the exemption

regardless of the number or importance of truely

educational purposes. * * *

The quotation from Better Business Bureau relates to

“purpose” while section 1.501(c\3)-1(cX1), Income Tax

Regs., relates more to “activities.” In Christian Manner

International, Inc. v. Commissioner, 71 T.C. 661, 668

(1979), it was stated:

Under the rationale of Better Business Bureau the

existence of a substantial nonexempt purpose for a

corporation’s organization and existence would

appear to defeat the exemption. But under the

regulation, even if there was no nonexempt purpose

for the organization and existence of the entity, it

must actually engage primarily in activities which

accomplish one of the exempt purposes, and if more

than an insubstantial part of its activities do not

further such exempt purpose, the entity is not ex-

empt. It has been recognized, however, that an

27 continued

or in part to the benefit of private shareholders or in-

dividuals. For the definition of the words “private

a or individual”, see paragraph (c) of §1.501(a)-

This prohibition against private inurement of net earnings

ppears che mrngeent since _ a benefit —— be a

with operating exclusively for an exempt pu ’

Hospital Association v. aniaton, 56 ™C 850, 857, fn.

je ty B.H.W. age Foundation, Inc. v. Commissioner,

—2la—

organization engaged in a single activity may have

more than one purpose in conducting the activity.

B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352,

357 (1978). So we must be concerned with both the

actual as well as the stated purposes for the ex-

istence of the organization and the activities it

engages in to accomplish those purposes. What

those purposes are and what purposes the activity

or activities engaged in support are questions of

ma Resource v. Commissioner, 70 T.C. 594

1978).

There is no question that, based on its articles of in-

corporation, petitioner was organized for a religious pur-

pose. No activities were conducted, however, which ac-

complished the stated purpose.

Petitioner argues that it conducted two activities in

furtherance of its exempt purpose: (1) One-to-one mis-

sionary work by Slough; and (2) accumulation of a

building fund. For the reasons set forth below, we con-

clude that these activities are not in furtherance of

petitioner’s stated purpose.”

During the years under examination, petitioner did

not conduct religious services.”

8 Although Slough testified that he considered the money he

allegedly distributed to needy individuals a function of

petitioner, it was not cited by petitioner as an activity in sup-

port of its stated purpose. Considering that this activity was

conducted for only a short time in 1972, it would not aid

petitioner’s case. Furthermore, it has been held under similar

circumstances that grants made on a personal basis rather

than in an objective and nondiscriminatory manner do not

constitute an activity in furtherance of an a Pur ;

Church In Boston v. Commissioner, 71 T.C. 102, 107 (1978).

29 Respondent cites the absence of any such services as

evidence that petitioner was not operated exclusively for tax-

exempt purposes. Petitioner argues that the absence of any

statutory or regulatory guidelines concerning minimum

religious functions precludes the denial of exempt status on

those grounds; that to deny petitioner tax-exempt status solely

because it failed to conduct religious services would run afoul

(Footnote continued on following page)

—22a—

In addition to Slough, his wife, and his daughter,

positive evidence was introduced to identify only two

other individuals as members of petitioner. Slough

claimed that petitioner had 40 members, but he refused

to reveal their identities claiming it would be an inva-

sion of privacy.

Objective evidence of the number of petitioner’s

members is certainly relevant to our inquiry concerning

the nature of the activities of petitioner and whether it

was operated exclusively for religious purposes. Bronner

v. Commissioner, 72 T.C. 368 (1979). Since petitioner

bears the burden of proving that it is entitled to tax-

exempt status, and in the absence of objective evidence

indicating a greater number, the Court must proceed as

if petitioner had only 5 members. This is not to say that

an organization of such small dimensions cannot qualify

for tax-exempt status. It is certainly relevant, however,

in determining the extent of Slough’s one-to-one ac-

tivities, which petitioner claims as one of its religious ac-

tivities.

The only evidence of Slough’s one-to-one activity was

the generalized testimony of Slough and the testimony of

two other witnesses to whom Slough had talked. Both of

the other witnesses were acquaintances of Slough’s prior

to the formation of petitioner. While they both agreed to

become members of petitioner, there is no evidence that

they actually did become members or that they par-

2 continued

of the First Amendment guarantee of freedom of religion; and

that any attempt to set forth guidelines concerning the of

religious activity necessary to qualify for tax-exempt status

would be constitutionally suspect. Nonetheless, the type of ac-

tivities engaged in by an organization is central to our inquiry

as to whether that organization is operated exclusively for

tax-exempt pu . Had petitioner conducted services, it

certainly would have been a factor to consider. Its not doing

so, however, while not a ceaeee factor per se, is somethi

which must be considered given the stated purpose 0

petitioner to build churches in which, presumably, religious

services would be held.

8 See Blake v. Commissioner, T.C. Memo 1970-117.

—23a—

ticipated in any way in religious functions with

titioner. The evidence indicates that all it took to

me members of petitioner was to accept petitioner’s

general tenets and agree to attend future services. One

of these witnesses was the recipient of a grant from

petitioner, and both apparently had some personal

problems that Slough discussed with them. The amount

of time spent by Slough on such discussions was

minimal, and we believe Slough’s efforts were motivated

more by personal reasons than in preaching the gospel.

At best Slough’s ministeries were directed to the

problems of private individuals rather than to the public

at large. See Callaway Family Association v. Com-

missioner, 71 T.C. 340 (1978). Petitioner has failed to

convince us that this one-to-one activity of Slough was a

religious activity conducted in behalf of petitioner. And

the evidence indicates that no one other than Slough

performed any activities in behalf of petitioner.

Illustrative of the fact that Slough’s activities were

more personal than church oriented is the manner in

which Slough selected the individuals who allegedly

received the money from the checks Slough wrote on

petitioner’s bank account to cash. Slough testified that

the individuals selected were people whom Slough per-

sonally knew to be in need of funds. These individuals

neither applied to Slough nor to petitioner. Rather,

Slough unilaterally selected them. The grants were not

made in an objective and nondiscriminatory manner

based on established criteria. It has been held that

grants made on a personal basis do not constitute ex-

empt activity. Church In Boston v. Commissioner, 71

T.C. 102 (1978). This type of — activity by Slough,

while commendable, cannot be said to be the activity of

petitioner.

Petitioner’s primary, if not sole, activity was the mak-

ing of passive irivestments. This included investments in

certificates of deposit, stocks, and real estate. It borrow-

ed considerable amounts of money in order to finance its

investment activities. During both 1973 and 1974 it

made a profit in excess of $25,000 from its buying and

selling of stocks.

—24a—

Petitioner’s involvement in a moneymaking activity is

not a per se bar to qualification as a tax-exempt

organization. Aid to Artisans, Inc. v. Commissioner, 71

T.C. 202, 211 (1978); Pulpit Resource v. Commissioner,

supra; Orton v. Commissioner, 56 T.C. 147 (1971). The

question is what purpose is accomplished by this activi-

ty. The avowed purpose was to make a profit in order to

accumulate money with which to build a church. Thus

the Court is not presented with a case where the

moneymaking activity, in ana of itself, accomplished an

exempt purpose. Compare Pulpit Resource v. Com-

missioner, supra; Orton v. Commissioner, supra; Saint

mo Foundation v. Commissioner, 26 T.C. 648

1956).

However, the prospects of accomplishing the avowed

purpose at any time in the foreseeable future appears

remote. While an architect friend of Slough’s had made

preliminary sketches of an elaborate church building

during his spare time, nothing had been done to follow

through on the design. Slough testified that it would

have cost $4-5 million to build such an edifice at the

time it was sketched and that due to inflation the cost

would be considerably more today. Slough testified that

petitioner had about $190,000 in assets at the time of

trial, 7 years after petitioner was formed. About $50,000

of this amount was produced bv petitioner’s investment

activities, and most of the balance came from con-

tributions by Slough who had contributed almost $100,-

000 to petitioner by the end of 1974. There is no

evidence that petitioner solicited either the public or its

members for contributions.*!

The facts present in the instant case are similar to

those in Randall Foundation v. Riddell, 244 F. 2d 803

(9th Cir. 1957). In Randall Foundation the principal ac-

7 of the organization was securities trading. Most of

81 Apparently the only other contributions received by

igen we Ae 5 were two contributions of $500 each, but we cannot

certain that these were not repayments of cash given the

contributors by Slough.

—25a—

the profit earned from such activity was accumulated,

although small charitable contributions were made.

Testimony was introduced in that case to the effect that

the accumulated funds were to be used for a boys’ home

but that more funds were needed before that objective

could be pursued. In holding that the organization’s

principal activity was the trading of stocks and that it

was not tax exempt, the Court stated:

It is not our intention to say that a case can never

be made out on the facts of a particular situation

for aggregation of funds by a corporation for ul-

timate disposition to a charitable purpose. But a

corporation which in its inception engages in trade,

business or speculation, and only has a vague

charitable design, does not in our opinion come

within the terms of the statute. * * * [Fn. omitted;

244 F. 2d at 804-805.]

As in Randall Foundation petitioner had no obligation

to use the accumulated funds for the avowed purpose.

The similarities between the two cases as to the nature

of the profit-making activities, the accumulation of those

profits, and the vague, ultimate, albeit potentially ex-

empt, disposition of those profits makes Randall Foun-

dation difficult to distinguish. We therefore find that

petitioner was not primarily engaged in activities which

accomplished a tax-exempt purpose.

In addition, petitioner has failed to convince us that

petitioner was no more than insubstantially operated for

the private benefit of Slough or that no net earnings in-

ured to the benefit of private individuals. The prohibi-

tion against operation of an organization for a private

benefit is but another way of requiring that an organiza-

tion be operated exclusively for tax-exempt purposes,

ie., for public benefit. Sec. 1.501(cX3)-1(dX1Xi) and (ii),

Income Tax Regs. Although the requirement that an

organization be operated exclusively for tax-exempt pur-

poses (and not for a private benefit) is statutorily dis-

tinct from the prohibition against the inurement of net

earnings to the benefit of private individuals, for con-

venience both requirements will be discussed together

—26a—

because much of the evidence is applicable to both.’? No

single factor or combination thereof controls our conclu-

sion. Rather, these factors, taken in the aggregate, re-

quire the conclusion we reach.

Slough testified that one of his reasons for organizing

petitioner was to have an organization in which he

would participate and dictate some of the policies. The

amount of control Slough exercised over petitioner’s

operations and the blurring of the lines of demarcation

between the activities and interests of petitioner, Slough,

and Slough’s wholly owned corporations makes it im-

possible to conclude that petitioner was operated for a

public benefit rather than a private interest.

Slough made large contributions to petitioner for

which he took charitable contribution deductions. This

money, however, never passed out of Slough’s control

since he dominated petitioner. Nor was any substantial

portion of this money ever expended other than for in-

vestment purposes. Thus, in effect, Slough was able to

reduce his current taxable income for donations which

never left his control. In addition, one of the reasons for

petitioner’s purchase of an office building, its only in-

vestment in real estate, was Credit Control Services’

need for more office space. Petitioner’s downpayment for

the building was provided by Credit Control Services as

advance rental and the building was leased under a net

lease. Thus, Credit Control Services was able to current-

ly deduct the “cost” of the building. It was also able to

use petitioner’s credit. It is recognized that the office

building may have been a good investment for petitioner

and that Credit Control Services paid a reasonable rent.

Nevertheless, when petitioner’s investments are dictated

in Lg by the n of private interests, it cannot be

said that petitioner was operated exclusively for the

public benefit.

Considerable evidence was introduced concerning

petitioner’s financial transactions. There is a dispute

between the parties about whether, as a result of several

& See fn. 27.

—27a—

transactions, Business Management owed petitioner $3,-

000 or petitioner owed Business Management $10,000.

Petitioner’s failure to keep adequate records and the

manner in which money was handled and loans were

paid makes it impossible to trace completely pctitioner’s

financial transactions. In any event, it is clear that

money passed back and forth between petitioner and

Slough and his businesses whenever one or the other

needed the cash. Petitioner was utilized by Slough as an

“incorporated pocketbook” into which he could transfer

excess personal funds, claiming tax deductions, while he

still retained complete control of the funds and used

them for purposes unrelated to religious activities. Mean-

while, the income and gain from petitioner’s invest-

ment activities was intended to be tax free. And based

on past history, this situation will continue to exist

for a long time. And even if petitioner should eventually

build a church and conduct public services, Slough

would, presumably, continue to control the use of its

funds. As he testified, one of the reasons Slough orga-

nized petitioner was to have an organization in which he

could participate and dictate policies.

In addition, petitioner failed to introduce adequate

evidence to prove that Slough’s writing of $5,200 in

checks to cash and the payment of $1,600 to Slough’s

daughter did not inure to the benefit of private in-

dividuals. Slough’s testimony alone is not sufficient. It

was not only uncorroborated by records or the testimony

of other witnesses but his explanation of why the $1,600

was given to his daughter was inconsistent with the ex-

planation he had given the revenue agent.

Based on the evidence produced, we cannot conclude

that as a result of its financial transactions, no part of

petitioner’s net earnings inured to the benefit of Slough

or members of his family or one of his wholly owned cor-

porations. In view of petitioner’s burden of proof, this

question must be resolved in favor of respondent.

In summary, we conclude that petitioner was not

operated exclusively for a pur exempt under section

501(cX(3), that petitioner has failed to establish that no

—28a—

part of its net earnings inured to the benefit of a private

individual, and that respondent properly revoked

petitioner’s previously granted exemption.*

An appropriate order will be entered.

88 Petitioner does not make the alternative argument that

regardless of whether it is entitled to tax-exempt status, the

respondent’s determination should not be _ retroactively

applied. In view of respondent’s authority ‘to retroactivel

revoke the steam status of an organization, sec. 7806(b),

sec, 1.501(a)-1(aX2), Income Tax Regs., this issue need not be

—29a—

INTERNAL REVENUE CODE OF 1954

§501. Exemption from tax on corporations,

certain trusts, etc.

(a) Exemption from taxation—An organization de-

scribed in subsection (c) or (d) or section 401(a) shall be

exempt from taxation under this subtitle unless such ex-

emption is denied under section 502 or 503.

(b) Taz on unrelated business income and certain other

activities—An organization exempt from taxation under

subsection (a) shall be subject to tax to the extent pro-

vided in parts II, III, and VI of this subchapter, but (not-

withstanding parts IT, ITI, and VI of this subchapter) shall

be considered an organization exempt from income taxes

for the purpose of any law which refers to organizations

exempt from income taxes.

(c) List of exempt organizations.—The following or-

ganizations are referred to in subsection (a):

(1) Corporations organized under Act of Congress,

if such corporations are instrumentalities of the Unit-

ed States and if, under such Act, as amended and sup-

plemented, such corporations are exempt from Federal

income taxes.

(2) Corporations organized for the exclusive pur-

pose of holding title to property, collecting income

therefrom, and turning over the entire amount thereof,

less expenses, to an organization which itself is ex-

empt under this section.

(3) Corporations, and any community chest, fund,

or foundation, organized and operated exclusively for

religious, charitable, scientific, testing for public safety,

literary, or educational purposes, or to foster national

or international amateur sports competition (but only

if no part of its activities involve the provision of

athletic facilities or equipment), or for the prevention

of cruelty to children or animals, no part of the net

earnings of which inures to the benefit of any private

—30a—

shareholder or individual, no substantial part of the

activities of which is carrying on propaganda, or oth-

erwise attempting, to influence legislation (except as

otherwise provided in subsection (h)), and which does

not participate in, or intervene in (including the pub-

lishing or distributing of statements), any political

campaign on behalf of any candidate for public office.

(4) Civie leagues or organizations not organized

for profit but operated exclusively for the promotion

of social welfare, or local associations of employees,

the membership of which is limited to the employees

of a designated person or persons in a particular mu-

nicipality, and the net earnings of which are devoted

exclusively to charitable, educational, or recreational

purposes.

(5) Labor, agricultural, or horticultural organiza-

tions.

(6) Business leagues, chambers of commerce, real-

estate boards, boards of trade, or professional football

leagues (whether or not administering a pension fund

for football players), not organized for profit and no

part of the net earnings of which inures to the bene-

fit of any private shareholder or individual.

(7) Clubs organized for pleasure, recreation, and

other nonprofitable purposes, substantially all of the

activities of which are for such purposes and no part

of the net earnings of which inures to the benefit of

any private shareholder.

(8) Fraternal beneficiary societies, orders, or as-

sociations—

(A) operating under the lodge system or for

the exclusive benefit of the members of a fraternity

itself operating under the lodge system, and

(B) providing for the payment of life, sick, ac-

cident, or other benefits to the members of such

society, order, or association or their dependents.

(9) Voluntary employees’ beneficiary associations

providing for the payment of life, sick, accident, or

—3la—

other benefits to the members of such association or

their dependents or designated beneficiaries, if no part

of the net earnings of such association inures (other

than through such payments) to the benefit of any

private shareholder or individual.

(10) Domestic fraternal societies, orders, or asso-

ciations, operating under the lodge system—

(A) the net earnings of which are devoted ex-

clusively to religious, charitable, scientific, literary,

educational, and fraternal purposes, and

(B) which do not provide for the payment

of life, sick, accident, or other benefits.

(11) Teachers’ retirement fund associations of a

purely local character, if—

(A) no part of their net earnings inures (other

than through payment of retirement benefits) to

the benefit of any private shareholder or indi-

vidual, and

(B) the income consists solely of amounts re-

ceived from public taxation, amounts received

from assessments on the teaching salaries of mem-

bers, and income in respect of investments.

(12) Benevolent life insurance associations of a

purely local character, mutual ditch or irrigation com-

panies, mutual or cooperative telephone companies,

or like organizations; but only if 85 percent or more

of the income consists of amounts collected from

members for the sole purpose of meeting losses and

expenses. In the case of any mutual or cooperative

telephone company, the preceding sentence shall be

applied without taking into account any income re-

ceived or accrued from a nonmember telephone com-

pany for the performance of communication services

which involve members of such mutual or cooperative

telephone company.

(13) Cemetery companies owned and operated ex-

clusively for the benefit of their members or which are

not operated for profit; and any corporation chartered

solely for the purpose of the disposal of bodies by

—32a—

burial or cremation which is not permitted by its

charter to engage in any business not necessarily in-

cident to that purpose and no part of the net earn-

ings of which inures to the benefit of any private

shareholder or individual.

(14)(A) Credit unions without capital stock or-

ganized and operated for mutual purposes and with-

out profit.

(B) Corporations or associations without capital

stock organized before September 1, 1957, and op-

erated for mutual purposes and without profit for the

purpose of providing reserve funds for, and insurance

of shares or deposits in—

_(i) domestic building and loan associations,

(ii) cooperative banks without capital stock or-

ganized and operated for mutual purposes and

without profit, or

(iii) mutual savings banks not having capital

stock represented by shares.

(C) Corporations or associations organized before

September 1, 1957, and operated for mutual purposes

and without profit for the purpose of providing re-

serve funds for associations or banks described in

clause (i), (ii), or (iii) of subparagraph (B); but only

if 85 percent or more of the income is attributable

to providing such reserve funds and to investments.

This subparagraph shall not apply to any corporation

or association entitled to exemption under subpara-

graph (B).

(15) Mutual insurance companies or associations

other than life or marine (including inter-insurers and

reciprocal underwriters) if the gross amount received

during the taxable year from the items described in

section 822(b) (other than paragraph (1)(D) there-

of) and premiums (including deposits and assess-

ments) does not exceed $150,000.

(16) Corporations organized by an association sub-

ject to part IV of this subchapter or members there-

—33a—

of, for the purpose of financing the ordinary crop

operations of such members or other producers, and

operated in conjunction with such association. Exemp-

tion shall not be denied any such corporation because

it has capital stock, if the dividend rate of such stock

is fixed at not to exceed the legal rate of interest in

the State of incorporation or 8 percent per annum,

whichever is greater, on the value of the considera-

tion for which the stock was issued, and if substan-

tially all such stock (other than nonvoting preferred

stock, the owners of which are not entitled or per-

mitted to participate, directly or indirectly, in the

profits of the corporation, on dissolution or otherwise,

beyond the fixed dividends) is owned by such associa-

tin, or members thereof; nor shall exemption be de-

nied any such corporation because there is accumu-

lated and maintained by it a reserve required by State

law or a reasonable reserve for any necessary purpose.

(17)(A) A trust or trusts forming part of a plan

providing for the payment of supplemental unemploy-

ment compensation benefits, if—

(i) under the plan, it is impossible, at any time

prior to the satisfaction of all liabilities with re-

spect to employees under the plan, for any part

of the corpus or income to be (within the taxable

year or thereafter) used for, or diverted to, any

purpose other than the providing of supplemental

unemployment compensation benefits,

(ii) such benefits are payable to employees un-

der a classification which is set forth in the plan

and which is found by the Secretary not to be

discriminatory in favor of employees who are of-

ficers, shareholders, persons whose principal duties

consist of supervising the work of other employ-

ees, or highly compensated employees, and

(iii) such benefits do not discriminate in favor

of employees who are officers, shareholders, per-

sons whose principal duties consist of supervising

the work of other employees, or highly compen-

—34a—

sated employees. A plan shall not be considered

discriminatory within the meaning of this clause

merely because the benefits received under the

plan bear a uniform relationship to the total com-

pensation, or the basic or regular rate of com-

pensation, of the employees covered by the plan.

(B) In determining whether a plan meets the re-

quirements of subparagraph (A), any benefits pro-

vided under any other plan shall not be taken into

consideration, except that a plan shall not be con-

sidered discriminatory—

(i) merely because the benefits under the plan

which are first determined in a nondiscriminatory

manner within the meaning of subparagraph (A)

are then reduced by any sick, accident, or unem-

ployment compensation benefits received under

State or Federal law (or reduced by a portion of

such benefits if determined in a nondiscriminatory

manner), or

(ii) merely because the plan provides only for

employees who are not eligible to receive sick,

accident, or unemployment compensation benefits

under State or Federal law the same benefits (or

a portion of such benefits if determined in a nondis-

criminatory manner) which such employees would

receive under such laws if such employees were

eligible for such benefits, or

(iii) merely because the plan provides only

for employees who are not eligible under another

plan (which meets the requirements of subpara-

graph (A)) of supplemental unemployment com-

pensation benefits provided wholly by the employer

the same benefits (or a portion of such benefits if

determined in a nondiscriminatory manner) which

such employees would receive under such other

plan, but only if the employees eligible under

both plans would make a classification which would

be nondiscriminatory within the meaning of sab-

paragraph (A).

—35a—

(C) A plan shall be considered to meet the re-

quirements of subparagraph (A) during the whole

of any year of the plan if on one day in each quar-

ter it satisfies such requirements.

(D) The term ‘‘supplemental unemployment com-

pensation benefits’? means only—

(i) benefits which are paid to an employee be-

cause of his involuntary separation from the em-

ployment of the employer (whether or not such

separation is temporary) resulting directly from

a reduction in force, the discontinuance of a plant

or operation, or other similar conditions, and

(ii) sick and accident benefits subordinate to

the benefits described in clause (i).

(E) Exemption shall not be denied under subsec-

tion (a) to any organization entitled to such exemption

as an association described in paragraph (9) of this

subsection merely because such organization provides

for the payment of supplemental unemployment bene-

fits (as defined in subparagraph (D)(i)).

(18) A trust or trusts created before June 25, 1959,

forming a part of a plan providing for the payment

of benefits under a pension plan funded only by con-

tributions of employees, if—

(A) under the plan, it is impossible, at any

time prior to the satisfaction of all liabilities with

respect to employees under the plan, for any part

of the corpus or income to be (within the taxable

year or thereafter) used for, or diverted to, any

purpose other than the providing of benefits under

the plan,

(B) such benefits are payable to employees un-

der a classification which is set forth in the plan

and which is found by the Secretary not to be dis-

criminatory in favor of employees who are officers,

shareholders, persons whose principal duties con-

sist of supervising the work of other employees, or

highly compensated employees, and

—36a—

(C) such benefits do not discriminate in favor

of employees who are officers, shareholders, per-

sons whose principal duties consist of supervising

the work of other employees, or highly compen-

sated employees. A plan shall not be considered

discriminatory within the meaning of this subpara-

graph merely because the benefits received under

the plan bear a uniform relationship to the total

compensation, or the basic or regular rate of com-

pensation, of the employees covered by the plan.

(19) A post or organization of war veterans, or

an auxiliary unit or society of, or a trust or founda-

tion for, any such post or organization—

(A) organized in the United States or any of

its possessions,

(B) atleast 75 percent of the members of which

are war veterans and substantially all of the other

members of which are individuals who are vet-

erans (but not war veterans), or are cadets, or are

spouses, widows, or widowers of war veterans or

such individuals, and

(C) no part of the net earnings of which inures

to the benefit of any private shareholder or indi-

vidual.

(20) an organization or trust created or organized

in the United States, the exclusive function of which

is to form a part of a qualified group legal services

plan or plans, within the meaning of section 120. An

organization or trust which receives contributions be-

cause of section 120(c) (5) (C) shall not be prevented

from qualifying as an organization described in this

paragraph merely because it provides legal services or

indemnification against the cost of legal services un-

associated with a qualified group legal services plan.

(21) a trust or trusts established in writing, cre-

ated or organized in the United States, and contributed

to by any person (except an insurance company) if—

(A) the purpose of such trust or trusts is ex-

clusively—

—37a—

(i) to satisfy, in whole or in part, the lia-

bility of such person for, or with respect to,

claims for compensation for disability or death

due to pneumoconiosis under Black Lung Acts;

(ii) to pay premiums for insurance exclu-

sively covering such liability; and

(iii) to pay administrative and other inci-

dental expenses of such trust (including legal,

accounting, actuarial, and trustee expenses)

in connection with the operation of the trust

and the processing of claims against such per-

son under Black Lung Acts, and

(B) no part of the assets of the trust may be

used for, or diverted to, any purpose other than—

(i) the purposes described in subpara-

graph (A), or

(ii) investment (but only to the extent that

the trustee determines that a portion of the

assets is not currently needed for the pur-

poses described in subparagraph (A)) in—

(I) public debt securities of the United

States,

(II) obligations of a State or local

government which are not in default as

to principal or interest, or

(IIT) time or demand deposits in a

bank (as defined in section 581) or an in-

sured credit union (within the meaning

of section 101(6) of the Federal Credit

Union Act, 12 U.S.C. 1752(6)) located

in the United States, or

(iii) payment into the Black Lung Dis-

ability Trust Fund established under section

3 of the Black Lung Benefits Revenue Act

of 1977, or into the general fund of the Unit-

ed States Treasury (other than in satisfaction

of any tax or other civil or criminal liability

of the person who established or contributed

to the trust).

—38a—

For purposes of this paragraph the term ‘‘Black Lung

Acts’’ means part C of title IV of the Federal Coal

Mine Health and Safety Act of 1969, and any State

law providing compensation for disability or death

due to pneumoconiosis.

(d) Religious and apostolic organizations.—The follow-

ing organizations are referred to in subsection (a): Reli-

gious or apostolic associations or corporations, if such as-

sociations or corporations have a common treasury or com-

munity treasury, even if such associations or corporations

engage in business for the common benefit of the mem-

bers, but only if the members thereof include (at the time

of filing their returns) in their gross income their entire

pro rata shares, whether distributed or not, of the taxable

income of the association or corporation for such year. Any

amount so included in the gross income of a member shall

be treated as a dividend received.

(e) Cooperative hospital service organizations.—F or

purposes of this title, an organization shall be treated as

an organization organized and operated exclusively for

charitable purposes, if—

(1) such organization is organized and operated

solely—

(A) to perform, on a centralized basis, one or

more of the following services which, if performed

on its own behalf by a hospital which is an or-

ganization described in subsection (c)(3) and ex-

empt from taxation under subsection (a), would

constitute activities in exercising or performing

the purpose or function constituting the basis for

its exemption: data processing, purchasing, ware-

housing, billing and collection, food, clinical, in-

dustrial engineering, laboratory, printing, com-

munications, record center, and personnel (includ-

ing selection, testing, training, and education of

personnel) services; and

(B) to perform such services solely for two or

more hospitals each of which is—

—39a—

(i) an organization described in subsection

(c) (3) which is exempt from taxation under

subsection (a).

(ii) a constituent part of an organization de-

scribed in subsection (¢) (3) which is exempt

from taxation under subsection (a) and which,

if organized and operated as a: separate en-

tity, would constitute an organization de-

scribed in subsection (c) (3), or

(iii) owned and operated by the United

States, a State, the District of Columbia, or

a possession of the United States, or a politi-

cal subdivision or an agency or instrumental-

ity of any of the foregoing;

(2) such organization is organized and operated

on a cooperative basis and allocates or pays, within

814 months after the close of its taxable year, all net

earnings to patrons on the basis of services performed

for them; and

(3) if such organization has capital stock, all of

such stock outstanding is owned by its patrons.

For purposes of this title, any organization which, by rea-

son of the preceding sentence, is an organization described

in subsection (c) (3) and exempt from taxation under sub-

section (a), shall be treated as a hospital and as an or-

ganization referred to in section 170(b) (1 )(A) (iii).

(f) Cooperative service organizations of operating edu-

cational organizations.—For purposes of this title, if an

organization is—

(1) organized and operated solely to hold, com-

mingle, and collectively invest and reinvest (includ-

ing arranging for and supervising the performance by

independent contractors of investment services related

thereto) in stocks and securities, the moneys con-

tributed thereto by each of the members of such or-

ganization, and to collect income therefrom and turn

over the entire amount thereof, less expenses, to such

members,

—40a—

(2) org nized and controlled by one or more such

members, and

(3) comprised solely of members that are organiza-

tions described in clause (ii) or (iv) of section 170(b)

(1) (A)—

(A) which are exempt from taxation under sub-

section (a), or

(B) the income of which is excluded from taxa-

tion under section 115(a),

then such organization shall be treated as an organization

organized and operated exclusively for charitable purposes.

(zg) Definition of agricultural—For purposes of sub-

section (c) (5), the term ‘‘agricultural’’ includes the art

or science of cultivating land, harvesting crops or aquatic

resources, or raising livestock.

(h) Expenditures by public charities to influence legis-

lation.—

(1) General rule.—In the case of an organization to

which this subsection applies, exemption from taxa-

tion under subsection (a) shall be denied because a

substantial part of the activities of such organization

consists of carrying on propaganda, or otherwise at-

tempting, to influence legislation, but only if such or-

ganization normally—

(A) makes lobbying expenditures in excess of

the lobbying ceiling amount for such organization

for each taxable year, or

(B) makes grass roots expenditures in excess

of the grass roots ceiling amount for such organi-

zation for each taxable year.

(2) Definitions.—For purposes of this subsection—

(A) Lobbying expenditures.—The term ‘‘lob-

bying expenditures’? means expenditures for the

purpose of influencing legislation (as defined in

section 4911(d)).

(B) Lobbying ceiling amount.—The lobbying

ceiling amount for any organization for any tax-

—4la—

able year is 150 percent of the lobbying nontax-

able amount for such organization for such taxable

year, determined under section 4911.

(C) Grass roots expenditures—The term

‘‘yrass roots expenditures’’ means expenditures

for the purpose of influencing legislation (as de-

fined in section 4911(d) without regard to para-

graph (1) (B) thereof).

(D) Grass roots ceiling amount.—The grass

roots ceiling amount for any organization for any

taxable year is 150 percent of the grass roots non-

taxable amount for such organization for such

taxable year, determined under section 4911.

(3) Organizations to which this subsection applies.

—This subsection shall apply to any organization which

has elected (in such manner and at such time as the

Secretary may prescribe) to have the provisions of

this subsection apply to such organization and which,

for the taxable year which includes the date the elec-

tion is made, is described in subsection (c) (3) and—

(A) is described in paragraph (4), and

(B) is not a disqualified organization under

paragraph (5).

(4) Organizations permitted to elect to have this

subsection apply.—An organization is described in this

paragraph if it is described in—

(A) section 170(b) (1) (A) (ii) (relating to

educational institutions),

(B) section 170(b) (1) (A) (iii) (relating to

hospitals and medical research organizations),

(C) section 170(b) (1) (A) (iv) (relating to

organizations supporting government schools),

(D) section 170(b) (1) (A) (vi) (relating to

organizations publicly supported by charitable

contributions),

(E) section 509(a) (2) (relating to organiza-

tions publicly supported by admissions, sales,

ete.), or

—42a—

(F) section 509(a) (3) (relating to organiza-

tions supporting certain types of public charities)

except that for purposes of this subparagraph,

section 509(a) (3) shall be applied without regard

to the last sentence of section 509(a).

(5) Disqualified organizations——For purposes of

paragraph (3) an organization is a disqualified or-

ganization if it is—

(A) described in section 170(b) (1) (A) (i)

(relating to churches),

(B) an integrated auxiliary of a church or of

a convention or association of churches, or

(C) amember of an affiliated group of organi-

zations (within the meaning of section 4911(f)

(2)) if one or more members of such group is de-

scribed in subparagraph (A) or (B).

(6) Years for which election is effective.—An ele-

tion by an organization under this subsection shall be

effective for all taxable years of such organization

which—

(A) end after the date the election is made,

and

(B) begin before the date the election is re-

voked by such organization (under regulations pre-

scribed by the Secretary).

(7) No effect on certain organizations.—With re-

spect to any organization for a taxable year for

which—

(A) such organization is a disqualified or-

ganization (within the meaning of paragraph

(5)), or

(B) an election under this subsection is not in

effect for such organization,

nothing in this subsection or in section 4911 shall be

construed to affect the interpretation of the phrase,

‘‘no substantial part of the activities of which is car-

rying on propaganda, or otherwise attempting, to in-

fluence legislation,’’ under subsection (c) (3).

—43a—

(8) Affiliated organizations.—

For rules regarding affiliated organizations, see

section 4911(f).

(i) Prohibition of discrimination by certain social clubs.

—Notwithstanding subsection (a), an organization which

is described in subsection (c) (7) shall not be exempt from

taxation under subsection (a) for any taxable year if, at

any time during such taxable year, the charter, bylaws, or

other governing instrument, of such organization or any

written policy statement of such organization contains a

provision which provides for discrimination against any

person on the basis of race, color, or religion.

(j) Cross reference.—

For nonexemption of Communist-controlled or-

ganizations, see section 11(b) of the Internal Se-

eurity Act of 1950 (64 Stat. 997; 50 U.S.C. 790(b)).

Aug. 16, 1954, c. 736, 68A Stat. 163; Mar. 13, 1956, ¢. 83,

§ 5(2), 70 Stat. 49; Apr. 22, 1960, Pub.L. 86-498, § 1, 14

Stat. 54; July 14, 1960, Pub.L. 86-667, § 1, 74 Stat. 534; Oct.

16, 1962, Pub.L. '87- 834, §8(d), 76 Stat. 997; Feb. 2, ‘1966,

Pub. L. 89-352, § 1, 80 Stat. 4; Nov. 8, 1966, Pub. L. 89-800,

§ 6(a), 80 Stat. 1515; June 28, 1968, Pub. % 90-364, Title

§ 109(a), 82 Stat. 969 ; Dee. 30, 1969, Pub.L. 91- 172, Title

I, $§ 101(j) (3)-(6), 121(b) (5) (A), (6) (A), 83 Stat. 526,

527, 041; Dec. 31, 1970, Pub.L. 91-618, § 1, 84 Stat. 1855;

Aug. 29, ‘1972, Pub.L, 92-418, § 1(a), 86 Stat. 656; June g,

1974, Pub.L. 93- 310, § 3(a), 88 Stat. sgh Jan. 3, 1975, Pub.

L. 93. 625, § 10(c), 88 Stat. 2119; Oct. 4, 1976, Pub.L. 94-

455, Title XIU, $§ 1307(a) (1), (a) (1) (A), 1312(a), 1313

(a), Title XIX, § 1906(b) (13) (A), Title XXT, §§ 2113(a),

2134(b), 90 Stat. 1720, 1727, 1730, 1834, 1907, 1927; Oct. 20,

1976, Pub.L. 94-568, §§ 1(a), 2(a), 90 ‘Stat. 2697; Feb. 10,

1978, Pub.L. 95-227, § 4(a), 92 Stat. 15; Aug. 15, 1978, Pub.

L. 95-345, § 1(a), 99 Stat. 481; Nov. 6, 1978, Pub.L. 95-

600, Title VII, § 703(b) (2), (g) (2) (B), 92 Stat. 2939, 2940.

—44a—

§504. Denial of exemption

(a) General rule.—In the case of any organization de-

scribed in section 501(c) (3) to which section 503 is ap-

plicable, exemption under section 501 shall be denied for

the taxable year if the amounts accumulated out of in-

come during the taxable year or any prior taxable year

and not actually paid out by the end of the taxable year—

(1) are unreasonable in amount or duration in order

to carry out the charitable, educational, or other purpose

or function constituting the basis for exemption under sec-

tion 501 (a) of an organization described in section 501

(c) (3); or

(2) are used to a substantial degree for purposes or

functions other than those constituting the basis for ex-

emption under section 501 (a) of an organization described

in section 501 (c) (3); or

(3) are invested in such a manner as to jeopardize the

carrying out of the charitable, educational, or other pur-

pose or function constituting the basis for exemption un-

der section 501 (a) of an organization described in sec-

tion 501(c) (3).

Paragraph (1) shall not apply to income attributable to

property of a decedent dying before January 1, 1951, which

is transferred under his will to a trust created by such

will. In the case of a trust created by the will of a decedent

dying on or after January 1, 1951, if income is required to

be accumulated pursuant to the mandatory terms of the

will creating the trust, paragraph (1) shall apply only to

income accumulated during a taxable year of the trust

beginning more than 21 years after the date of death of

the last life in being designated in the trust instrument.

(b) Cross references.—

For limitation on charitable contributions in case

of unreasonable accumulations by certain trusts,

see section 681 (c) (2).

—45a—

§511. Imposition of tax on unrelated business income

of charitable, etc., organizations

(a) Charitable, etc., organizations taxable at corpora-

tion rates.

(1) Imposition of tax.—There is hereby imposed

for each taxable year on the unrelated business tax-

able income (as defined in section 512) of every or-

ganization described in paragraph (2) a tax computed

as provided in section 11. In making such computa-

tion for purposes of this section, the term ‘‘taxable

income’’ as used in section 11 shall be read as ‘‘un-

related business taxable income’’.

(2) Organizations subject to tax.—

(A) Organizations described im sections 401

(a) and 501 (c).—The tax imposed by paragraph

(1) shall apply in the case of any organization

(other than a trust described in subsection (b)

or an organization described in section 501(c) (1))

which is exempt, except as provided in this part

or part ITI (relating to private foundations), from

taxation under this subtitle by reason of section

501(a).

(B) State colleges and universities.—The tax

imposed by paragraph (1) shall apply in the case

of any college or university which is an agency

or instrumentality of any government or any po-

litical subdivision thereof, or which is owned or

operated by a government or any political sub-

division thereof, or by any agency or instrumen-

tality of one or more governments or political sub-

divisions. Such tax shall also apply in the case

of any corporation wholly owned by one or more

such colleges or universities.

(b) Taz on charitable, etc., trusts.—

(1) Imposition of tax.—There is hereby imposed

for each taxabie year on the unrelated business taxable

income of every trust described in paragraph (2) a

—46a—

tax computed as provided in section 1(e). In making

such computation for purposes of this section, the

term ‘‘taxable income’’ as used in section 1 shall be

read as ‘‘unrelated business taxable income’’ as de-

fined in section 512.

(2) Charitable, etc., trusts subject to tax.—The tax

imposed by paragraph (1) shall apply in the case of

any trust which is exempt, except as provided in this

part or part II (relating to private foundations) from

taxation under this subtitle by reason of section 501

(a) and which, if it were not for such exemption, would

be subject to subchapter J (sec. 641 and following, re-

lating to estates, trusts, beneficiaries, and decedents).

(c) Special rule for section 501(c) (2) corporations.—

If a corporation described in section 501(¢) (2)—

(1) pays any amount of its net income for a tax-

able year to an organization exempt from taxation

under section 501(a) (or which would pay such an

amount but for the fact that the expenses of collect-

ing its income exceed its income), and

(2) such corporation and such organization file a

consolidated return for the taxable year,

such corporation shall be treated, for purposes of the tax

imposed by subsection (a), as being organized and operated

for the same purposes as such organization, in addition to

the purposes described in section 501(c) (2).

(d) Taz preferences.—

(1) Organizations taxable at corporate rates.—If an

organization is subject to tax on unrelated business

taxable income pursuant to subsection (a), the tax

imposed by section 56 shall apply to such organiza-

tions with respect to items of tax preference which en-

ter into the computation of unrelated business taxable

income in the same manner as section 56 applies to

corporations.

—47a-—

(2) Organizations taxable as trusts.—If an organi-

zation is subject to tax on unrelated business taxable

income pursuant to subsection (b), then taxes imposed

by section 55 and section 56 (as the case may be) shall

apply to such organization with respect to items of

tax preference which enter into the computation of

unrelated business taxable income.

Aug. 16, 1954, c. 736, 68A Stat. 169; July 14, 1960, Pub.L.

86-667, § 3, 74 Stat. 535; Feb. 2, 1966, Pub.L. 89-352, § 2,

80 Stat. 4; Dec. 30, 1969, Pub.L. 91-172, Title I, § 121(a)

(1)-(3), Title ITI, § 301(b) (8), Title VIII, § 803(d) (2),

83 Stat. 536, 585, 684; May 23, 1977, Pub.L. 95-30, Title I,

§ 101(d) (6), 91 Stat. 133; Nov. 6, 1978, Pub.L. 95-600,

Title IIT, § 301(b) (5), Title IV, § 421(e) (3), 92 Stat. 2821,

2876.

—48a—

§512. Unrelated business taxable income

(a) Definition—For purposes of this title—

(1) General rule—Except as otherwise provided

in this subsection, the term ‘‘unrelated business tax-

able income’’ means the gross income derived by any

organization from any unrelated trade or business (as

defined in section 513) regularly carried on by it, less

the deductions allowed by this chapter which are di-

rectly connected with the carrying on of such trade or

business, both computed with the modifications pro-

vided in subsection (b).

(2) Special rule for foreign organizations.—In the

case of an organization described in section 511 which

is a foreign organization, the unrelated business tax-

able income shall be—

(A) its unrelated business taxable income

which is derived from sources within the United

States and which is not effectively connected with

the conduct of a trade or business within the Unit-

ed States, plus

(B) its unrelated business taxable income

which is effectively connected with the conduct

of a trade or business within the United States.

(3) Special rules applicable to organizations de-

scribed in section 501(c) (7) or (9).—

(A) General rule.—In the case of an organiza-

tion described in section 501(c) (7) or (9), the

term ‘‘unrelated business taxable income’’ means

the gross income (excluding any exempt function

income), less the deductions allowed by this chap-

ter which are directly connected with the produc-

tion of the gross income (excluding exempt func-

tion income), both computed with the modifications

provided in paragraphs (6), (10), (11), and (12)

of subsection (b). For purposes of the preceding

sentence, the deductions provided by sections 243,

244, and 245 (relating to dividends received by

—49a—

corporations) shall be treated as not directly con-

nected with the production of gross income.

(B) Exempt function income.—For purposes

of subparagraph (A), the term ‘‘exempt function

income’’ means the gross income from dues, fees,

charges, or similar amounts paid by members of

the organization as consideration for providing

such members or their dependents or guests goods,

facilities, or services in furtherance of the pur-

poses constituting the basis for the exemption of

the organization to which such income is paid.

Such term also means all income (other than an

amount equal to the gross income derived from any

unrelated trade or business regularly carried on

by such organization computed as if the organiza-

tion were subject to paragraph (1)), which is set

aside—

(i) for a purpose specified in section 170

(c) (4), or

(ii) in the case of an organization de-

scribed in section 501(c) (9), to provide for

the payment of life, sick, accident, or other

benefits,

including reasonable costs of administration di-

rectly connected with a purpose described in clause

(i) or (ii). If during the taxable year, an amount

which is attributable to income so set aside is used

for a purpose other than that described in clause

(i) or (ii), such amount shall be included, under

subparagraph (A), in unrelated business taxable

income for the taxable year.

(C) Applicability to certain corporations de-

scribed in section 501(c) (2).—In the case of a

corporation described in section 501(c) (2), the

income of which is payable to an organization de-

scribed in section 501(c) (7) or (9), subparagraph

(A) shall apply as if such corporation were the

organization to which the income is payable. For

—50a—

purposes of the preceding sentence, such corpora-

tion shall be treated as having exempt function

income for a taxable year only if it files a con-

solidated return with such organization for such

year.

(D) Nonrecognition of gain,.—If property used

directly in the performance of the exempt function

of an organization described in section 501(c) (7)

or (9) is sold by such organization, and within a

period beginning 1 year before the date of such

sale, and ending 3 years after such date, other

property is purchased and used by such organi-

zation directly in the performance of its exempt

function, gain (if any) from such sale shall be

recognized only to the extent that such organiza-

tion’s sales price of the old property exceeds the

organization’s cost of purchasing the other prop-

erty. For purposes of this subparagraph, the de-

struction in whole or in part, theft, seizure, requi-

sition, or condemnation of property, shall be treat-

ed as the sale of such property, and rules similar

to the rules provided by subsections (b), (c), (e),

and (j) of section 1034 shall apply.

(4) Special rule applicable to organizations de-

scribed in section 501(c) (19).—In the case of an or-

ganization described in section 501(c) (19), the term

‘‘unrelated business taxable income’’ does not include

any amount attributable to payments for life, sick,

accident, or health insurance with respect to members

of such organizations or their dependents which is

set aside for the purpose of providing for the pay-

ment of insurance benefits or for a purpose specified

in section 170(c) (4). If an amount set aside under

the preceding sentence is used during the taxable

year for a purpose other than a purpose described in

the preceding sentence, such amount shall be included,

under paragraph (1), in unrelated business taxable

income for the taxable year.

—5la—

(5) Definition of payments with respect to secu-

rities loans.—

(A) The term ‘‘payments with respect to se-

curities loans’’ includes all amounts received in

respect of a security (as defined in section 1236

(c)) transferred by the owner to another person

in a transaction to which section 1058 applies

(whether or not title to the security remains in

the name of the lender) including—

(i) amounts in respect of dividends, in-

terest, or other distributions,

(ii) fees computed by reference to the

period beginning with the transfer of secu-

rities by the owner and ending with the trans-

fer of identical securities back to the trans-

feror by the transferee and the fair market

value of the security during such period,

(iii) income from collateral security for

such loan, and

(iv) income from the investment of col-

lateral security.

(B) Subparagraph (A) shall apply only with

respect to securities transferred pursuant to an

agreement between the transferor and the trans-

feree which provides for—

(i) reasonable procedures to implement

the obligation of the transferee to furnish to

the transferor, for each business day during

such period, collateral with a fair market value

not less than the fair market value of the

security at the close of business on the pre-

ceding business day,

(ii) termination of the loan by the trans-

feror upon notice of not more than 5 business

days, and

(iii) return to the transferor of securities

identical to the transferred securities upon

termination of the loan.

—52a—

(b) Modifications. The modifications referred to in

subsection (a) are the following:

(1) There shal! be excluded all dividends, interest,

payments with respect to securities loans (as defined

in section 512(a) (5)), and annuities, and all deduc-

tions directly connected with such income.

(2) There shall be excluded all royalties (including

overriding royalties) whether measured by produc-

tion or by gross or taxable income from the property,

and all deductions directly connected with such income.

(3) In the case of rents—

(A) Except as provided in subparagraph (B),

there shall be excluded—

(i) all rents from real property (includ-

ing property described in section 1245(a) (3)

(C)), and

(ii) all rents from personal property in-

cluding for purposes of this paragraph as

personal property any property described in

section 1245(a) (3) (B)) leased with such

real property, if the rents attributable to

such personal property are an incidental

amount of the total rents received or accrued

under the lease, determined at the time the

personal property is placed in service.

(B) Subparagraph (A) shall not apply—

(i) if more than 50 percent of the total

rent received or accrued under the lease is

attributable to personal property described in

subparagraph (A) (ii), or

(ii) if the determination of the amount of

such rent depends in whole or in part on the

income or profits derived by any person from

the property leased (other than an amount

based on a fixed percentage or percentages

of receipts or sales).

(C) There shall be excluded all deductions di-

rectly connected with rents excluded under sub-

paragraph (A).

—538a—

(4) Notwithstanding paragraph (1), (2), (3), or

(5), in the case of debt-financed property (as defined

in section 514) there shall be included, as an item of

gross income derived from an unrelated trade or busi-

ness, the amount ascertained under section 514(a) (1),

and there shall be allowed, as a deduction, the amount

ascertained under section 514(a) (2).

(5) There shall be excluded all gains or losses from

the sale, exchange, or other disposition of property

other than—

(A) stock in trade or other property of a

kind which would properly be includible in in-

ventory if on hand at the close of the taxable

year, or

(B) property held primarily for sale to cus-

tomers in the ordinary course of the trade or

business.

There shall also be excluded all gains on the lapse

or termination of options, written by the organiza-

tion in connection with its investment activities, to

buy or sell securities (as defined in Section 1236(c)).

This paragraph shall not apply with respect to the

cutting of timber which is considered, on the applica-

tion of section 631, as a sale or exchange of such

timber.

(6) The net operating loss deduction provided in

section 172 shall be allowed, except that—

(A) the net operating loss for any taxable

year, the amount of the net operating loss carry-

back or carryover to any taxable year, and the

net operating loss deduction for any taxable year

shall be determined under section 172 without

taking into account any amount of income or de-

duction which is excluded under this part in com-

puting the unrelated business taxable income; and

(B) the terms ‘‘preceding taxable year’’ and

‘*preceding taxable years’’ as used in section 172

shall not include any taxable year for which the

—54a—

organization was not subject to the provisions

of this part.

(7) There shall be excluded all income derived

from research for (A) the United States, or any of

its agencies or instrumentalities, or (B) any State

or political subdivision thereof; and there shall be

excluded all deductions directly connected with such

income. :

(8) In the case of a college, university, or hospital,

there shall be excluded all income derived from re-

search performed for any person, and all deductions

directly connected with such income.

(9) In the case of an organization operated pri-

marily for purposes of carrying on fundamental re-

search the results of which are freely available to

the general public, there shall be excluded all income

derived from research performed for any person, and

all deductions directly connected with such income.

(10) In the case of any organization described in

section 511(a), the deduction allowed by section 170

(relating to charitable etc. contributions and gifts)

shall be allowed (whether or not directly connected

with the carrying on of the trade or business), but shall

not exceed 5 percent of the unrelated business tax-

able income computed without the benefit of this para-

graph.

(11) In the case of any trust described in section

511(b), the deduction allowed by section 170 (relating

to charitable ete. contributions and gifts) shall be

allowed (whether or not directly connected with the

carrying on of the trade or business), and for such

purpose a distribution made by the trust to a bene-

ficiary described in section 170 shall be considered

as a gift or contribution. The deduction allowed by this

paragraph shall be allowed within the limitations pre-

scribed in section 170(b) (1) (A) and (B) determined

with reference to the unrelated business taxable in-

-— 5d5a—

come computed without the benefit of this paragraph

(in lieu of with reference to adjusted gross income).

(12) Except for purposes of computing the net op-

erating loss under section 172 and paragraph (6),

there shall be allowed a specific deduction of $1,000.

In the case of a diocese, province of a religious order,

or a convention or association of churches, there shall

also be allowed, with respect to each parish, individual

church, district, or other local unit, a specific deduc-

tion equal to the lower of—

(A) $1,000, or

(B) the gross income derived from any unre-

lated trade or business regularly carried on by

such local unit.

(13) Notwithstanding paragraphs (1), (2), or (3),

amounts of interest, annuities, royalties, and rents

derived from any organization (in this paragraph called

the ‘‘controlled organization’’) of which the organi-

zation deriving such amounts (in this paragraph called

the ‘‘controlling organization’’) has control (as de-

fined in section 368(c)) shall be included as an item

of gross income (whether or not the activity from

which such amounts are derived represents a trade or

business or is regularly carried on) in an amount which

bears the same ratio as—

(A) (i) in the case of a controlled organiza-

tion which is not exempt from taxation under sec-

tion 501(a), the excess of the amount of taxable

income of the controlled organization over the

amount of such organization’s taxable income

which if derived directly by the controlling organi-

zation would not be unrelated business taxable

income, or

(ii) in the case of a controlled organization

which is exempt from taxation under section

501(a), the amount of unrelated business taxable

income of the controlled organization, bears to

(B) the taxable income of the controlled or-

ganization (determined in the case of a controlled

?%

—56a—

organization to which subparagraph (A) (ii) ap-

plies as if it were not an organization exempt

from taxation under section 501(a)), but not less

than the amount determined in clause (i) or (ii),

as the case may be, of subparagraph (A),

both amounts computed without regard to amounts

paid directly or indirectly to the controlling organiza-

tion. There shall be allowed all deductions directly

connected with amounts included in gross income un-

der the preceding sentence.

(14) Except as provided in paragraph (4), in the

ease of a church, or convention or association of

churches, for taxable years beginning before January

1, 1976, there shall be excluded all gross income de-

rived from a trade or business and all deductions

directly connected with the carrying on of such trade

or business if such trade or business was carried on

by such organization or its predecessor before May

27, 1969.

(15) Except as provided in paragraph (4), in the

case of a trade or business—

(A) which consists of providing services under

license issued by a Federal regulatory agency,

(B) which is carried on by a religious order or

by an educational organization described in sec-

tion 170(b) (1) (A) (ii) maintained by such reli-

gious order, and which was so carried on before

May 27, 1959, and ,

(C) less than 10 percent of the net income of

which for each taxable year is used for activities

which are not related to the purpose constituting

the basis for the religious order’s exemption,

there shall be excluded all gross income derived from

such trade or business and all deductions directly con-

nected with the carrying on of such trade or business,

so long as it is established to the satisfaction of the

Secretary that the rates or other charges for such

—57a—

services are competitive with rates or other charges

charged for similar services by persons not exempt

from taxation.

(c) Special rules applicable to partnerships.—If a trade

or business regularly carried on by a partnership of which

an organization is a member is an unrelated trade or busi-

ness with respect to such organization, such organization

in computing its unrelated business taxable income shall,

subject to the exceptions, additions, and limitations con-

tained in subsection (b), include its share (whether or

not distributed) of the gross income of the partnership

from such unrelated trade or business and its share of

the partnership deductions directly connected with such

gross income. If the taxable year of the organization is

different from that of the partnership, the amounts to be

so included or deducted in computing the unrelated busi-

ness taxable income shall be based upon the income and

deductions of the partnership for any taxable year of

the partnership ending within or with the taxable year of

the organization.

Aug. 16, 1954, c. 736, 68A Stat. 170; Apr. 7, 1958, Pub.L.

85-367, § 1(a), 72 Stat. 80; July 17, 1964, Pub.L. 88-380,

§ 1, 78 Stat. 333; Nov. 13, 1966, Pub... 89-809, Title I, § 104

(g), 80 Stat. 1559; Dec. 30, 1969, Pub.L. 9-172, Title I,

§ 121(b) (1), (2), 83 Stat. 537, 538; Aug. 29, 1972, Pub.L.

92-418, § 1(b), 86 Stat. 656; Sept. 3, 1976, Pub.L, 94-396,

§ 1(a), 90 Stat. 1201; Oct. 4, 1976, Pub.L. 94-455, Title XIX,

§§ 1091(b) (8) (F), 1906(b) (13) (A), 1951 (b) (8) (A),

90 Stat. 1794, 1834, 1839; Oct. 20, 1976, Pub.L. 94-568, § 1

(b), 90 Stat. 2697; Aug. 15, 1978, Pub.L. 95-345, §2(a) (2),

(b), 92 Stat. 481.

—58a—

§513. Unrelated trade or business

(a) General rule—The term ‘‘unrelated trade or busi-

ness’’ means, in the case of any organization subject to

the tax imposed by section 511, any trade or business the

conduct of which is not substantially related (aside from

the need of such organization for income or funds or the

use it makes of the profits derived) to the exercise or

performance by such organization of its charitable, edu-

cational, or other purpose or function constituting the

basis for its exemption under section 501 (or, in the case

of an organization described in section 511(a) (2) (B),

to the exercise or performance of any purpose or func-

tion described in section 501(c) (3)), except that such

term does not include any trade or business—

(1) in which substantially all the work in carrying

on such trade or business is performed for the or-

ganization without compensation; or

(2) which is carried on, in the case of an organi-

zation described in section 501(c) (3) or in the case

of a college or university described in section 511(a)

(2) (B), by the organization primarily for the con-

venience of its members, students, patients, officers,

or employees, or, in the case of a local association of

employees described in section 501(c) (4) organized

before May 27, 1969, which is the selling by the or-

ganization of items of work-related clothes and equip-

ment and items normally sold through vending ma-

chines, through food dispensing facilities, or by snack

bars, for the convenience of its members at their usual

places of employment; or

(3) which is the selling of merchandise, substan-

tially all of which has been received by the organi-

zation as gifts or contributions.

(b) Special rule for trusts —The term ‘‘unrelated trade

or business’’ means, in the case of—

(1) a trust computing its unrelated business tax-

able income under section 512 for purposes of sec-

tion 681; or

—59a—

(2) a trust described in section 401(a), or section

501(c) (17), which is exempt from tax under section

501 (a);

any trade or business regularly carried on by such trust

or by a partnership of which it is a member.

(c) Advertising, etc., activities—For purposes of this

section, the term ‘‘trade or business’’ includes any activ-

ity which is carried on for the production of income from

the sale of goods or the performance of services. For pur-

poses of the preceding sentence, an activity does not

lose identity as a trade or business merely because it is

carried on within a larger aggregate of similar activities

or within a larger complex of other endeavors which may,

or may not, be related to the exempt purposes of the

organization. Where an activity carried on for profit con-

stitutes an unrelated trade or business, no part of such

trade or business shall be excluded from such classifica-

tion merely because it does not result in profit.

(d) Certain activities of trade shows, state fairs, etc.—

(1) General rule—The term ‘‘unrelated trade or

business’’ does not include qualified public entertain-

ment activities of an organization described in para-

graph (2) (C), or qualified convention and trade show

activities of an organization described in paragraph

(3) (C).

(2) Qualified public entertainment activities.—For

purposes of this subsection—

(A) Public entertainment actiwity.—The term

‘*public entertainment activity’’ means any enter-

tainment or recreational activity of a kind tra-

ditionally conducted at fairs or expositions pro-

moting agricultural and educational purposes, in-

cluding, but not limited to, any activity one of

the purposes of which is to attract/the public to

fairs or expositions or to promote the breeding of

animals or the development of products or equip-

ment.

—60a—

(B) Qualified public entertainment activity.—

The term ‘‘qualified public entertainment activity”’

means a public entertainment activity which is

conducted by a qualifying organization described

in subparagraph (C) in—

(i) conjunction with an international, na-

tional, State, regional, or local fair or exposi-

tion,

(ii) accordance with the provisions of

State law which permit the activity to be op-

erated or conducted solely by such an or-

ganization, or by an agency, instrumentality,

or political subdivision of such State, or

(iii) accordance with the provisions of

State law which permit such an organization

to be granted a license to conduct not more

than 20 days of such activity on payment to

the State of a lower percentage of the revenue

from such licensed activity than the State

requires from organizations not described in

section 501(¢c) (3), (4), or (5).

(C) Qualifying organization—For purposes

of this paragraph, the term ‘‘qualifying organi-

zation’’ means an organization which is described

in section 501(c) (3), (4), or (5) which regularly

conducts, as one of its substantial exempt pur-

poses, an agricultural and educational fair or

exposition. |

(3) Qualified convention and trade show activ-

ities.—

(A) Convention and trade show activity.—The

term ‘‘convention and trade show activity’’ means

any activity of a kind traditionally conducted at

conventions, annual meetings, or trade shows, in-

cluding, but not limited to, any activity one of

the purposes of which is to attract persons in an

industry generally (without regard to membership

in the sponsoring organization) as well as mem-

bers of the public to the show for the purpose

—6la—

of displaying industry products or to stimulate

interest in, and demand for, industry products or

services, or to educate persons engaged in the

industry in the development of new products and

services or new rules and regulations affecting

the industry. |

(B) Qualified convention and trade show ac-

tivity.—The term ‘‘qualified convention and trade

show activity’’ means a convention and trade show

activity carried out by a qualifying organiza-

tion described in subparagraph (C) in conjunc-

tion with an international, national, State, region-

al, or local convention, annual meeting, or show

conducted by an organization described in sub-

paragraph (C) if one of the purposes of such

organization in sponsoring the activity is the pro-

motion and stimulation of interest in, and de-

mand for, the products and services of that in-

dustry in general, and the show is designed to

achieve such purpose through the character of

the exhibits and the extent of the industry prod-

ucts displayed.

(C) Qualifying organization—For purposes of

this paragraph, the term ‘‘qualifying organiza-

tion’’ means an organization described in section

501(c) (5) or (6) which regularly conducts as one

of its substantial exempt purposes a show which

stimulates interest in, and demand for, the prod-

ucts of a particular industry or segment of such

industry.

(4) Such activities not to affect exempt status.—

An organization described in section 501(c) (3), (4),

or (5) shall not be considered as not entitled to the

exemption allowed under section 501(a) solely because

of qualified public entertainment activities conducted

by it.

(e) Certain hospital services.—In the case of a hospital

described in section 170(b) (1) (A) (iii), the term ‘‘unre-

lated trade or business’’ oes not include the furnishing

—62a—

of one or more of the services described in section 501(e)

(1) (A) to one or more hospitals described in section 170

(b) (1) (A) (iii) if—

(1) such services are furnished solely to such hos-

pitals which have facilities to serve not more than

100 inpatients;

(2) such services, if performed on its own behalf

by the recipient hospital, would constitute activities

in exercising or performing the purpose or function

constituting the basis for its exemption; and

(3) such services are provided at a fee or cost

which does not exceed the actual cost of providing

such services, such cost including straight line de-

preciation and a reasonable a

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