## Facts

- Zagfly, Inc. was incorporated in California in 2006 as a nonprofit corporation with articles stating charitable purposes and a § 501(c)(3) dissolution clause.
- Zagfly’s stated mission was to create internet businesses enabling consumers to support charities through everyday purchases.
- Its initial and primary planned activity was operating an online flower brokerage selling flowers at market rates through third-party florists, in substantially the same manner as for-profit online flower retailers.
- Customers could designate 1–2% of the purchase price for donation to a listed charity, representing roughly 10–20% of Zagfly’s profit per sale; most profit would remain with Zagfly.
- Zagfly anticipated that most revenue would come from flower sales rather than donations and planned to solicit additional donations to cover administrative costs of distributing charitable contributions.
- Zagfly applied for recognition of exemption under I.R.C. § 501(c)(3) (Form 1023), but the IRS denied the request, characterizing Zagfly as a feeder organization.
- Zagfly sought declaratory judgment review in the Tax Court under I.R.C. § 7428; the case was submitted on the administrative record.

## Issues

1. Whether Zagfly was operated “exclusively” (i.e., primarily) for exempt purposes under I.R.C. § 501(c)(3) when its primary activity was a commercial online flower business with partial profit-sharing to charities.
2. Whether Zagfly was a feeder organization under I.R.C. § 502 because it was operated primarily to carry on a trade or business for profit, notwithstanding planned distributions to charities.

## Decision

- The Tax Court upheld the IRS’s adverse determination and denied § 501(c)(3) recognition.
- Zagfly failed the § 501(c)(3) operational test because its primary purpose and activity were commercial rather than charitable.
- Zagfly was a feeder organization under § 502 because it was operated primarily to conduct a for-profit trade or business, and charitable payments were merely a use of profits.

## Legal Principles

- To qualify under § 501(c)(3), an organization must be organized and operated exclusively for exempt purposes; “exclusively” is construed as “primarily,” and more than an insubstantial nonexempt purpose defeats exemption.
- Under § 502, an organization carrying on a trade or business for profit is not exempt merely because its profits are payable to one or more exempt organizations.
- Operating in a manner substantially similar to commercial businesses, charging market rates, and relying primarily on sales revenue indicate a nonexempt commercial purpose.
- Distributing some (or even all) profits to charity does not convert a fundamentally commercial enterprise into a § 501(c)(3) organization when the charitable element is incidental to the business activity.
- Nonprofit corporate form and charitable language in organizing documents are insufficient when intended operations show that commercial activity predominates.

## Conclusion

The Tax Court sustained the denial of exemption because Zagfly’s planned operations centered on a standard commercial flower-sales business, with only incidental charitable distributions, making it ineligible under the § 501(c)(3) operational test and classified as a feeder organization under § 502.


Zagfly, Inc. v. Commissioner, T.C. Memo. 2013-29 (2013)