Brian Ruud Intern. v. US, Civ. A. No. 85-2917.

• Decision Date: 21 April 1989
• Docket Number: Civ. A. No. 85-2917.
• Citation: 733 F. Supp. 396
• Parties: BRIAN RUUD INTERNATIONAL, Plaintiff, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — District of Columbia

733 F. Supp. 396

BRIAN RUUD INTERNATIONAL, Plaintiff, v. UNITED STATES of America, Defendant.

Civ. A. No. 85-2917.

United States District Court, District of Columbia.

April 21, 1989.

John M. Wood, Reed, Smith, Shaw and McClay, Washington, D.C., Thomas Fraser, Fredrickson and Byron, of counsel, Minneapolis, Minn., for plaintiff.

Edward J. Snyder, Michael J. Salem, Attorneys, Tax Div., U.S. Dept. of Justice, Joseph E. diGenova, U.S. Atty., of counsel, Washington, D.C., for defendant.

MEMORANDUM

HAROLD H. GREENE, District Judge.

Brian Ruud International (BRI), a religious organization devoted to the ministry of Brian Ruud, seeks a declaratory ruling that it is a tax-exempt religious organization under 26 U.S.C. § 501(c)(3). Presently before the Court is plaintiff's motion for summary judgment. At a hearing on that motion, the parties agreed to treat defendant's opposition to that motion as a motion for summary judgment on its own behalf. Therefore, this controversy can be determined on the basis of these cross-motions.

I Background

Sections 501(a) and (c) of the Internal Revenue Code allow tax exemptions for organizations that are organized and operated exclusively for religious, charitable, and other specified exempt purposes, provided that no part of the net earnings of the organization inures to the benefit of any private shareholder or individual. Treasury Regulation § 1.501(c)(3)-1(a)(1) requires that, in order to be exempt pursuant to section 501(c)(3), an organization must be both organized and operated exclusively for any one or more of the purposes enumerated in that Code section. An organization is not operated exclusively for such exempt purposes if its net earnings inure in whole or in part to the benefit of private shareholders or individuals, Treasury Regulation § 1.503(c)(3)-1(c)(2), or if it serves a private rather than a public interest. Treasury Regulation § 1.503(c)(3)-1(d)(1)(ii).

Applying these principles to the facts offered by plaintiff, defendant revoked plaintiff's exemption. In its final action of June 19, 1985, defendant stated:

You are not operated exclusively for charitable, religious or any other exempt purpose as described in section 501(c)(3) of the Internal Revenue Code. You have been operating in such a manner that a portion of your net earnings has inured to the benefit of private individuals. Moreover, you have been operated to confer a private rather than a public benefit.

In actions for declaratory judgments such as this, the scope of review is confined to the administrative record unless good cause is shown. Big Mama Rag, Inc. v. United States, 494 F.Supp. 473, 474 n. 1 (D.D.C.1979). The standard of review is de novo. Id. Since defendant relies in its motion here on the same reasons given plaintiff in the final administrative action, the burden is upon plaintiff to show that defendant's determination is wrong. Basic Bible Church v. United States, 74 T.C. 846, 855 & n. 7 (1980). Thus, in order to succeed plaintiff must show (1) that it is operated for public, rather than private, benefit and (2) that no portion of the organization's net income inures to the benefit of a private individual.

One of the most serious problems cited by defendant is plaintiff's failure to maintain satisfactory internal financial controls. Plaintiff concedes that this is the case. This alone is not sufficient to justify the denial of tax exempt status, but it has frustrated the efforts of both parties to determine the extent to which BRI paid for personal expenses of the Ruuds. Nevertheless, the parties have submitted a lengthy administrative record detailing the various accounts and expenses at issue. The Court has reviewed the record in detail, and it concludes that plaintiff has met its burden of showing that defendant's determination was incorrect. Accordingly, plaintiff's motion for summary judgment will be granted.

II Public versus Private Benefit

Section 501(c)(3) sets out the specific standards that govern the determination as to whether an organization should be exempt from taxation. The corporation must be "organized and operated exclusively for religious, charitable ... or educational purposes ... no part of the net earnings of which inures to the benefit of any private shareholder or individual...." Courts have long recognized that the two parts of the test are closely interrelated, but plaintiff must satisfy both parts in order to prevail.

It cannot seriously be disputed that plaintiff is a religious organization whose primary purpose is to convey Brian Ruud's teachings to others. The administrative record contains Brian Ruud's speaking schedule and copies of newspaper articles and promotional material regarding his appearances, all of which indicate that preaching his religion occupied a vast amount of Ruud's time. Further, the record contains the calendar for a retreat in Victoria which also indicates that much time was devoted to prayer meetings, youth groups, and counseling.

Thus this organization differs dramatically from the organizations in the cases cited by defendant which were found not to be organized for religious purposes. See, e.g., Bubbling Well Church of Universal Love, Inc. v. Commissioner, 74 T.C. 531 (1980); Western Catholic Church v. Commissioner, 73 T.C. 196 (1979). In both of those cases, the leaders of the organizations spent virtually no time on religious matters, and it was clear that their only purpose was to act as a tax shelter or as an "incorporated pocketbook" for their founders. Id.

Even a bona fide religious organization which devotes substantial time to carrying out its religious purposes may still not satisfy the first test. The existence of any nonexempt purpose, if it is "not insubstantial," destroys the exemption. Freedom Church of Revelation v. United States, 588 F.Supp. 693, 696 (D.D.C.1984); see also, Better Business Bureau v. United States, 326 U.S. 279, 283, 66 S.Ct. 112, 114, 90 L.Ed. 67 (1945). It should be noted that, despite the strong language of Freedom Church, it, too, was a case in which the organization's primary purpose was tax avoidance for its members. 588 F.Supp. at 696. Even applying this strict test, however, the Court finds that BRI was not formed for any substantial nonexempt purpose.

In an effort to identify nonexempt purpose of BRI, the IRS contends that BRI operated essentially as a source of credit for Brian Ruud and his wife Gayle. They used a corporate charge card and a corporate account to pay for personal expenses. These expenses were charged to an officer loan account and only later repaid by deducting these amounts from their salary. In one year, Ruud actually only received $1,000 in salary because so much was deducted to repay the corporation for the Ruuds' personal expenses. Defendant does not claim, however, that the Ruuds did not repay their accumulated debts to plaintiff, or that they obtained substantial loans from plaintiff at favorable rates of interest.

Thus, while the argument is made that the corporation served as a private source of credit to the Ruuds, all that this really amounts to is a claim that the corporation paid personal expenses of the Ruuds for which it either was or was not later repaid. This argument relates to the second test, not the first. In fact, one of the decisions that defendant relies on for the proposition that use of the corporation as a private source of credit "in and of itself, indicates a violation of the private benefit rule" actually held that such use of the corporation may violate the rule against private inurement (the second part of the test). Founding Church of Scientology v. United States, 412 F.2d 1197, 1202, 188 Ct.Cl. 490 (1969).

Defendant has not identified any specific nonexempt purpose for which BRI was organized. Of course, if the corporation was operated for the financial benefit of Brian Ruud, in violation of the second part of the test, it would also violate the first part of the test. It is clear, then, that the real issue in this case is whether any of the net earnings of the corporation inured to the private benefit of the Ruuds. It is to that issue that the parties have devoted the most attention.

III Private Inurement

The payment of reasonable compensation to ministers does not constitute private inurement. Founding Church of Scientology v. United States, 412 F.2d 1197, 1200, 188 Ct.Cl. 490 (D.C.Cir.1969). The question here is whether payments for the benefit of the Ruuds in addition to strict salary payments constitute private inurement or are part of reasonable compensation.

Defendant has identified two different categories of private inurement allegedly received by the Ruuds during 1979 and 1980. The first are personal expenses charged on the corporate "Chargex" account, and the second are personal expenses paid out of the corporate checking account.

According to defendant, the Chargex amounts at issue total $4,153.66 for 1979 and $4,811.29 for 1980. The other personal items paid for by the corporation total $16,299.56 in 1979 and $10,812.02 in 1980. Thus, defendant maintains, corporate earnings amounting to $36,076.53 inured to the benefit of the Ruuds during the two-year period.

While plaintiff does not deny that personal expenses of the Ruuds were paid by the corporation, it does dispute the $36,076.53 figure. First, plaintiff concedes that food and gasoline expenses listed on the Chargex account and the other personal expenditures category are a mixture of personal and business expenses. While plaintiff is unable to determine precisely what portion of these expenses were personal, it notes that the personal expense portion was covered by food and auto allowances given to the Ruuds by the corporation. The allowance provided for $3,000 in food expenditures, and $2,400 in automobile-related expenditures. See Exhibit 209-HB. According to Joint Exhibits 104-CZ and 133-EC, the Ruuds exceeded their $3,000 food allowance in ...