Factors for determining a bona-fide

(1) When an ATEO transfers money to a disqualified person and indicates it’s a loan,

we must first determine whether the transfer is a bona-fide loan. Generally, whether the transfer of funds from one party to another is a loan, or some other kind of transfer, such as a gift, dividend, or compensation, depends on the intent of the parties.

(2) The courts have provided factors to consider when analyzing loans. In Vinikoor v.

Commissioner, T.C. Memo 1998-152, the Tax Court identified the following nine factors to consider for analyzing loans:

a. the existence or absence of loan documents

b. whether interest was charged

c. security or collateral

d. a fixed maturity date

e. whether a demand for payment was ever made

f. any actual payment

g. the purported borrower’s ability to repay the loan

h. evidence in the lender’s and borrower’s books and records that the transfer

was treated as a loan and

i. how the transaction was reported for tax purposes

(3) The factors listed above aren’t exclusive, and no one factor is controlling. For

example, in Vinikoor, the promissory notes had no amortization schedule and no minimum payment.

(4) All the relevant facts and circumstances must be considered when evaluating

whether a bona-fide loan exists. For example, consider whether a schedule for payments was created, actual repayments were made, and any consequences if the repayment schedule wasn’t honored. In addition, the organization’s records and returns should reflect the indebtedness.

(5) Another factor to consider is whether the organization received any other

economic benefit. The value received by the disqualified person must exceed the value, or consideration, paid by the organization.

(6) Loan proceeds may not be the only economic benefit that the disqualified person

received. If the disqualified person hasn’t been paying interest, or paid belowmarket interest, the disqualified person has received a measurable economic benefit from the organization in the form of forgone interest. The forgone interest transfers occur annually regardless of whether any actual funds change hands.

(7) Even if transfers of funds were bona-fide loans, an organization providing loans to

disqualified persons may still constitute inurement because it serves a private rather than a public interest. See Treas. Reg. 1.501(c)(3)-1(d)(ii). In Founding Church of Scientology v. United States, 412 F.2d 1197 (Ct. Cl. 1969), the court held, "Indeed, the very existence of a private source of loan credit from an organization's earnings may itself amount to inurement of benefit." Examiners should consider whether the organization’s exempt purpose is furthered by the loans. If not, then the examiner should consider whether the loans constitute inurement that would justify proposing revocation.

(8) In Lowry Hospital Association v. Commissioner, 66 T.C. 850, 857-859 (1976),

which involved an exempt hospital founded by Dr. Lowry, the court held that the hospital didn’t qualify as tax-exempt under Section 501(c)(3) because some of the net earnings inured to the benefit of the founding physician. The court noted, “While the interest rate received by the petitioner on the unsecured loans was roughly equivalent to the interest rate it was receiving or could have received on passbook deposits from the local bank at the time the loan was made, the nursing home loans represented a substantially greater risk.” The court concluded that the exempt hospital executed loans that weren’t in its own best interest or made on an arm's-length basis.