T.C. Memo. 2005-285
UNITED STATES TAX COURT
SOUTH COMMUNITY ASSOCIATION, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 10959-03X. Filed December 14, 2005.
Roger J. Makley, Lance A. Gildner, and John T. Ernest,1 for
petitioner.
William I. Miller and Linda C. Grobe, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
LARO, Judge: Respondent determined that petitioner is not
exempt from Federal income tax under section 501(c)(3) and
1
John T. Ernest entered an appearance for petitioner on
Jan. 27, 2004, and withdrew as petitioner’s counsel on June 4,
2004.
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revoked petitioner’s tax-exempt status effective January 1,
1992.2 Petitioner has exhausted its administrative remedies and
has petitioned this Court to declare its qualification for
tax-exempt status under section 501(c)(3). See sec. 7428; see
also Rule 211(a), (b), (g). Following the parties’ filing with
the Court of the administrative record underlying respondent’s
determination, the Court’s granting of the parties’ joint motion
to calendar this case for trial, and the conclusion of the
ensuing trial, we decide whether respondent properly revoked
petitioner’s tax-exempt status under section 501(c)(3). We hold
that respondent did.
FINDINGS OF FACT
Some facts were stipulated and are so found. We incorporate
herein by this reference the parties’ stipulations of fact and
the exhibits submitted therewith. Petitioner is an association
that was formed by Larry Parr (Parr) on June 17, 1979. When its
petition for declaratory judgment was filed, petitioner’s
principal place of business was in Middletown, Ohio.
On August 3, 1982, respondent determined that petitioner was
a section 501(c)(3) organization exempt from Federal income tax.
The determination was effective as of the day of petitioner’s
formation. At the time of this determination, petitioner did not
2
Section references are to the applicable versions of the
Internal Revenue Code, Rule references are to the Tax Court Rules
of Practice and Procedure, and dollar amounts are rounded.
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conduct any gaming activity. According to its bylaws,
petitioner’s exempt purpose was (and is) to provide aid for all
forms of education. At some time between August 3, 1982, and
January 1, 1992, petitioner began a gaming operation (gaming
operation). The gaming operation was the idea of Parr, who
during the relevant years did not work for petitioner but whose
company sold to petitioner the supplies that petitioner used in
the gaming operation.
From 1992 until 1995, the years audited by respondent in
connection with his determination revoking petitioner’s
exemption, petitioner contributed $1,423,729 to various charities
generally for the purposes of starting educational programs,
building a school, and transporting handicapped individuals to
various schools. Petitioner’s contributions during the
respective years were $440,055, $323,088, $386,599, and $273,987.
Many of the recipients of these contributions were charities
controlled by petitioner’s president, James Clausing (Clausing).
Petitioner funded its contributions almost entirely through its
gaming operation.
Petitioner’s gaming operation consisted of its sale of bingo
cards and instant pull-tab tickets.3 Petitioner sold its bingo
3
Each of petitioner’s instant pull-tab tickets was a paper
ticket with a covered symbol. Upon purchasing an instant
pull-tab ticket and uncovering the symbol, the purchaser won a
prize if the symbol was one that was predesignated to win.
(continued...)
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cards and instant pull-tab tickets at bingo games that petitioner
held at a bingo hall in Middletown, Ohio, from 6:30 p.m. to 11:30
p.m. on every Saturday and Sunday. An average of approximately
300 patrons attended the bingo games each night that the games
were held. Beginning in 1993, petitioner also sold instant
pull-tab tickets at one or two other locations on each Saturday
and Sunday from 10:30 a.m. to 6 p.m. and on every other day of
the week from 10:30 a.m. to 7 p.m.4 Petitioner’s sales of
instant pull-tab tickets represented most of petitioner’s gaming
receipts in each of the years 1992 through 1995. In addition to
sales of instant pull-tab tickets, petitioner’s remaining income
for those years was from interest and from petitioner’s sales
during the bingo games of bingo cards, raffle tickets, and
concessions.
Eight or nine individuals generally worked in the bingo hall
on each night that the games were held. These individuals
consisted of bingo workers, instant pull-tab ticket workers,
concession workers, kitchen workers, a security guard, and one or
two game administrators (Clausing and/or Mark Carroll (Carroll),
3
(...continued)
Whether the instant pull-tab ticket contained one of the
predesignated symbols was a matter of luck.
4
In 1993, 1994, and 1995, petitioner sold instant pull-tab
tickets at a storefront booth in Middletown, Ohio. In 1994 and
1995, petitioner also sold instant pull-tab tickets at a second
booth.
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petitioner’s vice president). Petitioner recruited its bingo,
instant pull-tab ticket, concession, and kitchen workers
(collectively, nonofficer/nonsecurity guard workers) through
informal means such as by word of mouth. All of petitioner’s
nonofficer/nonsecurity guard workers were trained by one of
petitioner’s officers, Diane Whitaker (Whitaker). Whitaker
instructed those workers on how to handle money and how to keep
certain records. Whitaker also scheduled petitioner’s gaming
activities and approved any time off taken by the nonofficer/
nonsecurity guard workers. Whitaker (and/or another one of
petitioner’s officers) informed these workers that they would be
paid in cash for their services and that they were not to discuss
this payment arrangement with anyone.
The services performed in the gaming operation by the
nonofficer/nonsecurity guard workers were demanding, and it was
not easy for those workers to take a day off. Many of those
workers were pressured to work in the bingo games on both
Saturday and Sunday, were required to give advance notice for any
vacation time that they sought, and seldom received time off.
Petitioner required that its nonofficer/nonsecurity guard workers
who worked at the bingo games be at the bingo hall from 4:30 p.m.
until approximately just after 11:30 p.m. As of the latter time,
the workers were then required to accompany Clausing (and/or
Carroll) to a bank where the receipts from that night’s
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activities were deposited. Petitioner generally paid each of its
nonofficer/nonsecurity guard workers $65 in cash a day for his or
her work in the gaming operation (exclusive of tips or Christmas
bonuses). Petitioner did not report any of these payments either
to the recipient (e.g., through a Form W-2, Wage and Tax
Statement) or to respondent. In addition to working for
petitioner in the gaming operation, many of the nonofficer/
nonsecurity guard workers also worked fulltime for employers
other than petitioner. At least one of the nonofficer/
nonsecurity guard workers traveled more than 20 miles to work in
the gaming operation.
Ohio law requires that a security guard be present during
the bingo games, and petitioner paid a security agency to furnish
a security guard to work at the bingo games while the games were
conducted. Petitioner also paid the security agency to furnish a
security guard to work with petitioner’s instant pull-tab ticket
workers when, and on the sites where, the instant pull-tab
tickets were sold. For the services of these security guards,
petitioner paid the security agency $7,776, $12,936, $9,908, and
$11,643 during 1992 through 1995, respectively.
Clausing was petitioner’s president and full-time
administrator from 1992 through 1995. He worked for petitioner
an average of 30 hours per week in 1992 and an average of 35
hours per week in 1993 through 1995. During 1992 through 1995,
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petitioner reportedly paid Clausing compensation of $4,800,
$27,600, $32,428, and $41,627, respectively. As to the gaming
operation, Clausing negotiated the bingo supply contracts, ran
the bingo games, handed out tickets at the bingo games, collected
the proceeds from petitioner’s sales of bingo cards and instant
pull-tab tickets, deposited most of petitioner’s daily proceeds
in the bank, prepared daily sheets, and managed petitioner’s
inventory (e.g., of instant pull-tab tickets). Clausing also
each day visited the sites where petitioner sold its instant
pull-tab tickets and, when there, counted money and prepared
daily sheets. As to petitioner’s activities other than the
gaming operation (nongaming operation), Clausing ran petitioner’s
monthly board meetings, made annual decisions about grants, and
wrote checks to petitioner’s grant recipients. The amount of
time that Clausing spent on petitioner’s nongaming operation was
substantially less than the amount of time that Clausing spent on
the gaming operation.
Carroll was petitioner’s vice president in 1992 through 1995
and an administrator of its gaming operation in 1994 and 1995.
Carroll reportedly was not paid by petitioner in 1992 and 1993.
Petitioner reportedly paid Carroll $18,928 and $23,427 in 1994
and 1995, respectively. Carroll worked for petitioner an average
of 10 hours per week in 1994 and an average of 40 hours per week
in 1995. As part of his work for petitioner, Carroll sometimes
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visited the sites where the instant pull-tab tickets were sold
and supervised the bingo games.
From 1992 through 1995, petitioner received no public
support. For those years, petitioner reported to respondent that
its gross income was as follows:
Year Gaming Operation Interest Income
1992 $871,893 $20,199
1993 1,305,461 7,128
1994 2,085,332 11,456
1995 2,043,145 11,291
During petitioner’s audit, Clausing and petitioner’s counsel
informed petitioner’s workers that one of respondent’s agents
might question the workers on whether they were paid by
petitioner for their work in the gaming operation. Clausing and
petitioner’s counsel advised the workers on what they should and
should not say in response to the questions.
OPINION
Section 501(a) generally provides that organizations
described in section 501(c) are exempt from Federal income tax.
Section 501(c)(3) includes within that description certain
“Corporations * * * organized and operated exclusively for
religious, charitable, scientific, testing for public safety,
literary, or educational purposes”. Exemptions from tax are
exceptions to the norm, and petitioner bears a heavy burden to
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prove that it falls within the terms of the quoted text.5 See
Harding Hosp., Inc. v. United States, 505 F.2d 1068, 1071 (6th
Cir. 1974); see also Fla. Hosp. Trust Fund v. Commissioner, 103
T.C. 140, 146 (1994) (taxpayers generally bear the burden of
proving that the Commissioner improperly revoked an exemption
from tax under section 501), affd. 71 F.3d 808 (11th Cir. 1996).
In order for petitioner to prevail on the issue that we
decide herein, we must find that petitioner was both organized
and operated exclusively for one or more exempt purposes. See
sec. 1.501(c)(3)-1(a), Income Tax Regs. We focus on the
statute’s requirement as to operation because the parties do not
dispute the statute’s requirement as to organization. Under the
regulations, an “organization will be regarded as ‘operated
exclusively’ for one or more exempt purposes only if it engages
primarily in activities which accomplish one or more of such
exempt purposes specified in section 501(c)(3).” Sec.
5
Sec. 7491(a) was added to the Code by the Internal Revenue
Service Restructuring and Reform Act of 1998, Pub. L. 105-206,
sec. 3001(c), 112 Stat. 727, effective for court proceedings
arising from examinations commencing after July 22, 1998. Sec.
7491(a)(1) provides that the burden of proof shifts to the
Commissioner in specified circumstances. We need not and do not
decide whether sec. 7491(a)(1) applies in the setting of a
declaratory judgment action such as we have here. Petitioner in
its posttrial brief makes no mention of sec. 7491(a)(1), and we
conclude that, even if sec. 7491(a)(1) did apply in the setting
of a declaratory judgment action, it would not apply here. See,
e.g., sec. 7491(a)(2) (sec. 7491(a)(1) applies with respect to an
issue only if the taxpayer establishes certain requirements); see
also Mediaworks, Inc. v. Commissioner, T.C. Memo. 2004-177.
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1.501(c)(3)-1(c)(1), Income Tax Regs. “An organization will not
be so regarded if more than an insubstantial part of its
activities is not in furtherance of an exempt purpose.” Id.; see
also Orange County Agric. Socy., Inc. v. Commissioner, 893 F.2d
529, 532 (2d Cir. 1990), affg. T.C. Memo. 1988-380.
Respondent revoked petitioner’s tax-exempt status effective
January 1, 1992. Respondent advances the following grounds for
revocation: (1) Petitioner had as its primary activity the
operation of a trade or business, i.e., its gaming operation,
that was not in furtherance of its exempt purpose, (2) petitioner
operated as a “feeder organization” within the meaning of section
502, and (3) petitioner’s operation served the private interests
of its founder, Parr, and his company. Petitioner argues in
response to respondent’s determination that petitioner was
operated exclusively for an exempt purpose. According to
petitioner, its gaming operation should not be deemed unrelated
to its exempt purpose in that, it asserts, all of the work in
carrying on its gaming operation was performed by uncompensated
workers. Cf. sec. 513(a)(1). Respondent disputes that
substantially all of the work in that operation was
uncompensated. We agree with respondent that petitioner’s
carrying on of the gaming operation disqualified petitioner from
the tax exemption that it seeks to retain.
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In support of their respective positions, the parties each
called witnesses to testify about any compensation paid by
petitioner for services performed in the gaming operation.
Petitioner’s witnesses on this subject were Clausing, Parr,
Edward Helton (Helton), Shawna Phillips (Phillips), Karen Cornett
(Cornett), and Lulu Blair (collectively, petitioner’s six
witnesses). Petitioner’s six witnesses generally testified that
they were not paid for any services that they performed in the
gaming operation and that they believed none of petitioner’s
workers was paid for his or her work in the gaming operation.
Respondent’s witnesses on this subject were Jessica Seaks,
Melissa Conyer, and Linda Grooms (collectively, respondent’s
three witnesses). Respondent’s three witnesses generally
testified that petitioner surreptitiously paid both them and each
other nonofficer worker cash of $65 a day (exclusive of tips and
Christmas bonuses) and that one or more of petitioner’s officers
instructed them (respondent’s witnesses and petitioner’s other
nonofficer/nonsecurity guard workers) not to disclose this
payment arrangement to anyone.
Our resolution of this dispute turns mainly on a
determination of the credibility of petitioner’s six witnesses
and respondent’s three witnesses. Such a determination
epitomizes the ultimate duty of a trial court, as trier of fact,
to determine the truth of a matter on the basis of conflicting
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oral testimony. We must be wary, on the one hand, of the
courtroom's becoming a quagmire in which an honest litigant is
mired and, on the other hand, of the courtroom’s becoming a
refuge for the proficient liar. See Diaz v. Commissioner,
58 T.C. 560, 564 (1972); Hawkins v. Commissioner, T.C. Memo.
1993-517, affd. without published opinion 66 F.3d 325 (6th Cir.
1995). We have evaluated each referenced witness’s testimony by
observing his or her candor, sincerity, and demeanor and by
assigning weight to the elicited testimony for the primary
purpose of finding disputed facts. See Neonatology Associates v.
Commissioner, 115 T.C. 43, 84 (2000), affd. 299 F.3d 221 (3d Cir.
2002). We determine the credibility of each witness, weigh each
piece of evidence, draw appropriate inferences, and choose
between conflicting inferences in finding the facts of a case.
See id.; see also Gallick v. Baltimore & O.R. Co., 372 U.S. 108,
114-115 (1963); Boehm v. Commissioner, 326 U.S. 287, 293 (1945);
Wilmington Trust Co. v. Helvering, 316 U.S. 164, 167-168 (1942).
We hear and view the testimony of respondent’s three
witnesses to be more credible than that of petitioner’s six
witnesses, whom we find to be not credible. Our perception of
petitioner’s six witnesses (and our resulting disregard of their
testimony) is supported by our review of independent indicia of
reliability found in the record and from the reasonable
inferences that we draw therefrom. First, Clausing, the security
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guards, and Carroll (at least in 1994 and 1995) were undisputably
paid by petitioner for their services, and we find such as a
fact. Petitioner asserts that it paid Clausing and Carroll only
to work in its nongaming activities and that any work they
performed in the gaming operation was without compensation. We
consider that assertion to be incredible. We find as a fact that
petitioner’s payments to Clausing and Carroll were at least in
part payment for services that they performed in connection with
the gaming operation. Indeed, we would be hard put to find to
the contrary given that almost all of petitioner’s resources
(including the time of its workers) were devoted to the gaming
operation and that the gaming operation represented the lion’s
share of petitioner’s activities. We conclude from the record
before us that Clausing’s and Carroll’s compensation from
petitioner was attributable in small part to their services in
petitioner’s nongaming activity and, for the most part, to their
services in the gaming operation. The mere fact that petitioner
may label all of their compensation as being paid only for the
former purpose is not dispositive of this matter.
Second, as we understand it, none of the four of
petitioner’s six witnesses who received the $65 payments from
petitioner ever reported those payments as income.6 Petitioner
6
Of petitioner’s six witnesses, Clausing and Parr were
never paid the $65 payments.
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does not dispute a proposed finding of fact by respondent, which
we find as a fact, that Clausing and counsel for petitioner
advised petitioner’s workers on what the workers should and
should not say in response to questions that respondent might ask
them during petitioner’s audit as to the gaming operation and
their compensation therefrom. We believe that each of
petitioner’s six witnesses at the time of his or her testimony
knew that the $65 payments were reportable as taxable income and
that those payments were not reported as such. We surmise that
petitioner’s six witnesses also were generally aware at the time
of their testimony of the potential repercussions of not
reporting the $65 payments as income and the consequences of any
admission that they may make at trial as to that omission.
Third, five of petitioner’s six witnesses were generally
longtime workers for petitioner who continued to work for
petitioner as of the time that they testified in this proceeding,
and the sixth, Parr, was petitioner’s founder and its key
supplier. Petitioner’s six witnesses’ allegiance to petitioner
and to its interests in this proceeding cannot be denied.
Petitioner and petitioner’s six witnesses all have much to lose
from a decision here adverse to petitioner and have much to gain
from a decision here favorable to petitioner.
Fourth, we conclude from the record at hand that some if not
all of petitioner’s four witnesses who received the $65 payments
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would have declined to work in the gaming operation had they
received no compensation for their services. We find in the
record that working in the gaming operation was demanding, that
the nonofficer/nonsecurity guard workers were pressured to work
in the bingo games on both Saturday and Sunday for a total of 14
hours (exclusive of the additional time that they were required
to spend accompanying Clausing and/or Carroll to the bank to
deposit the days’ receipts), that those workers were required to
give advance notice for any vacation time that they sought, and
that those workers were seldom given time off. We also find in
the record that at least Helton, Phillips, and Cornett also
worked full-time for employers other than petitioner and that at
least Cornett traveled more than 20 miles to work in the gaming
operation. Given that we are unable to find on the basis of
credible evidence in the record that any of petitioner’s workers
worked in the gaming operation out of motivation to further
petitioner’s educational purpose, or even out of motivation by
charitable impulses in general, we are hard pressed to, and do
not, conclude that any of petitioner’s four witnesses who
received the $65 payments would have steadily and consistently
worked for petitioner without being paid for his or her services.
As to respondent’s three witnesses, we perceive the
testimony of those witnesses to be candid, sincere, and credible.
Petitioner attempts to discredit that testimony by arguing that
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respondent’s three witnesses seek revenge against petitioner
because their services in the gaming operation were discontinued.
We find this attempt unavailing. Given that none of respondent’s
three witnesses reported her receipt of the $65 cash payments as
income, we do not believe that they simply out of revenge
testified against their self-interests by admitting clearly and
under oath that they received the $65 payments and knowingly did
not report those payments as income.
In addition to its witnesses, petitioner relies upon
approximately 29 affidavits contained in the administrative
record. These affidavits, which were mostly signed in bulk in
June or September of 1997 and were submitted to respondent during
the audit, were from various workers of petitioner and stated
that the affiant was not paid for his or her services in the
gaming operation. We are unpersuaded by these affidavits, and we
give them no weight. The affiants included 12 workers of
petitioner who did not work for petitioner during the relevant
years and 4 of petitioner’s officers (including Clausing,
Carroll, and Whitaker). Many of the affiants did not testify at
trial so as to be subject to our determination of their
credibility or to questioning as to the circumstances under which
they signed or otherwise acquiesced in the statements contained
in the affidavits. As to the affidavits, most of them were
written pro forma on petitioner’s letterhead and were prepared by
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petitioner’s legal counsel for purposes of respondent’s audit
(and presumably for purposes of any litigation that resulted
thereafter); in some cases, the affidavits were incomplete as to
the dates of the affiant’s service in the gaming operation. The
affidavits for the most part were presented to the affiants for
their signature at a monthly board meeting of petitioner in the
presence of petitioner’s current trial counsel, who signed as
notary of many of the affidavits.
Petitioner also challenges a characterization of the
security guards as workers in petitioner’s gaming operation for
purposes of the “substantially all” test of section 513(a)(1).
We conclude that the characterization is appropriate. Petitioner
argues that the security guards did not work in the gaming
operation because they were independent contractors rather than
employees. We disagree. The fact that the security guards were
directly compensated by another entity through a contract with
petitioner is of no consequence to our determination under
section 513(a)(1). A plain reading of that section requires that
we focus on the “work” performed in “carrying on such trade or
business”. We read nothing in the statute that limits this work
to that performed by employees as opposed to independent
contractors. See also Executive Network Club, Inc. v.
Commissioner, T.C. Memo. 1995-21 (finding that casino workers
paid in tips by players worked for compensation even though the
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exempt organization did not pay the workers directly); cf. Piety,
Inc. v. Commissioner, 82 T.C. 193, 194 (1984) (finding that
workers who conducted bingo games in a building rented by the
organization were “compensated” when the organization’s rental
payments included payment for “all labor for the supervision and
handling of each bingo occasion upon the premises”).
Petitioner also argues that the security guards were not
petitioner’s workers in that petitioner paid the security agency
to safeguard petitioner against an attempted theft or robbery and
the guards did not actually work in carrying on petitioner’s
gaming operation. In this regard, petitioner asserts, the
security guards were not an attraction important to the success
of the gaming operation, the security guards provided little
labor in the absence of a theft or robbery, and the gaming
participants received no direct products or services from the
security guards. In addition, petitioner asserts, the guards
never called bingo numbers, never sold bingo cards or instant
pull-tab tickets, and never assisted in the actual administration
of the gaming operation.
We find petitioner’s argument unpersuasive. If the security
guards had not been present at the bingo games, petitioner would
have been precluded from conducting these games by virtue of the
State law requirement that security guards be present at bingo
games. Moreover, irrespective of that law, the security guards
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were physically present at the bingo games and at the locations
of the instant pull-tab ticket sales, and they were an integral
part of those activities. While petitioner asks this Court to
view the role of the security guards narrowly so as not to
consider them as working in the gaming operation absent their
acting in the setting of a robbery or an attempted robbery, we
decline to do so. The role of the security guards as we see it
was to prevent a robbery from being attempted in the first place,
primarily by virtue of their physical presence at the sites of
the bingo games and the instant pull-tab ticket sales. We
consider the security guards to be part of the workforce of the
gaming operation, cf. Waco Lodge No. 166, Benevolent & Protective
Order of Elks v. Commissioner, 696 F.2d 372 (5th Cir. 1983)
(concluding that a bartender’s services on bingo night were
connected with the carrying on of the bingo games although the
bar was down the hall from the games), affg. T.C. Memo. 1981-546,
and conclude that the security guards worked in the gaming
operation for purposes of the “substantially all” test.
Accordingly, on the basis of our review of the record before
us, we find that many (if not all) of the workers in the gaming
operation were compensated for their work. We do not find that
any of the workers in the gaming operation were uncompensated
within the meaning of section 513(a)(1). The gaming operation
was petitioner’s principal activity and was conducted by
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petitioner as a business for profit. Petitioner does not argue,
nor do we find, that this activity was in furtherance of its
exempt purpose.7 We therefore conclude that respondent properly
revoked petitioner’s tax-exempt status effective January 1, 1992,
because petitioner was not operated exclusively for an exempt
purpose. See Help the Children, Inc. v. Commissioner, 28 T.C.
1128 (1957); cf. Piety, Inc. v. Commissioner, supra. While
Congress allows certain organizations tax-exempt status for
specific limited activities, petitioner attempts to retain tax-
exempt status for activities that are outside of those permitted.
We have considered all arguments made by petitioner for a
contrary holding, and we conclude that any of those arguments not
discussed herein is without merit.
Decision will be entered for
respondent.
7
Nor does petitioner argue in its posttrial brief that any
part of its activities is a “bingo game” as defined in sec.
513(f)(2). In fact, as to petitioner’s sale of instant pull-tab
tickets, the source of most of petitioner’s gaming receipts in
each of the years 1992 through 1995, the parties have stipulated
that petitioner’s instant pull-tab ticket activity is not a
“bingo game” as defined in sec. 513(f)(2). See also Julius M.
Israel Lodge of B’nai B’rith No. 2113 v. Commissioner, 98 F.3d
190 (5th Cir. 1996) (affirming this Court’s determination that
instant bingo games are not “bingo games” within the meaning of
sec. 513(f)(2)), affg. T.C. Memo. 1995-439.