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Organizational Test
Organizational Test – IRC 501(c)(3)
By Elizabeth Ardoin
Overview
Purpose |
“The difference between the right word and the almost right word
is the difference between lightning and the lightning bug.” Mark
Twain
This article addresses specific issues that have arisen in
determining whether the organizational test is satisfied. The
organizational test requires that the articles of organization
(hereafter “creating document”) of an organization described in
IRC 501(c)(3) contain an explicit statement that its purposes are
501(c)(3) exempt purposes. The organizational test also requires
an appropriate dissolution provision unless operation of state law
or court action produces the same result. Private foundations have
additional organizational test requirements.
An organization’s creating document may be articles of
incorporation, articles of association, trust indenture, or
constitution. A limited liability company’s (LLC’s) creating
document is its state-approved articles of organization. If an LLC
has adopted an operating agreement then this document is part of
the creating document, but it would not, separately, be required
to meet the organizational test. The required provisions in the
creating document or state law are important because they subject
an organization to enforcement of these provisions by appropriate
Federal, State, and judicial authorities.
Most of the issues will be illustrated using a Question-and-Answer
(Q & A) approach, along with numerous examples. |
In This Article |
This article contains the following topics: |
Topic |
Page |
Overview |
1 |
Exempt Purposes and Dedication of Assets |
2 |
Exempt Purposes: Q & A’s and Examples |
4 |
Dissolution Provision: Q & A’s |
10 |
Private Foundations |
13 |
Conclusion |
13 |
Exhibit 1: Rev. Proc. 2003-12, 2003-4 I.R.B. 316 |
14 |
Exempt Purposes and Dedication of Assets
Exempt Purposes and Dedication of Assets |
An organization is organized exclusively for one or more 501(c)(3)
exempt purposes only if its creating document:
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Limits the purposes of such organizations to one or more exempt
purposes,
Does not expressly empower the organization to engage, other than
as an insubstantial part of its activities, in activities which in
themselves are not in furtherance of one or more exempt purposes,
and
Permanently dedicates the organization’s assets to 501(c)(3)
purposes on dissolution.
See Reg. 1.501(c)(3)-1(b)(1)(i) and 1.501(a)(3)-1(b)(1)(4).
The organizational test must be met by the creating document or
state law. It cannot be met by oral representations or
representations made in other documents. See Reg.
1.501(c)(3)-1(b)(1)(iv).
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501(c)(3) Exempt Purposes |
Exempt purposes are described in IRC 501(c)(3) and the applicable
regulations. Exempt purposes described in IRC 501(c)(3) are:
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Charitable
Religious
Educational
Scientific
Literary
Testing for public safety
Fostering national or international amateur sports competition
Preventing cruelty to children or animals.
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Specific Charitable Purposes |
The exempt purposes described in 501(c)(3) regulations encompass
the general legal definition of the term “charitable.” The
regulations list the following specific charitable purposes:
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Relief of the poor, the distressed, or the underprivileged;
Advancement of religion
Advancement of education or science
Erecting or maintaining public buildings, monuments, or works
Lessening the burdens of government
Lessening neighborhood tensions
Eliminating prejudice and discrimination
Defending human and civil rights secured by law
Combating community deterioration and juvenile delinquency
See Reg. 1.501(c)(3)-1(d)(2).
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More 501(c)(3) Regulations Purposes |
The 501(c)(3) regulations also include the exempt purpose of
receiving contributions and paying them over to organizations that
are described in IRC 501(c)(3). See Reg. 1.501(c)(3)-1(b)(1)(ii).
Finally, these regulations note the exempt purpose of operating of
a school for education when the creating document describes in
detail the manner of the operation of such school. See Reg.
1.501(c)(3)-1(b)(1)(ii). |
Publication 557 |
Publication 557,
Tax-Exempt Status for Your Organization,
(Rev. May 2003), at Chapter 3,
Articles of Organization,
contains samples of language that will meet the organizational
test. However, other language may also satisfy the organizational
test. For example, charitable purposes specified in revenue
rulings and court decisions may be referenced. Publication 557 may
be accessed at:
-
(800)
829-3676 to order IRS tax forms and publications
www.irs.gov
.
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Exempt Purposes: Q & A’s and Examples
Q.1: Purposes Described in IRC 501(c)(3) |
Q1. Must an organization’s creating document contain a provision
expressly limiting its purposes to one or more exempt purposes?
A1. Yes. The creating document must refer to purposes that come
within those described in IRC 501(c)(3). This may be accomplished
by a statement that it is formed for charitable, religious,
educational, scientific, or other purposes referred to in IRC
501(c) (3) or the applicable regulations. The purposes do not have
to expressly refer to IRC 501(c)(3).
See Reg. 1.501(c)(3)-1(b)(1)(ii). |
Examples of Acceptable and Unacceptable Purposes |
Example:
If a creating document states that the organization is formed to
operate for educational purposes, this statement would satisfy the
purpose requirement since the term “educational” is contained in
IRC 501(c)(3).
Example:
If a creating document states that the organization is formed to
eliminate prejudice and discrimination, this statement would
satisfy the purpose requirement since the term “eliminate
prejudice and discrimination” is contained in Reg.
1.501(c)(3)-1(d)(2).
Example:
If a creating document states that the organization is formed to
operate a school, this statement would not satisfy the purpose
requirement. The term “school” is not contained in IRC 501(c)(3)
or the applicable regulations. To operate a school does not
necessarily further an exempt purpose. See Reg.
1.501(c)(3)-1(b)(1)(ii).
Example:
If a creating document states that the organization is formed to
operate a school for educational purposes, this statement would
satisfy the purpose requirement. |
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Example:
If a creating document states that an organization was formed to
promote health, this statement would not satisfy the purpose
requirement. To promote health does not necessarily further an
exempt purpose. For example, a hospital might promote health by
providing medical care without necessarily dedicating itself to
the promotion of health in a charitable manner as described in
Rev. Rul. 69-545, 1969-2 C.B. 117.
Example:
If a creating document states that the organization was formed to
operate a medical clinic to serve the health care needs of the
community exclusively in furtherance of charitable purposes, this
statement would satisfy the purpose requirement of the
organizational test. |
Q.2: Effect of the “Notwith-standing” Clause |
Q2. If a creating document contains a purpose that does not
necessarily accomplish exempt purposes as described in IRC
501(c)(3), should the organization amend its creating document to
limit its purpose to those described in IRC 501(c)(3)?
A2. Yes. However, if the creating document contains a purpose that
does not satisfy the organizational test, but such purpose is not
expressly contrary to 501(c)(3) exempt purposes, the following
type of provision in the creating document will meet the purpose
requirement of the organizational test: “Notwithstanding other
language (or provisions) in the creating document, the purposes
will be limited exclusively to exempt purposes within the meaning
of IRC 501(c)(3).” In this circumstance, no further amendment is
necessary. This type of provision is generally referred to as a
“notwithstanding clause.”
See Reg. 1.501(c)(3)-1(b)(1)(iii). |
Examples of the “Notwith-standing Clause” |
Example:
A creating document provides that an organization is formed to
promote philanthropic and eleemosynary purposes. This statement
would not satisfy the purpose requirement. But, if the creating
document also states that notwithstanding any other provision in
this instrument, it will not further any specified purpose to more
than an insubstantial degree other than those described in IRC
501(c)(3), the organization would not have to amend its creating
document to meet the purpose requirement of the organizational
test.
Example:
A creating document provides that an organization is formed to
provide scholarship assistance to individuals. Without further
limitation, the term “providing scholarship assistance to
individuals” could describe purposes outside the scope of IRC
501(c)(3). For example, the term could include providing financial
assistance to children who are pre-selected by the organization’s
founder. Therefore, this statement would not satisfy the purpose
requirement of the organizational test.
Example:
A creating document provides that an organization is formed to
provide scholarship assistance to individuals. It also provides
that notwithstanding any other provision in this instrument, it
will not further any specified purpose to more than an
insubstantial degree other than those described in IRC 501(c)(3).
This statement would satisfy the purpose requirement of the
organizational test.
Example:
A creating document provides that an organization is formed to
promote educational and political purposes. Educational purposes
come within the scope of the purposes described in IRC 501(c)(3);
however, political purposes include intervening in political
campaigns, which is specifically prohibited. Therefore, a
notwithstanding clause would not be sufficient because the
creating document contains a purpose that cannot be limited to
make it fit within the scope of exempt purposes described in IRC
501(c)(3). |
Q.3: Effect of Limitations on Activities |
Q3. If a creating document contains purposes outside of those
described in IRC 501(c)(3) but expressly states that the
organization will not engage in
activities
other than those described in IRC 501(c)(3), does this satisfy the
purpose
requirement?
A3. No. A provision in an organization’s creating document
limiting its
activities
to those described in IRC 501(c)(3) would not cure an overly broad
purpose
statement. |
Example of Effect of Limitations on Activities |
Example:
A creating document states that an organization is formed to
provide tutoring. The instrument also states that notwithstanding
other language in the creating document, it will not engage in
activities that are not described in IRC 501(c)(3). The provision
of tutoring does not necessarily accomplish exempt purposes within
the meaning of IRC 501(c)(3). If the notwithstanding clause had
limited the organization’s
purposes
to those described in IRC 501(c)(3), rather than its
activities,
no amendment would be necessary. Limiting the organization’s
activities does not correct its overly broad purposes statement.
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Q.4 & 5: Cross- referencing IRC 170 |
Q4. If a creating document contains a purpose clause that provides
that the organization will limit its purposes to those carried out
by organizations described in IRC 501(c)(3) or organizations
contributions to which are deductible under IRC 170, should the
organization amend its creating document to limit is purposes to
those described in IRC 501(c)(3)?
A4. Yes. IRC 170(c) refers to charitable contributions rather than
charitable purposes. Under that section, contributions to
organizations other than those described in IRC 501(c)(3) are
treated as charitable contributions. For example, IRC 170(c)(5)
refers to contributions to a cemetery company. Thus, a creating
document stating that an organization’s purposes will be limited
to those carried out by organizations described in IRC 170 would
allow an organization to operate a cemetery.
Q5. If a creating document refers to IRC 170(c)(1) or (c)(2)
instead of IRC 170, should the organization amend its creating
document to limit its purposes to those described in IRC
501(c)(3)?
A5. No. IRC 170(c)(1) refers to contributions to a government
entity exclusively for a public purpose and IRC 170(c)(2) refers
to contributions for purposes that are consistent with those
described in IRC 501(c)(3). |
Q.6: Limitations on Prohibited Activities |
Q6. Must an organization’s creating document include language
that:
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Prohibits the inurement of net earnings to its members,
trustees, officers, or other private persons;
Limits its activities to those described in IRC 501(c)(3);
States that no substantial part of the activities of the
organization shall be the carrying on of propaganda, or otherwise
attempting to influence legislation; and/or,
States that the organization will not participate in or intervene
in a political campaign on behalf of or in opposition to a
candidate for public office?
A6. The Code and Regulations do not require any of these four
specific provisions to be stated in a creating document. Thus, no
amendment is necessary unless the creating document:
Expressly states that there will be inurement of net earnings,
such as a statement that the profits of the organization will be
distributed to its members, officers, directors or other
individuals;
Describes activities that are outside the scope of IRC 501(c)(3)
and does not indicate that such activities will be insubstantial;
Expressly states that the organization will be engaged in the
carrying on of propaganda, or otherwise attempting to influence
legislation but does not indicate that the activities will be
insubstantial or will come within the limits set forth in IRC
501(h); or,
Expressly states that the organization participates in, or
intervenes in, any political campaign on behalf of or in
opposition to any candidate for public office.
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Example of Limitations on Prohibited Activities |
Example:
A creating document provides that an organization is formed for
educational purposes. It also provides that the organization will
be attempting to influence legislation. The creating document does
not state that the legislative activities will be insubstantial.
Therefore, the organization would need to specifically state that
legislative activities will be insubstantial.
In this case, the organization would only need to add this
restriction on influencing legislation and would otherwise not
need to add any of the other limitations provisions listed in Q.6. |
Q.7: Express Allowance of Prohibited Activities |
Q7. If the organization has to amend its creating document for
other reasons, can it be required to prohibit the activities
described at Q.6?
A7. No. We may suggest that the organization consider adding
language to that effect. However, we must also state that it is
not required.
See Reg. 1.501(c)(3)-1(b)(3). |
Dissolution Provision: Q & A’s
Q. 8: Effect of No Dissolution Provision and
State Law Remedies |
Q8. Must an organization’s creating document permanently dedicate
its assets to an exempt purpose?
A8. Yes. An organization will not qualify for exemption unless its
creating document contains a dissolution provision that
permanently dedicates its assets to an exempt purpose. Publication
557,
Tax-Exempt Status for Your Organization,
(Rev. May 2003), at Chapter 3,
Articles of Organization,
contains samples of language that will meet the dissolution
provision requirement.
However, an organization can also meet the dissolution provision
requirement if, by operation of State law or court action, its
assets would be distributed for one or more exempt purposes, or to
the Federal government, or to a State or local government, for a
public purpose, even though a specific dissolution provision is
not contained in its creating document.
See Reg. 1.501(c)(3)-1(b)(4).
For purposes of determining whether an organization will meet the
dissolution provision requirement by operation of State law or
court action Rev. Proc. 82-2, 1982-1 C.B. 367 provides that:
1.
Nonprofit charitable corporations
located in one of the states listed would not be required to
include a dissolution provision in its creating document. This
exception only applies to corporations. Any unincorporated
nonprofit association needs an adequate dissolution provision in
its organizing document.
2.
Charitable testamentary trusts
located in: a) one of the states listed would not be required to
include a dissolution provision in its creating document, b) one
of states listed would not be required to include a dissolution
provision in its creating document if the settlor has demonstrated
a general charitable intent in the language of the trust
instrument, or c) one of the states listed in which the creating
document always needs to include a dissolution provision.
3. An
inter vivos
charitable trust,
except in Delaware, should be required to have an adequate
dissolution provision in its creating document. |
Q.9 & 10 Substitutes for “Exempt Purpose” |
Q9. How does the organizational test apply to an organization
whose creating document specifies that upon dissolution its assets
will be distributed to a State or local government?
A9. An organization’s creating document must specify that its
assets must be used for a public purpose if they are to be
distributed upon dissolution to a State or local government. See
Reg. 1.501(c)(3)-1(b)(4).
IRC 115(l) excepts from federal income tax amounts derived from
the exercise of any essential governmental function and accruing
to a State, any political subdivision thereof or the District of
Columbia. Rev. Proc. 2003-12, 2003-4 I.R.B. 316 provides guidance
on the dissolution provision for an organization described in IRC
501(c)(3) that requests a letter ruling that its income is
excluded from gross income under IRC 115(l). This revenue
procedure also provides examples of appropriate dissolution
provisions. A copy of Rev. Proc. 2003-12 is Exhibit 1.
Q10. The language at Reg. 1.501(c)(3)-1(b)(4) provides that the
assets of an organization described in IRC 501(c)(3) must be
“dedicated to an exempt purpose.” In that section, it does not
expressly refer to IRC 501(c)(3). Does this mean that a
dissolution provision that refers to an exempt purpose without
further limitation is sufficient?
A10. No. Reg. 1.501(c)(3)-1(a)(2) provides that for purposes of
Reg. 1.501(c)(3)-1, the term “exempt purpose or purposes” means
any purpose or purposes specified in IRC 501(c)(3). Accordingly,
the reference to an exempt purpose at Reg. 1.501(c)(3)-1(b)(4)
would include only those purposes described in IRC 501(c)(3).
Thus, the creating document must expressly refer to IRC 501(c)(3)
unless the language in the creating document indicates that the
assets will be distributed:
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A. For charitable purposes;
B. For purposes identical to those of the organization; or,
C. To a governmental entity exclusively for a public purpose.
Where the assets will be distributed for purposes identical to
those of the organization, a provision to that effect is
sufficient. The organization need not repeat the language that
appears in its purposes provision.
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Q.11: Assuring Permanent Dedication of Assets |
Q11. If the creating document indicates that the assets will be
distributed to a particular organization that is described in IRC
501(c)(3), must it provide a contingency clause ensuring that the
assets will be dedicated to a charitable purpose in the event the
named organization is unwilling to accept its assets, is no longer
described in IRC 501(c)(3), or is no longer in existence?
A11. Yes. Reg. 1.501(c)(3)-1(b)(4) requires that an adequate
dissolution provision must specify that upon the dissolution of
the organization its assets shall be distributed for one or more
exempt purposes within the meaning of IRC 501(c)(3), or shall be
distributed to the Federal government, or to a State or local
government, for a public purpose. State law or court action of the
type described in Rev. Proc. 82-2 satisfies the requirement for a
dissolution provision where there is no provision in the creating
document. However, if the creating document contains a dissolution
provision that is defective, state law or court action would not
cure the defect. |
Private Foundations
Private Foundations and IRC 508(e) |
Under IRC 508(e), a private foundation’s creating document must
contain certain provisions concerning IRC 4941, 4942, 4943, 4944,
and 4945.
Publication 557,
Tax-Exempt Status for Your Organization,
(Rev. May 2003), at Chapter 3,
Private Foundations and Public Charities,
contains samples of language that will meet this private
foundation requirement. However, other language may also satisfy
this requirement.
Rev. Rul. 75-38, 1975-1 C.B. 161 identifies those states that have
adopted legislation satisfying the requirements of IRC 508(e).
Therefore, the governing instruments of private foundations
located in those states are considered to satisfy the requirements
of IRC 508(e) if additional specific requirements listed for each
state are met. |
Conclusion
Conclusion |
The organizational test is a technical requirement that an
organization must satisfy to be qualified for tax exempt status
under IRC 501(c)(3). However, it should not be applied to compel
an organization to add language to its creating document that is
not required. |
Exhibit 1
Rev. Proc. 2003-12, 2003-4 I.R.B. 316
January 27, 2003 SECTION 1. PURPOSE This Revenue Procedure provides
guidance on dissolution provisions for any organization described in §
501(c)(3) and exempt from federal income tax under § 501(a) of the
Code that requests a letter ruling that its income is excluded from
gross income under § 115(1). SECTION 2. BACKGROUND .01 Section 115(1)
of the Code provides that gross income does not include income that is
(i) derived from a public utility or from the exercise of any
essential governmental function (the "essential government function
test"), and (ii) accruing to a State, any political subdivision
thereof, or the District of Columbia (the "accrual test"). An entity
is not required to obtain a ruling from the Service to claim an
exclusion from gross income under § 115(1). .02 One aspect of the
accrual test of § 115(1) is that assets of the organization must be
distributed upon the organization's dissolution to one or more States,
political subdivisions thereof, the District of Columbia, or to other
organizations the income of which is excluded from gross income under
§ 115(1) (the "distribution of assets upon dissolution requirement").
The assets of an entity described in § 115(1) may not be distributed
upon dissolution (or at any other time) to the United States
government.
See
Rev. Rul. 90-74, 1990-2 C.B. 34; Rev. Rul. 77-261, 1977-2 C.B. 45;
Rev. Rul. 71-589, 1971-2 C.B. 94.
An organization seeking a ruling under § 115(1) will not be found to
satisfy the distribution of assets upon dissolution requirement of the
§ 115(1) accrual test if its articles of organization fail to limit
distribution of all the organization's assets upon dissolution to one
or more States, political subdivision(s) thereof, the District of
Columbia, or to other organizations whose income is excluded from
gross income under § 115(1). .03 An organization may be described in
§ 501(c)(3) of the Internal Revenue Code
and its income may also be excluded from gross income under § 115(1).
See
Treas. Reg. § 1.6033-2(g)(1)(v)
(a state institution exempt from taxation under § 501(a) the income of
which is excluded from gross income under § 115(a) (now § 115(1)) is
not required to file an annual information return on Form 990,
Return of Organization Exempt From Income Tax);
see also
Rev. Proc. 95-48,
§§ 3.01, 4.02,
1995-2 C.B. 418.
.04 To qualify as an organization described in § 501(c)(3) and exempt
from federal income tax under § 501(a), an organization must meet the
requirements of the organizational test of § 501(c)(3). One
requirement of the organizational test is that the assets of the
organization be dedicated to an exempt purpose.
Treas. Reg. § 1.501(c)(3)-1(b)(4)
.
.05 A § 501(c)(3) organization's articles of organization must contain
a dissolution clause that satisfies the organizational test of
§ 1.501(c)(3)-1(b)(4) of the Treasury Regulations
, unless the organization is organized under State laws that satisfy
the distribution of assets upon dissolution provisions of §
1.501(c)(3)-1(b)(4).
See
Treas. Reg. § 1.501(c)(3)-1(b)(4)
;
Rev. Proc. 82-2, 1982-1 C.B. 367.
SECTION 3. APPLICATION A § 501(c)(3) organization can satisfy the
organizational test of
§ 1.501(c)(3)-1(b)(4) of the Treasury Regulations
by reason of its articles of organization or by operation of law.
However, for purposes of obtaining a § 115(1) ruling, a § 501(c)(3)
organization will not satisfy the "distribution of assets upon
dissolution requirement" of § 115(1) unless its articles of
organization also limit distribution of assets on dissolution (to the
extent consistent with § 1.501(c)(3)-1(b)(4)) to one or more States,
political subdivisions of States, the District of Columbia, or other
organizations the income of which is excluded under § 115(1). For
purposes of obtaining a
§ 115(1)
ruling, the organization may not rely on a provision of state law to
satisfy the distribution of assets upon dissolution requirement of §
115(1). SECTION 4. EXAMPLES .01 Organization A is exempt from federal
income tax under § 501(a) as an organization described in § 501(c)(3).
Organization A has a dissolution clause in its articles of
organization that satisfies
Treas. Reg. § 1.501(c)(3)-1(b)(4)
. Organization A's articles state that, upon dissolution, any assets
remaining after the payment of debts and the satisfaction of
liabilities are to be distributed (1) to an organization described in
§ 501(c)(3) for one or more exempt purposes, or (2) to the United
States government, or to a State or local government, for a public
purpose. Organization A requests a letter ruling that its income is
excluded from gross income under § 115(1). Although the dissolution
clause in the articles of Organization A meets the organizational
requirements of § 501(c)(3), the dissolution clause allows for
distribution to entities to which distributions may not be made under
§ 115(1). The dissolution clause, therefore, fails to satisfy the
distribution of assets upon dissolution requirement of the accrual
test of § 115(1). In these circumstances, a favorable ruling on §
115(1) would not be issued. .02 Organization B is exempt from federal
income tax under § 501(a) as an organization described in § 501(c)(3).
Organization B has a dissolution clause in its articles of
organization that satisfies
Treas. Reg. § 1.501(c)(3)-1(b)(4)
. Organization B's articles state that, upon dissolution, any assets
remaining after the payment of debts and the satisfaction of
liabilities are to be distributed either (1) to a State or political
subdivision thereof for a public purpose or (2) for one or more exempt
purposes to an organization described in § 501(c)(3) and whose income
is also excludable from gross income under § 115(1). Organization B
requests a letter ruling that its income is excluded from gross income
under § 115(1). The dissolution clause in the articles of Organization
B meets the requirements of the organizational test of § 501(c)(3) and
also satisfies the distribution of assets upon dissolution requirement
of the accrual test of § 115(1).
.03 Organization C is exempt from federal income tax under § 501(a) as
an organization described in § 501(c)(3). Upon dissolution,
Organization C's remaining assets will be distributed by operation of
the law of Organization C's state of incorporation to a political
subdivision of the state for a public purpose. Organization C requests
a letter ruling that its income is excluded from gross income under §
115(1). Although state law provides a dissolution distribution scheme
that meets the organizational test of
Treas. Reg. § 1.501(c)(3)-1(b)(4)
, the state's dissolution provision fails to satisfy the accrual test
of § 115(1) for purposes of obtaining a § 115(1) letter ruling. In
these circumstances, a favorable ruling on § 115(1) would not be
issued. To receive a favorable § 115(1) letter ruling, Organization C
must have articles of organization that contain a provision satisfying
the distribution of assets upon dissolution requirement for the §
115(1) accrual test. SECTION 5. DRAFTING INFORMATION The principal
author of this revenue procedure is Sara T. S. Wolff of the Office of
Division Counsel/Associate Chief Counsel (Tax Exempt and Government
Entities).
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