Milk Saving Starving Children Foundation v. Commissioner

No Milk, Just Beignets: Foundation Loses Exemption

The IRS successfully revoked a foundation's tax-exempt status after it traded charitable milk distribution for a coffee shop and rental properties, costing the organization significant tax benefits and highlighting the critical importance of adhering to exempt purposes. At stake was the organization’s continued qualification as a tax-exempt entity under Section 501(c)(3), which allows organizations operated exclusively for charitable purposes to be exempt from federal income tax under Section 501(a). The Tax Court granted summary judgment for the IRS, revoking the 501(c)(3) status effective July 1, 2017, an outcome that underscores the court's willingness to assert its authority over exemption determinations. The irony was palpable: the Milk Saving Starving Children Foundation became a commercial enterprise, a transformation the court found incompatible with its purported charitable mission.

From Charity to Coffee Shop

The Milk Saving Starving Children Foundation had humble beginnings. Incorporated on June 9, 2001, in Pennsylvania, its stated purpose was to raise money to purchase and distribute rice, soy, and powdered milk to starving children worldwide. According to its initial application for exemption under Section 501(c)(3) — which allows organizations operated exclusively for charitable purposes to be exempt from federal income tax under Section 501(a) — the foundation shipped $159.60 worth of powdered milk to Ecuador and Haiti in 2001.

However, the foundation's trajectory soon veered from its original mission. Around November 15, 2001, the board approved a plan to purchase and renovate a building to operate a coffee shop. On July 15, 2002, the foundation purchased the property for $90,000. "Café Beignet" opened its doors in November 2003, selling beignets, coffee, tea, and soft drinks. In 2005, the foundation began planning an addition to the property, completed around September 7, 2009. Over the next decade, the foundation rented space in the building to various tenants, including two pizza shops and an Indian restaurant.

While the cafe thrived, milk donations dwindled. The foundation reported spending $1,100 on milk donations in 2008, and in 2011, powdered milk donations ceased entirely. Though some shipments of powdered milk to aid organizations in Mexico, Haiti, Peru, and local community shelters in Scranton, Pennsylvania, occurred during 2020 after the IRS began its examination for petitioner’s 2018 tax year, the record did not indicate the quantity or frequency of the shipments.

The foundation's tax filings further muddied the waters. For tax year 2008, the foundation filed Form 990, Return of Organization Exempt From Income Tax, reporting that it was doing business as Café Beignet. From 2009 to 2015, it filed Form 990-EZ, Short Form Return of Organization Exempt From Income Tax, which requires reporting limited financial and operational information. However, for tax years 2011, 2013, 2014, 2016, and 2018 through 2021, the foundation filed Form 990-N, Electronic Notice (e-Postcard) for Tax-Exempt Organizations Not Required to File Form 990. Form 990-N is used by organizations with gross receipts not greater than $50,000 and does not require taxpayers to report financial or operational information. The foundation even filed Forms 990-N for tax years 2010, 2012, and 2015, despite filing Forms 990-EZ for those same years, creating a confusing picture of its financial activities.

The Audit: Too Little, Too Late

Following the series of inconsistent Form 990 filings, the IRS initiated an audit of the foundation's 2018 tax year. On September 26, 2019, an IRS revenue agent notified the petitioner of the audit and scheduled an on-site visit. During the November 4, 2019 visit, the agent interviewed Ms. Orazzi, the foundation's secretary who also worked at Café Beignet, who stated the foundation's mission had changed from powdered milk distribution, though without providing specifics.

The revenue agent's review of the foundation’s 2018 financials revealed a stark disconnect between income and claimed charitable purpose. Income sources included $1,697 from Café Beignet sales, $6,000 in rental income, $13,100 from a golf fundraiser, and $5,650 in donations, totaling $26,447. Expenses, totaling $26,097, were allocated to sales tax ($50), golf tournament expenses ($2,063), salaries ($3,900), baking supplies ($876), phone ($264), insurance ($1,500), loans to Mr. Lucas ($9,090), mortgage payments ($6,000), and A/C unit repairs ($2,354). Tellingly, the audit found no expenses related to rice, soy, or powdered milk.

Further Information Document Requests (IDRs) were sent, and Ms. Orazzi eventually conceded that the foundation hadn't distributed powdered milk for several years, stating the "want for this decreased after 2011." She claimed the foundation engaged in other charitable activities, such as a charity golf tournament and selling baked goods at Café Beignet. However, these activities primarily generated revenue.

In response to the audit, the foundation appeared to engage in what the Tax Court would later characterize as "panicked compliance." Only after the IRS raised concerns about the lack of charitable activity, the foundation scrambled to purchase powdered milk. Receipts showed Amazon purchases of powdered milk on November 4, 2020 ($74.78 and $50.62), and January 8, 2021 ($50.50), with the deliveries going to Café Beignet. Despite these last-minute purchases, the IRS issued a proposed adverse determination letter on June 8, 2021, stating the foundation was "no longer fulfilling its exempt purpose" and that its primary activity, "operating a café to raise funds is neither charitable nor educational." The IRS revoked the foundation’s Section 501(c)(3) status, effective July 1, 2017. The foundation, in its petition to the Tax Court, argued that it "planned" to restart its charitable activities.

Court Analysis: Frying the Beignet Defense

The IRS argued that the Milk Saving Starving Children Foundation failed the "operational test" for maintaining its Section 501(c)(3) tax-exempt status. Section 501(a) exempts from federal income taxation organizations described in Section 501(c). Section 501(c)(3) describes organizations "organized and operated exclusively 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." To be exempt, an organization must be both organized and operated exclusively for exempt purposes, as outlined in Treasury Regulation § 1.501(c)(3)-1(a)(1).

Treasury Regulation § 1.501(c)(3)-1(c)(1) elaborates on the operational test, stating that an organization must "engage primarily in activities which accomplish one or more of such exempt purposes." It also clarifies that an organization is not operated exclusively for exempt purposes if "more than an insubstantial part of its activities is not in furtherance of an exempt purpose." The court emphasized that "exclusively" does not mean "solely." However, citing Better Business Bureau of Wash., D.C., Inc. v. United States, 326 U.S. 279, 283 (1945), the court underscored that the presence of a single nonexempt purpose, if substantial, precludes exempt status regardless of the number or importance of truly exempt purposes.

The IRS determined that the foundation's primary activity had become operating a commercial coffee shop, Café Beignet, and renting out property, not distributing milk. The funds raised were not demonstrably used for charitable purposes.

Critically, the Tax Court noted the Foundation's procedural misstep. Tax Court Rule 121(d) states that when faced with a Motion for Summary Judgment, the nonmovant "must respond, setting forth specific facts...to show that there is a genuine dispute of fact for trial." Because the Foundation failed to respond to the IRS’s Motion for Summary Judgment, the court, citing Rule 121(f), considered the IRS's factual assertions as undisputed. The court found that the Foundation's extensive commercial activities disqualified it from tax-exempt status because these activities did not further its exempt purpose.

Impact: Commercial Activity Warning

This case serves as a stark reminder that a Section 501(c)(3) organization can lose its tax-exempt status by engaging in substantial commercial activities unrelated to its charitable mission. Moreover, it highlights the critical importance of responding to motions in court, as a failure to do so can result in the court accepting the moving party's version of the facts as true.

Impact: Commercial Activity Warning

As the Tax Court reminded with this ruling, a Section 501(c)(3) organization risks losing its tax-exempt status if it engages in substantial commercial activities that do not further its charitable mission. The court's application of the "single nonexempt purpose" doctrine, stemming from Better Business Bureau of Wash., D.C., Inc. v. United States, 326 U.S. 279 (1945), emphasized that even a single substantial nonexempt purpose, such as operating a for-profit cafe, can be fatal to tax-exempt status, regardless of other charitable activities.

Further, the case underscores the critical importance of procedural compliance in Tax Court. Tax Court Rule 121 governs summary judgment, and Rule 121(d) mandates that a party opposing summary judgment must respond to the motion with specific facts showing a genuine dispute. Failure to respond allows the Court to deem the moving party's facts undisputed. In this case, the Milk Saving Starving Children Foundation’s failure to respond to the IRS's motion effectively conceded the facts, leading to an adverse ruling.

Practitioners should advise nonprofit clients to ensure that any commercial activities directly and substantially further their exempt purpose, lest those activities overshadow the charitable mission. A contemporaneous record of charitable activities can serve as vital evidence if challenged. Furthermore, organizations must diligently respond to Tax Court motions. Ignoring a Tax Court order to respond to a motion is a guaranteed way to lose. The revocation of the Milk Saving Starving Children Foundation's tax-exempt status was effective July 1, 2017.