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Churches are eligible for tax exempt status only if no part of their net earnings inure to the benefit of private individuals. Each phrase of the statute has significance. The term "no part" is absolute. The organization loses tax exempt status if even a small percentage of income inures to a private individual.
The Church of Scientology (Church) was incorporated as a nonprofit corporation in the State of California in 1954. In 1957, the Commissioner recognized it as a tax-exempt organization under § 501(c)(3) of the Internal Revenue Code of 1954. The Commissioner revoked the Church's tax-exempt status in 1967. The letter of revocation stated that the Church was engaged in a business for profit, and was operated in a manner whereby a portion of its earnings inured to the benefit of a private individual. The letter instructed the Church to file federal income tax returns. The Church did not file income tax returns for the years 1970 through 1972, instead, it submitted Form 990, information returns. In 1977, after auditing the Church's records, the IRS sent a Notice of Deficiency for the years 1970, 1971, and 1972. Thereafter, the Church filed suit in United States Tax Court challenging the Commissioner's determination of tax deficiency. The Tax Court upheld the determination of the Tax Commissioner, holding that the Church did not qualify for exemption from taxation under §§ 501(a) & 501(c)(3) because the Church was operated for a substantial commercial purpose, and its earnings inured to the benefit of private persons. The Church sought review of the decision, arguing that the Commissioner improperly revoked the Church’s tax-exempt status.
Did the Commissioner improperly revoke the Church’s tax-exempt status?
On appeal, the court examined the church founder, and found that he benefited greatly from income derived for the Church. The court rejected the Church’s claims that all funds were used for church purposes. The court upheld the decision which revoked the Church’s tax-exempt status on the ground that a portion of its income inured to the benefit of the church's founder, as well as others. The court rejected the Church’s argument that a notice of deficiency by the Commissioner was constitutionally and administratively defective. The court also upheld the imposition of a penalty on the Church for failure to file the proper returns. The decision was affirmed accordingly.