## Facts

- A Vermont nonprofit corporation was formed in 1992 to raise funds for distribution to charitable causes.
- The organization’s founders owned a for-profit lounge that served as the exclusive site for the organization’s fundraising activity.
- The organization’s only revenue-producing activity was selling break-open lottery tickets, sold solely at the founders’ lounge during normal business hours.
- Ticket sales were conducted by the lounge’s owners and employees; the organization had no separate premises or independent operational presence.
- Governance was repeatedly structured so that directors were largely family members or otherwise related to the lounge owners; a stated plan to eliminate related directors was not carried out.
- The organization made grants to local charities, and check presentations were publicized in local media, often at or in front of the lounge.
- The IRS issued a final adverse determination denying recognition of exemption under I.R.C. §§ 501(a) and 501(c)(3).
- The organization sought declaratory relief under I.R.C. § 7428; the case was decided on the stipulated administrative record.

## Issues

1. Whether the organization was operated “exclusively” for exempt purposes under I.R.C. § 501(c)(3) for purposes of exemption under I.R.C. § 501(a).
2. Whether operating a gaming-based fundraiser exclusively at a related for-profit lounge conferred more than insubstantial private benefit, defeating § 501(c)(3) qualification.
3. Whether distributing net proceeds to charity is sufficient to satisfy the § 501(c)(3) operational test despite substantial operational integration with private business interests.

## Decision

- The Tax Court sustained the Commissioner’s adverse determination and held the organization did not qualify for exemption under § 501(c)(3).
- The court found the organization failed the operational test because its activities conferred impermissible private benefit on the related for-profit lounge and its owners.
- The court rejected the argument that charitable distributions alone established exempt operation where the fundraising method materially advanced private commercial interests.
- Judgment was entered for the Commissioner based on the administrative record.

## Legal Principles

- An organization is not “operated exclusively” for § 501(c)(3) purposes if more than an insubstantial part of its activities does not further exempt purposes or if it serves private interests more than incidentally.
- The operational test focuses on how the organization conducts its activities, not solely on where net proceeds ultimately go; a “destination of income” theory is insufficient.
- Substantial private benefit may be shown by operational entanglement with a related for-profit enterprise, including exclusive use of the business’s premises, staffing, and promotional effects.
- In a § 7428 declaratory judgment case, the organization bears the burden to show the IRS determination was erroneous on the administrative record.

## Conclusion

The Tax Court held that a nonprofit fundraising exclusively through gaming at a related for-profit lounge, under governance and operations closely tied to the lounge owners, conferred more than insubstantial private benefit and therefore did not qualify for exemption under I.R.C. § 501(c)(3) despite making charitable grants.


KJ’s Fund Raisers, Inc. v. Commissioner, T.C. Memo. 1997-424 (1997)