Wednesday, September 17, 2014
The Washington Post has an interesting article on the National Football League, listing the various ways in which the NFL has been supported by taxpayers at the federal and state level over the decades, including of course through tax-exempt status as a 501(c)(6) organization. The article makes the general point that subsidies that were initially thought desirable when the NFL was a fledgling organization are harder to justify today. The New York Times also recently conducted a debate about the NFL’s tax-exempt status.
Taking aside the case for or against the NFL, the Post article represents a larger point about tax benefits and the ongoing need for them that could be applied to other exempt organizations, including charitable exempts such as hospitals and colleges and universities. Tax exemption, eligibility to receive deductible contributions, tax-exempt financing all become perpetual tax benefits. Although the original case for a tax benefit might be strong, over time as organizations grow, the case might weaken. Yet because benefits are written into the tax code, it is hard to make appropriate adjustments.
The NFL has attracted scrutiny because of high compensation for its commissioner, the personal conduct of players, and their (modest) punishment. This fits a pattern where scandal forces us to take a closer look at tax expenditures. In the case of the NFL, adjustments have been proposed, initially by Senator Coburn, and now also by Senator Cantwell (who cites the NFL’s refusal to change the name of the Washington Redskins).
The question though is whether as part of tax reform we should seriously examine tax-exemption and other related tax benefits for other exempt organizations as well, without waiting for a scandal.
Side comment: In the case of the NFL, the tax benefits conveyed may not be not obvious from the label “exempt status.” In general, the benefits are that NFL member teams accelerate deductible expenses to the extent the NFL does not spend member dues currently. In addition, the deduction for member dues to the NFL can convert capital expenditures to current deductions to the extent the NFL uses monies to invest in capital projects. Loss of tax-exempt status as proposed by Senators Coburn and Cantwell would eliminate both benefits. Another approach would be to tax the investment income of the NFL, or even 501(c)(6) organizations more broadly.
Monday, September 15, 2014
On September 4, 2014, I attended an excellent conference on the valuation of conservation easements in Sioux Falls, SD, sponsored by the North Star Chapter of the Appraisal Institute. The conference featured five representatives from the IRS:
- Lou Garone, MAI, SRA, IRS Senior Appraiser (firstname.lastname@example.org)
- Anita Gill, Supervisory Attorney, IRS Office of Chief Counsel (email@example.com)
- Karin Gross, Supervisory Attorney, IRS Office of Chief Counsel (firstname.lastname@example.org)
- Frank Molinari, SRA, IRS Senior Appraiser (email@example.com)
- Stephen Whiteaker, IRS Director of Field Operations (firstname.lastname@example.org)
The purpose of the conference was to help appraisers develop a greater understanding of the relevant requirements and the IRS’s intent to actively review appraisals in the easement context.
Below are some highlights from the conference that should be of interest not only to appraisers, but also to conservation easement donors and their legal advisors.
Avoid Embarrassing Cross-Examination at Trial. The IRS representatives staged a mock trial in which one of the IRS Senior Appraisers played the role of the taxpayer’s appraiser. The appraiser was required to defend the conservation easement appraisal he had prepared for the taxpayer years earlier. The appraisal was not well done, and the appraiser’s discomfiture at having to admit, among other things, inconsistencies in the appraisal, lack of support for his conclusions, and that some of the appraisal did not represent his own work product (he used data from another appraiser without verifying it), was very instructive (the content of the appraisal and the cross-examination were based on actual tax court trial proceedings). The IRS representatives explained that, when the value of a conservation easement is challenged, the goal on cross-examination of the taxpayer’s appraiser is to show that the appraiser is incompetent.
- The appraiser was also challenged regarding his engagement letter, which stated that he agreed “to determine the loss in the value of the subject property due to the conservation easement.” The “lawyer” cross-examining the appraiser noted that this statement implied the appraiser was acting as an advocate for the taxpayer, rather than with impartiality, objectivity, and independence as ethical rules require; that, as provided in Treasury Regulation § 1.170A-14(h)(3)(ii), “there may be instances where the grant of a conservation restriction may have no material effect on the value of the property or may in fact serve to enhance, rather than reduce, the value of property”; and that, in accordance with the Ethics Rule in USPAP, “An appraiser must not accept an assignment that includes the reporting of predetermined opinions and conclusions.”
A Dip in The Hot Tub. Judges may employ a new technique known as the “hot tub” method for the presentation of evidence on valuation. Rather than (or in addition to) having the government’s valuation expert and the taxpayer’s valuation expert testify separately, and often with a considerable time lapse in between, the experts may be called upon to “take a dip in the hot tub” and offer their opinions concurrently in a dialogue with the judge. One commentator explains:
Under the [hot tub] method, the experts engage in a face-to-face discussion with each other and the trial judge about all relevant issues dealing with their expert opinions and the underlying bases for such opinions. No longer is the process a disjointed mess. One foreign jurist lauds [the method] for making it possible for judges to avoid ‘having to compare a witness giving evidence now with the half-remembered evidence of another expert given perhaps some weeks previously.’ Not only does the basic premise of concurrent evidence better assist the trier of fact in highlighting and reconciling competing evidence, it results in an effective medium for reducing partisan bias as well as the time and expense of litigation.
Michael R. Devitt, A Dip in the Hot Tub: Concurrent Evidence Techniques for Expert Witnesses in Tax Court Cases, 117 J. Tax’n 213 (Oct. 2012).
Tax Court Judge Laro employed this technique in Crimi v. Comm'r, T.C. Memo. 2013-51, involving a bargain sale of land. He explained:
An expert qualified to testify in a judicial proceeding owes a duty to the Court that transcends the duty to his or her client insofar as the expert must present his or her opinion, as well as the facts, data, and analysis on which he or she relied, neutrally and candidly…. Experts who breach their duty to the Court in order to advance their client's litigating position compromise their usefulness. We are mindful of the “cottage industry of experts who function primarily in the market for tax benefits”…and our concerns about the helpfulness of expert testimony in one recent case, and in these cases, led us to have the experts testify concurrently…. The concurrent testimony in these cases enabled us to more easily separate the reliable portions of the expert reports from the unreliable, and consequently, to expedite our decisionmaking process….
One of the IRS Senior Attorneys at the Sioux Falls conference explained that another Tax Court Judge had recently employed the hot tub method in a case involving a challenge to a deduction for a conservation easement donation (the opinion in that case has not yet been issued). She also cautioned that, if a Judge thinks an appraiser is acting as an advocate for the taxpayer, the court may throw out the expert’s report and testimony. See Boltar v. Comm'r, 136 T.C. 326 (2011). Judges, she said, take very seriously the fact that valuation experts should be independent and their role is to assist the court, not advocate for the client’s position.
Valuation Will Generally be an Issue in Litigation. Unless the IRS agrees with an appraisal, valuation will generally be raised as an issue in litigation even if substantiation of the deduction or satisfaction of the requirements of § 170(h) and the Treasury Regulations are also contested. This is because (i) the IRS may not be successful on substantiation or qualification grounds and contesting valuation provides them with a fallback position and (ii) as part of the Pension Protection Act of 2006, Congress expanded the circumstances under which penalties can be imposed for overvaluations.
Scope of Assignment. An appraiser may find him or herself having to defend a conservation easement appraisal in the context of an audit or litigation many years after the appraisal was prepared. This can be difficult and time consuming. Appraisers should define the scope of a conservation easement valuation assignment in the engagement letter and make it clear that, if the valuation is later challenged, defense of the appraisal would be a separate assignment for which the appraiser must be paid.
Red Flags. The following “red flags” in conservation easement appraisals may lead to greater scrutiny, audit, and litigation:
- Appraisal does not conform to generally accepted appraisal standards (USPAP).
- Appraisal does not comply with Internal Revenue Code and Treasury Regulation requirements.
- Appraisal relies on unconventional (not widely used or accepted) analysis.
- Analysis is not thorough or consistent with the conclusions reached.
- Conclusions are based on unsupported opinion versus facts, or on assumptions that are not reasonable or supported by the market. If the appraisal includes TMBs ("Trust me Baby" assertions) and LOFs ("Leaps of Faith") in lieu of good data and fully supported analysis, the appraiser loses all credibility.
- Highest and best use analysis is not preceded by market analysis.
- Failure to explain why potential comparable sales were not used; all comparables are adjusted in one direction; comparables are from outside the geographic area in which the subject property is located.
- Failure to include relevant information in report (e.g., failure to note that the property was listed for sale at a certain price and did not sell).
- Subdivision development analysis is based on assumptions that are not supported by the market or thoroughly explained (less than optimum comparable sales are better than a manufactured assumptions).
- Estimated value from subdivision development analysis is not consistent with comparable sales.
- Computational errors.
- Bad grammar.
- Bad writing.
Good Writing Is Crucial. The ability to communicate is a key element in meeting IRS expectations.
- A good appraisal is well-written, easy to follow, and holds the reader’s interest. It logically leads the reader from the presentation of the data to a reasonable, fact-based and market-supported conclusion.
- Consider the audience for the appraisal—it is not just the easement donor. Other users include the IRS and the court. If an IRS agent (who is not an appraiser) cannot understand the appraisal, he or she will send it to an IRS appraiser for scrutiny. Write the appraisal report to communicate the analysis and conclusions to the least sophisticated reader.
- Longer is not necessarily better—a clear, concise, fully-supported appraisal report that avoids excess verbiage and unnecessary jargon is best. If parts of a report are incomprehensible, IRS appraisers (all of whom have over 20 years of experience) will pull out the pencil sharpener and go to work.
- In the words of Albert Einstein: “If you can’t explain something simply, you don’t understand it well.” Or, in the words of a conference attendee from Arkansas: “Put the cookies on the low shelf where everyone can reach in and get em.’”
Fair Market Value. The definition of fair market value for charitable contribution purposes is:
the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. Treas. Reg. §1.170A-1(c) (2).
In other words, fair market value is the price at which the taxpayer could realistically sell the land in its current state on the open market. This most basic of rules is sometimes lost in a flood of data, statistics, and assumptions, particularly when an appraiser relies on the subdivision development analysis. At the end of the day, the appraiser should ask him or herself: Could this property realistically be sold on the open market for the value I have estimated?
HBU. An appraiser cannot come to an accurate conclusion about highest and best use without doing a thorough market analysis. The foundation of all valuation considerations lies in the accurate and reasonable analysis of the market in which a property competes. Does the conclusion make sense? If you build it, will they come?
Conservation Purposes. The appraiser should examine the property, the baseline documentation, and the final version of the conservation easement deed. An appraiser cannot, for example, prepare an accurate appraisal without knowing that there are endangered species on a property, the presence of which will limit the property’s development under federal law. Similarly, an appraiser cannot prepare an accurate appraisal without knowing the final (as opposed to draft) terms of the easement.
Be Specific. Do not wax on about South Dakota if the property is located in Sioux Falls; focus on Sioux Falls.
Entire Contiguous Parcel and Enhancement Rules. Although both rules are set forth in Treasury Regulation § 1.170A-14(h)(3)(i), they are different and require different analyses.
- Entire Contiguous Parcel Rule. The regulation provides that “[t]he amount of the deduction in the case of a charitable contribution of a perpetual conservation restriction covering a portion of the contiguous property owned by a donor and the donor's family…is the difference between the fair market value of the entire contiguous parcel of property before and after the granting of the restriction.” This difference is the amount that should be reported as the “appraised fair market value” of the donated easement on the IRS Form 8283 (the “appraisal summary”) when this rule applies.
- IRS Chief Counsel Memorandum 201334039 provides in a footnote that “Whether the entire contiguous parcel is valued as one large property or as separate properties depends on the highest and best use (HBU) of the entire contiguous parcel.” One of the IRS Senior Appraisers explained that, if the entire contiguous parcel consists of multiple parcels and each has a unique HBU, the parcels should be valued separately. However, that does not mean the appraiser should simply add the values together to come up with the value of the entire contiguous parcel. The aggregate of the values might not be the same as what a willing buyer would pay a willing seller for the entire contiguous parcel. If the appraiser can show that the entire contiguous parcel could be sold for the aggregate of the values in short order (within a year), then the aggregate of the values is fair market value of the entire contiguous parcel. But if the entire contiguous parcel could not be sold in short order for the aggregate of the values, then the appraiser must apply an appropriate discount.
- Enhancement Rule. The regulation provides that “[i]f the granting of a perpetual conservation restriction…has the effect of increasing the value of any other property owned by the donor or a related person [i.e., property not captured by the entire contiguous parcel rule], the amount of the deduction for the conservation contribution shall be reduced by the amount of the increase in the value of the other property, whether or not such property is contiguous.” The IRS Senior Appraisers explained that estimating this “enhancement” is a separate step in the appraisal process. Moreover, enhancement does not affect the “appraised fair market value” of the easement that must be reported on the Form 8283 (see above). Rather, any enhancement should be explained in an attachment to the Form 8283. It is the taxpayer’s responsibility to then reduce the amount of the deduction claimed on his or her tax return by the estimated enhancement.
- What is Contiguous? There was a slight disagreement regarding how to determine whether properties are contiguous. One of the IRS Supervisory Attorneys indicated that state law controls. One of the IRS Senior Appraisers, on the other hand, said appraisers should use common sense. He said contiguity requires a case-by-case judgment call and the appraiser must be able to support his or her analysis. As examples, he said properties separated by a four-lane highway are not contiguous, but properties separated by a dirt path are.
- Family and Related Persons. For details on the definitions of “family” and “related person” see IRS Chief Counsel Memorandum 201334039.
Assuming Zoning Changes. If the appraiser is assuming that current zoning could be changed, the appraiser must consider the time it would take to make the change (delay), the costs associated with making the change, and the probability that the change would be made.
Quid Pro Quo. The burden of proof is on the taxpayer to show that the value of a conservation easement exceeds the value of any quid pro quo received in exchange. In Seventeen Seventy Sherman Street v. Comm'r, 2014-124, the Tax Court held that the taxpayer’s failure to identify and value all of the quid pro quo received in exchange for the donation of a façade easement was fatal to the deduction. Accordingly, the appraiser may have to value not only the conservation easement, but also the quid pro quo. If the taxpayer is a developer or it appears that the easement was conveyed in exchange for some sort of development approval or variance, the IRS representatives will look for quid pro quo.
Extinguishment. The only way to extinguish a tax-deductible easement is through condemnation or in a judicial proceeding in which it is established that an unexpected change in conditions surrounding the property has made continued use of the property for conservation purposes impossible or impracticable. See Treas. Reg. § 1.170A-14(g)(6); Carpenter v. Comm'r, T.C. Memo. 2013-172. Extinguishments should be very rare. This is important for appraisal purposes because the fact that an easement is intended to restrict the development and use of the property in perpetuity (i.e., until condemnation or a court finds impossibility or impracticality) will affect the value of the easement.
Bargain Sales. Sometimes a land trust or government entity will purchase a conservation easement for its fair market value based on an appraisal commissioned by that entity. The seller, however, may commission its own appraisal indicating that the purchase price was less than fair market value and attempt to claim a deduction for the “donation” component. In such an instance, the purchasing entity should not sign an IRS Form 8283 (in which it would have to represent that a charitable donation has been made), and the entity may be asked to provide the IRS with its appraisal. See, e.g., Headlands Reserve, LLC v. Ctr. for Natural Lands Mgmt., 523 F. Supp. 2d 1113 (C.D. Cal. Nov. 16, 2007).
Timeliness of Appraisal. A qualified appraisal must prepared (i) not earlier than 60 days before the date of the contribution of a conservation easement and (ii) not later than the due date (including extensions) of the return on which a deduction for the easement is first claimed. It is the IRS’s position that the date of the contribution of a conservation easement is the date on which the easement is recorded in the local land use records. Before that time, the easement is not “enforceable in perpetuity.” See Zarlengo v. Comm'r, T.C. Memo. 2014-161. Accordingly, if recordation of an easement is delayed, the appraiser may have to update the appraisal to fall within the 60-day window.
- It is best for the appraiser to make changes to (i.e., update) the existing appraisal and then sign and date the new updated appraisal. While addendums to the original report are sometimes used, an updated appraisal is easier to review and understand than an original report plus an addendum, and IRS representatives are sometimes provided with only the addendum, not the original report, which can slow down the review process.
- Simply changing the date on an appraisal is not sufficient to update the appraisal. The appraiser must, at a minimum, include a cover letter stating that he or she revisited the property and reviewed the appraisal and all relevant data to see if any of the data, analysis, or conclusions needed to be updated, and that he or she determined that no changes were necessary.
Appraiser’s Handbook. Suggested materials to be included in an appraiser’s “conservation easement handbook” include:
- Internal Revenue Code § 170(h) and § 170(f)(11).
- Treasury Regulation § 1.170A-13(c).
- Treasury Regulation § 1.170A-14.
- IRS Form 8283 and Instructions.
- IRS Publication 561, Determining the Value of Donated Property.
- IRS Publication 526, Charitable Contributions.
- IRS Notice 2006-96.
- Chief Counsel Memorandum 201334039.
Conservation Easement Valuation Cases. The IRS Senior Appraisers referenced the following cases as providing helpful insights regarding the valuation of easements.
- Trout Ranch v. Comm'r, 493 Fed. Appx. 944 (10th Cir. 2012) (unpublsihed), aff'g T.C. Memo. 2010-283
- Boltar v. Comm'r, 136 T.C. 326 (2011)
- Esgar Corp. v. Comm’r, 744 F.3d 648 (10th Cir. 2014), aff’g T.C. Memo. 2012-35
- Palmer Ranch v. Comm'r, T.C. Memo. 2014-79
- Schmidt v. Comm'r, T.C. Memo. 2014-159
Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law
The Tax Policy and Charities Project of the Urban Institute has released preliminary estimates of the impact of Chairman Dave Camp's tax reform plan on charitable giving. The overall estimate is that giving would decrease by 7 to 14 percent if the entire plan were adopted. The wide range is due to uncertainty about individual responsiveness to the tax incentive. The estimate is broken into four parts, taking into account: changes to the rate structure, the increase to the standard deduction, modifications to other itemized deductions, and direct reforms to the charitable deduction itself (e.g., the 2% of AGI floor and percentage limit changes). The estimate finds that the marginal tax benefit attributable to the charitable deduction would fall by nearly half, from about 23% to 12%.
Here is the abstract: This note estimates the effects of four groups of provisions from the Tax Reform Act of 2014 on individual charitable giving. The provisions of the tax reform plan, released earlier this year by House Ways and Means Committee Chairman Dave Camp (R-MI), are estimated to decrease individual giving by 7 to 14 percent.
Sunday, September 7, 2014
The American College of Trust and Estate Counsel and Boston College Law School are organizing the 6th Academic Symposium financially supported by the ACTEC Foundation. The symposium, The Centennial of the Estate Tax: Perspectives and Recommendations, will be held at Boston College Law School on Friday, October 2, 2015.
The symposium will examine the estate tax, which will have its 100th anniversary in 2016. Panels will address:
- whether it is it desirable to tax the gratuitous transfer of wealth during life or at death,
- whether methods other than an estate and gift tax could better address problems associated with wealth concentration, and
- what improvements could be made to the existing estate and gift tax system.
Michael Graetz, Columbia Alumni Professor of Tax Law at Columbia Law School and author of Death by a Thousand Cuts: The Fight Over Taxing Inherited Wealth (with Ian Shapiro) (Princeton University Press 2005), will be the symposium’s key-note speaker.
Papers presented at the symposium will consist of papers selected from this Call for Papers and papers from invited speakers. Symposium papers will be published in a Symposium Edition of the Boston College Law Review in May 2016. If you would like to be considered to be a presenter for one of the panels, please submit an abstract of your paper to James Repetti by email (Repetti@bc.edu) by December 1, 2014. Submissions that address domestic or international perspectives are welcomed, and submissions from new, as well as experienced, scholars are encouraged. The Boston College Law Review will notify individuals chosen to participate in the symposium by email no later than January 15, 2015.
Symposium speakers will be required to submit a draft of their papers by September 1, 2015. Symposium speakers will be reimbursed for their travel expenses (airfare and the cost of ground transportation and hotel) courtesy of an ACTEC Foundation grant. Speakers will also be invited to a Speakers’ Dinner on the evening of Thursday, October 1, and breakfast and lunch will be provided to both speakers and attendees on Friday, October 2, courtesy of the ACTEC Foundation grant.
Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law
Wednesday, September 3, 2014
(Note: This is a cross-posted multiple part series from WVU Law Prof. Josh Fershee from the Business Law Prof Blog and Prof. Elaine Waterhouse Wilson from the Nonprofit Law Prof Blog, who combined forces to evaluate benefit corporations from both the nonprofit and the for-profit sides. The previous installment can be found here (NLPB) and here (BLPB).)
What It Is: So now that we’ve told you (in Part I) what the benefit corporation isn’t, we should probably tell you what it is. The West Virginia statute is based on Model Benefit Corporation Legislation, which (according to B Lab’s website) was drafted originally by Bill Clark from Drinker, Biddle, & Reath LLP. The statute, a copy of which can be found, not surprisingly, at B Lab’s website, “has evolved based on comments from corporate attorneys in the states in which the legislation has been passed or introduced.” B Lab specifically states that part of its mission is to pass legislation, such as benefit corporation statutes.
As stated by the drafter’s “White Paper, The Need and Rationale for the Benefit Corporation: Why It is the Legal Form that Best Addresses the Needs of Social Entrepreneurs, Investors, and, Ultimately, the Public” (PDF here), the benefit corporation was designed to be “a new type of corporate legal entity.” Despite this claim, it’s likely that the entity should be looked at as a modified version of traditional corporation rather than at a new entity.
This is because the Benefit Corporation Act appears to leave a lot of room for the traditional business corporations act to serve as a gap-filler. West Virginia Code § 31F-1-103(c), for example, explains, “The specific provisions of this chapter control over the general provisions of other chapters of this code.” Thus, the benefit corporation provisions supplant the traditional business corporation act where stated specifically, such as with regard to fiduciary duties, but general provisions of the business corporations act apply where the benefit corporation act is silent, such as with regard to dissolution.
In contrast, the West Virginia Nonprofit Corporation Act is a broader act that discusses dissolution, mergers, and other items specifically in a way that more clearly indicates the nonprofit is a distinct, rather than modified, entity form. Furthermore, a benefit corporation is actually formed under the Business Corporations Act: “A benefit corporation shall be formed in accordance with article two, chapter thirty-one-d of this code, and its articles as initially filed with the Secretary of State or as amended, shall state that it is a benefit corporation.” W. Va. Code § 31F-2-201.
So what makes a benefit corporation unique?
1. Corporate purpose - The traditional West Virginia business corporation is created for the purpose “of engaging in any lawful business unless a more limited purpose is set forth in the articles of incorporation.” W. Va. Code § 31D-3-301. Under the Benefit Corporation Act, “A benefit corporation shall have as one of its purposes the purpose of creating a general public benefit.” Id. § 31F-3-301. A specific benefit may be stated as an option, but is not required. Note similarly that a part of the corporation’s purpose must be for general public benefit, but that benefit need not be a primary, substantial, significant or other part of the corporation’s purpose.
For purpose of comparison, the low-profit limited liability company (or L3C) typically has a much more onerous purpose requirement. For example, the Illinois L3C law requires
(a) A low-profit limited liability company shall at all times significantly further the accomplishment of one or more charitable or educational purposes within the meaning of Section 170(c)(2)(B) of the Internal Revenue Code of 1986, 26 U.S.C. 170(c)(2)(B), or its successor, and would not have been formed but for the relationship to the accomplishment of such charitable or educational purposes.
2. Standard of conduct – The statute requires, in § 31F-4-401, that the directors and others related to the entity:
(1) Shall consider the effects of any corporate action upon:
(A) The shareholders of the benefit corporation;
(B) The employees and workforce of the benefit corporation, its subsidiaries, and suppliers;
(C) The interests of customers as beneficiaries of the general or specific public benefit purposes of the benefit corporation;
(D) Community and societal considerations, including those of each community in which offices or facilities of the benefit corporation, its subsidiaries, or suppliers are located;
(E) The local and global environment;
(F) The short-term and long-term interests of the benefit corporation, including benefits that may accrue to the benefit corporation from its long-term plans and the possibility that these interests and the general and specific public benefit purposes of the benefit corporation may be best served by the continued independence of the benefit corporation; and
(G) The ability of the benefit corporation to accomplish its general and any specific public benefit purpose;
(emphasis added). While these are significant mandatory considerations, they are nothing more than considerations. Directors and others “[n]eed not give priority to the interests of a particular person referred to in subdivisions (1) and (2) of this section over the interests of any other person unless the benefit corporation has stated its intention to give priority to interests related to a specific public benefit purpose identified in its articles.” § 31F-4-401(a)(3).
As such, while directors must consider the general public benefit of their decisions (and any specific benefits if so chosen), it is not clear the ultimate decision making of a benefit corporation director would necessarily be any different than a traditional corporation. That is, a director of a benefit corporation could, for example, consider the impacts on a town of closing a plant (and determine it would be hard on the town and the workforce), but ultimately decide to close the plant anyway.
Furthermore, many corporations seek to serve communities and benefit the public. McDonald’s, Coca-Cola, and many others already have programs to benefit the public, so it appears that many traditional corporations have already volunteered to meet and exceed the standards of the West Virginia benefit corporations act.
3. Formation – An entity becomes a benefit corporation by saying so when filing initial articles of incorporation with the Secretary of State, § 31F-2-201, or by amending the articles of an already created corporation, § 31F-2-202. Presumably, this serves a notice function, informing the benefit corporation’s current and potential constituents that there is the possibility that profit maximization will not be (or may not be) the corporation’s primary goal. The notice function does not work in reverse, however, as benefit corporation status does guarantee that public benefits have any primacy at all, merely that such benefits will be considered.
4. Termination - Termination of the benefit corporation status is allowed and is achieved by changing the articles of incorporation in the same manner in which traditional corporations modify their articles. § 31D-10-1003. As a result, it doesn’t appear that there is anything in the statute from preventing a benefit corporation from reaping the public relations or capital raising upside of being a benefit corporation, and thereafter abandoning the status should it become inconvenient. Query whether to the extent a transfer to a benefit corporation could be deemed a gift for a public purpose, the Attorney General might have oversight over the contribution in the same manner as it has oversight in cy pres and similar proceedings.
5. Enforcement – Third parties have no right of action to enforce the benefit goals unless they are allowed to use derivatively as “specified in the articles of incorporation or bylaws of the benefit corporation.” Id. § 31F-4-403. Otherwise, a direct action of the corporation or derivative actions from a director or shareholder are the only ways to commence a “benefit enforcement proceeding.” Again, the statute does not give the Attorney General specific statutory authorization to proceed on the basis that a member of the public may have transferred funds to the benefit corporation in reliance upon its benefit corporation status.
So, the statute provides the option for stating and pursuing general and specific benefits, but there are not a lot of structural assurances to anyone—investor, lender, public—that a benefit corporation will actually benefit anyone other than its equity holders. But benefit corporations are required to consider doing so. This is not to say there isn’t some value. As Haskell Murray has noted,
Directors would benefit from having a primary master and a clear objective. . . . [But,] [t]he mandate that a benefit corporation pursue a "general public benefit purpose" is too vague because it does not provide a practical way for directors to make decisions.
As such, an entity may create a clear set of priorities and guidelines that could provide useful and lead to benefits, but the benefit corporation act most certainly does not mandate that.
Finally, although most of the above is focused on the West Virginia benefit corporation law, much of it applies to the other versions of such laws in other states. Cass Brewer notes
Effective July 1, 2014, West Virginia’s benefit corporation statute generally follows the B-Lab model legislation, but among other things relaxes the “independence” tests for adopting third-party standards and does not require the annual benefit report to disclose director compensation.
As an additional resource, Haskell Murray provides a detailed chart of the state-by-state differences, here.
Next up: Part III - So Why Bother? Isn’t the Business Judgment Rule Alive and Well?
EWW & JPF
For those who use Jim Fishman and Steve Schwarz's casebook, Nonprofit Organizations, Cases and Materials (4th ed. 2010), the 2014 Student Update is available here and 2014 Teacher's Manual Update is available here (instructor login required). (Full disclosure: I collaborated on these updates.)
The Nonprofit and Voluntary Sector Quarterly (actually bi-monthly) has published its August 2014 issue. Here is the table of contents:
- Gordon Liu, Teck-Yong Eng, and Yasmin Kaur Sekhon, Managing Branding and Legitimacy: A Study of Charity Retail Sector
- Leif Atle Beisland and Roy Mersland, Earnings Quality in Nonprofit Versus For-Profit Organizations: Evidence From the Microfinance Industry
- Lindsey M. McDougle and Marcus Lam, Individual- and Community-Level Determinants of Public Attitudes Toward Nonprofit Organizations
- Moonhee Cho and Kathleen S. Kelly, Corporate Donor–Charitable Organization Partners: A Coorientation Study of Relationship Types
- Elizabeth A. Bloodgood, Joannie Tremblay-Boire, and Aseem Prakash. National Styles of NGO Regulation
- Chung-An Chen, Nonprofit Managers’ Motivational Styles: A View Beyond the Intrinsic-Extrinsic Dichotomy
- Sergej Ljubownikow and Jo Crotty, Civil Society in a Transitional Context: The Response of Health and Educational NGOs to Legislative Changes in Russia’s Industrialized Regions
- Kevin P. Kearns, Book Review: America’s Nonprofit Sector: A Primer (3rd Edition). by L. M. Salamon
- Kathi Coon Badertscher, Book Review: Almost Worthy: The Poor, Paupers, and the Science of Charity in America, 1877-1917 by B. J. Ruswick
- Kathleen Hale, Book Review: Solidarity in Strategy: Making Business Meaningful in American Trade Associations by L. Spillman
The Globe and Mail reports that the Canada Revenue Agency (CRA) has told Oxfam Canada that its mission statement is too broad in that it provides the organization's purpose in that it includes preventing poverty, which might benefit people who are not already poor. CRA therefore concluded that preventing poverty is not an acceptable goal when asked to approval Oxfam CAnada's application for renewal of its non-profit statuts with Industry Canada. Oxfam Canada eventually conceded the point, by using the term "alleviate" instead of "end" or "prevent" in its revised mission statement. The newspaper report notes OxFam Canada has proven to be a thorn in the current Canadian government's side, and cites (not directly related) allegations that CRA is selectively auditing charities that have criticized government policies.
Over the summer those who believe the controversy is overblown - or even that the IRS did not do anything wrong in the first place - could point to a report from the Center for Public Integrity that the IRS had denied the exemption application of the left-leaning Arkansans for Common Sense as evidence that the IRS was, or least now is, even-handed in its treatment of such applications.
Critics of the IRS could point to a report from Judicial Watch that Justice Department attorneys have admited the emails of Lois Lerner and other IRS officials are not truly lost, but that it is simply too onerous to retrieve them from an apparently cumbersome backup system. (Additional coverage: The Hill; The Washington Free Beacon). They also could point to the decision by federal District Court Chief Judge Susan J. Dlott to let some of the claims made by NorCal Tea Party Patriots against the IRS proceed, although a careful reading of Judge Dlott's opinion reveals that some of the asserted claims did not in fact survive motions to dismiss. More specifcally, the claim of vionlations of the First and Fifth Amendments and of section 6103 (relating to confidentiality of tax return information) survived the motions to dismiss as against Treasury, the IRS, and IRS employees in their official capacities, but the constitutional claims did not survive as against IRS employees in their individual capacities (the 6103 claim was not asserted against the employees in their individual capacities). Interestingly, in allowing the constitutional claims to proceed the court relied significantly on an earlier opinion in the pending Z Street case.
Wednesday, August 27, 2014
The New York Times reports that members of the Board of Directors for the section 501(c)(6) United States Tennis Association appear to have numerous conflicts of interest. For example, the article reports that one board member's company is the largest single contractor with the USTA, receiving almost $3 million in 2012, and another board member is the executive director of a nonprofit that received almost $1 million in grants from a USTA charitable affiliate over three years. In response, the USTA denied that the board members had any say in the decision that led to funds going to organizations with which they are affiliated.
Yesterday the Department of the Treasury and the IRS issued the 2014-2015 Priority Guidance Plan. Included in the Exempt Organizations section of the list are numerous continuing projects, but also several new entries. The most notable new entry is "Proposed Regulations under 501(c) relating to political campaign intervention.", indicating that Treasury and the IRS plan to look at the political campaign intervention more broadly that just with respect to 501(c)(4) social welfare organizations.
Here is the full list:
1. Revenue Procedures updating grantor and contributor reliance criteria under §§170 and 509.
2. Revenue Procedure to update Revenue Procedure 2011-33 for EO Select Check.
3. Regulations under §§501(a), 501(c)(3), and 508 to allow the Commissioner to adopt a streamlined application process that eligible organizations may use to apply for recognition of tax-exempt status under §501(c)(3).
• PUBLISHED 07/02/14 in FR as TD 9674 (FINAL and TEMP) and REG-110948-14 (NPRM).
4. Revenue procedure setting forth procedures for issuing determination letters on exempt status under §501(c)(3) to eligible organizations that submit Form 1023-EZ.
• PUBLISHED 07/21/14 in IRB 2014-30 as REV. PROC. 2014-40 (RELEASED 07/01/2014).
5. Proposed regulations under §501(c) relating to political campaign intervention.
6. Final regulations on application for recognition of tax exemption as a qualified nonprofit health insurer under §501(c)(29) as added by §1322 of the ACA. Temporary and proposed regulations were published on February 7, 2012.
7. Final regulations under §§501(r) and 6033 on additional requirements for charitable hospitals as added by §9007 of the ACA. Proposed regulations were published on June 26, 2012 and April 5, 2013.
8. Additional guidance on §509(a)(3) supporting organizations.
9. Guidance under §512 regarding methods of allocating expenses relating to dual use facilities.
10. Guidance under §4941 regarding a private foundation's investment in a partnership in which disqualified persons are also partners.
11. Final regulations under §§4942 and 4945 on reliance standards for making good faith determinations. Proposed regulations were published on September 24, 2012.
12. Final regulations under §4944 on program-related investments and other related guidance. Proposed regulations were published on April 19, 2012.
13. Guidance regarding the excise taxes on donor advised funds and fund management.
14. Guidance under §6033 relating to the reporting of contributions.
15. Final regulations under §6104(c). Proposed regulations were published on March 15, 2011.
16. Final regulations under §7611 relating to church tax inquiries and examinations. Proposed regulations were published on August 5, 2009.
Tuesday, August 26, 2014
West Virginia is the latest jurisdiction to adopt benefit corporations – the text of our legislation can be found here. As with all benefit corporation legislation, the thrust of West Virginia’s statute is to provide a different standard of conduct for the directors of an otherwise for-profit corporation that holds itself out as being formed, at least in part, for a public benefit. (Current and pending state legislation for benefit corporations can be found here.)
As WVU Law has two members of the ProfBlog family in its ranks (Prof. Josh Fershee (on the Business Law Prof Blog) and Prof. Elaine Waterhouse Wilson (on the Nonprofit Law Prof Blog)), we combined forces to evaluate benefit corporations from both the nonprofit and the for-profit sides. For those of you on the Business Prof blog, some of the information to come on the Business Judgment Rule may be old hat; similarly, the tax discussion for those on the Nonprofit Blog will probably not be earth-shaking. Hopefully, this series will address something you didn’t know from the other side of the discussion!
Part I: The Benefit Corporation: What It’s Not: Before going into the details of West Virginia’s legislation (which is similar to statutes in other jurisdictions), however, a little background and clarification is in order for those new to the social enterprise world. A benefit corporation is different than a B Corporation (or B Corp). B Lab, which states that it is a “501(c)(3) nonprofit” on its website, essentially evaluates business entities in order to brand them as “Certified B Corps.”
It wants to be the Good Housekeeping seal of approval for social enterprise organizations. In order to be a Certified B Corp, organizations must pass performance and legal requirements that demonstrate that it meets certain standards regarding “social and environmental performance, accountability, and transparency.” Thus, a business organized as a benefit corporation could seek certification by B Lab as a B Corp, but a business is not automatically a B Corp because it’s a state-sanctioned benefit corporation – nor is it necessary to be a benefit corporation to be certified by B Labs.
In fact, it’s not even necessary to be a corporation to be one of the 1000+ Certified B Corps by B Lab. As Haskell Murray has explained,
I have told a number of folks at B Lab that "certified B corporation" is an inappropriate name, given that they certify limited liability companies, among other entity types, but they do not seem bothered by that technicality. I am guessing my fellow blogger Professor Josh Fershee would share my concern. [He was right.]
A benefit corporation is similar to, although different from, the low-profit limited liability company (or L3C), which West Virginia has not yet adopted. (An interesting side note: North Carolina abolished its 2010 L3C law as of January 1, 2014.) The primary difference, of course, is that a benefit corporation is a corporation and an L3C is a limited liability company. As both the benefit corporation and the L3C are generally not going to be tax-exempt for federal income tax purposes, the state law distinction makes a pretty big difference to the IRS. The benefit corporation is presumably going to be taxed as a C Corporation, unless it qualifies and makes the election to be an S Corp (and there’s nothing in the legislation that leads us to believe that it couldn’t qualify as an S Corp as a matter of law). By contrast, the L3C, by default will be taxed as a partnership, although again we see nothing that would prevent it from checking the box to be treated as a C Corp (and even then making an S election). The choice of entity determination presumably would be made, in part, based upon the planning needs of the individual equity holders and the potential for venture capital or an IPO in the future (both very for-profit type considerations, by the way). The benefit corporation and the L3C also approach the issue of social enterprise in a very different way, which raises serious operational issues – but more on that later.
Finally, let’s be clear – a benefit corporation is not a nonprofit corporation. A benefit corporation is organized at least, in some part, to profit to its owners. The “nondistribution constraint” famously identified by Prof. Henry Hansmann (The Role of Nonprofit Enterprise, 89 Yale Law Journal 5 (1980), p. 835, 838 – JSTOR link here) as the hallmark of a nonprofit entity does not apply to the benefit corporation. Rather, the shareholders of a benefit corporation intend to get something out of the entity other than warm and fuzzy do-gooder feelings – and that something usually involves cash.
In the next installments:
Part II – The Benefit Corporation: What It Is.
Part III – So Why Bother? Isn’t the Business Judgment Rule Alive and Well?
Part IV – So Why Bother, Redux? Maybe It’s a Tax Thing?
Part V - Random Thoughts and Conclusions
EWW and JPF
The Oregonian reports that lawyers have filed a class-action lawsuit in state court against Regence BlueCross BlueShield, claiming that the (taxable) nonprofit is acting like a for-profit company. More specifically, the lawsuit asserts that Regence is accumulating excess funds to support large, executive salaries instead of using those funds to benefit its members. The lawsuit points specifically to a public-purpose clause in Regence's bylaws that it claims is violated by these practices. The article further reports that Regence has responded by stating that the claim is without merit and that it intends to aggressively defend itself against the allegations.
Maryland Environmental Trust (MET), one of the oldest and largest land trusts in the country, with the assistance of the Maryland Attorney General’s Office, recently settled a suit enforcing a conservation easement that protects a 31-acre parcel near the Chesapeake Bay. Created by statute in 1967, MET is affiliated with the Maryland Department of Natural Resources and is represented by the Maryland AG’s Office. The easement, among other things, prohibits timbering of the forestland on 13 of the 31 acres to protect the habitat of forest interior dwelling bird species, such as the scarlet tanager (pictured above). These birds, the populations of which are declining in Maryland, live in tall mature trees and need a closed forest canopy.
Mr. and Mrs. Hooper granted the conservation easement to MET in 1999. Five years later they sold the property to a new owner but moved only a short distance away. In early 2012, the Hoopers became aware that the new owner was timbering within the 13-acre restricted area. Deeply concerned, the Hoopers contacted MET and MET confirmed that over 200 mature large girth hardwood trees had been removed from the restricted area. The removal of large portions of the forest canopy had destroyed the bird habitat and permitted invasive Japanese stiltgrass to flourish on the property.
Representatives from MET and Maryland AG’s Office met with the new owner to attempt to resolve the issues, but MET eventually had to file suit against the new owner for both the timber violation and a dumping violation (the new owner had also buried debris from a demolished garage on the property in violation of the easement). MET asked the trial court to require a remediation plan developed by the Maryland Department of Natural Resources that would eradicate the invasive stiltgrass and, over time, reestablish the hardwood trees. The plan indicated that it would take at least 50 years to reestablish the tree canopy needed by the forest interior dwelling bird species. MET also sought the $24,000 the new owner had earned from the sale of the timber on the ground of unjust enrichment.
MET, the Maryland AG’s Office, and the new owner discussed a possible settlement until the eve of trial but were unable to come to agreement. The one-day trial took place in July 2014. MET entered numerous exhibits, including its investigation report; photos of the destruction in the timbered area; photos of the site of the dumping and burial of the garage debris; and resumes of expert witnesses from the Maryland Department of Natural Resources who were prepared to testify, including a forestry expert, an invasive plant ecologist, and the state zoologist. MET’s stewardship manager was also in the courtroom and prepared to testify about the damage to the property.
After MET entered its exhibits, the new owner, who had no expert witnesses, offered to sign MET’s settlement agreement. MET’s Director accepted the offer and the trial court judge’s order approving the settlement requires, at the new owner’s expense and within specified time periods: (i) implementation of the Maryland Department of Natural Resources’ recommended reforestation and stiltgrass eradication plans (at an estimated cost of close to $30,000) and (ii) removal of the buried debris. The new owner is also required to pay MET $7,500 for the unjust enrichment claim and a $1,000 penalty for any payment or deadline with which he fails to comply.
After settling with MET, the new owner, a former attorney, proceeded with his third party claim against the lumber company that had timbered the property. He claimed that it was the lumber company’s responsibility to determine which trees could be cut on the property. He also testified that, before purchasing the property he had spoken with Mr. Hooper about some of the easement restrictions and obtained title insurance, but he had not read the conservation easement in full. In fact, he testified that the first time he read the conservation easement was after MET contacted him about the timber violation. The trial court judge was unsympathetic, stating that the conservation easement, which had been properly recorded in the land records, "stood squarely in the way” of the new owner’s plans to timber the property and the new owner, not the lumber company, was responsible for determining whether the conservation easement prohibited timbering in the restricted area.
MET attributes its success in this case to a collaborative effort. Its stewardship staff carefully documented the conservation easement violations and assisted the Maryland AG’s Office in preparing and presenting the case. The Maryland AG’s Office brought the suit, developed trial strategy, and prepared for and presented at trial. Scientists from the Maryland Department of Natural Resources served as key expert witnesses and prepared the reforestation and stiltgrass eradication plans. Finally, the Hoopers—the donors of the easement—were observant neighbors and alerted MET to the timbering violation and other neighbors were prepared to testify as to the dumping violation.
The result in this case is consistent with the approach of § 8.5 of Restatement (Third) of Property: Servitudes, which provides that a “conservation servitude held by a governmental body or a conservation organization is enforceable by coercive remedies and other relief designed to give full effect to the purpose of the servitude.” The drafters of the Restatement explain:
There is a strong public interest in conservation servitudes. Statutes have been enacted to eliminate questions about their enforceability…; they are often purchased with public funds or money raised from the public; they are often subsidized with tax benefits and other governmental benefits. The resources protected by conservation servitudes provide important public benefits, but are often fragile and vulnerable to degradation or loss by actions of the holder of the servient estate....
To give full effect to the purposes of the servitude, it may be necessary to order maintenance and restoration of the protected property to the condition contemplated by the servitude. In appropriate cases, additional remedies may be needed to compensate the public for irreplaceable losses in the value of the property protected by the servitude and other damages flowing from violation of the servitude. Remedies should also be designed to deter servient owners from conduct that threatens the interests protected by the servitude. In addition to punitive damages, which may be awarded in appropriate cases, remedies may also include restitution and disgorgement.
Connecticut has a particularly progressive statute addressing damages for "encroachment" on open space land and land encumbered by a conservation easement. The statute authorizes a court to award, among other things, "damages of up to five times the cost of restoration."
Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law (thanks to Kristen Maneval, Assistant Attorney General in the Maryland AG’s Office and Counsel to Maryland Environmental Trust, for her help with this description).
Monday, August 25, 2014
Ronald Chester (New England) has posted The Life and Death of the Ipswich Grammar School: Is Enduring Dead Hand Control Possible?, ACTEC Journal (forthcoming). Here is the abstract:
This article examines the reasons for the 360-year longevity of the Ipswich (Mass.) Grammar School trust, which was in force from 1652 to 2012, the longest-running charitable trust in American history. It concludes that the cornerstone of the trust’s longevity was the emphasis of its major donor, the Puritan William Paine, on open-handed contribution to the community, rather than dead hand control. A wealthy merchant and landowner and friend of Massachusetts Bay Colony Governor John Winthrop and his son, Paine imbued his commercial activities with a profound civic-mindedness.
A 1647 law required the establishment of a grammar school by any town within the Colony that had 100 families or more. The town of Ipswich, where Paine then resided, established a formal trust in 1652 to fund the school. Upon his death in 1660, Paine devised a unique parcel of land called Little Neck to the trust, whose trustees (“feoffees”) were the elders of Ipswich. The only restriction on Paine's gift of the land “forever” was that the property not be “sold or wasted.”
Although the trust was terminated by agreement of the feoffees and their tenants, and approved by the Massachusetts Attorney General and Courts, the author contends that it could easily have survived with Paine’s vision intact had the feoffees, many of whom were conflicted and inexperienced, been replaced by more professional trustees. The article compares and contrasts the Ipswich trust to the less successful 17th century Hopkins trust and to the modern Barnes Foundation trust in Pennsylvania. The Hopkins trust, which created the Cambridge (Mass.) Grammar School among other entities, spawned litigation lasting 135 years. The Barnes trust, founded in the early- and mid- 20th century and containing some of the most important art works in the world, likewise triggered much litigation, which may not be over, even today. The article concludes that “the longevity a donor’s charity achieves depends on the donor’s swallowing his or her ego and leaving the charitable vehicle open to change by the living.”
Erik Jensen (Case Western Reserve) has posted Taking the Student Out of Student Athlete: College Sports and the Unrelated Business Income Tax, Journal of Taxation of Investments (forthcoming). Here is the abstract:
A recent decision by a National Labor Relations Board regional director, concluding that football players at Northwestern University are employees for purposes of the National Labor Relations Act, could have spillover effects in tax law. This article considers whether severing the connection between participation in athletics and the educational function of a university — i.e., ending the pretense that athletes are student athletes — could lead to imposition of the unrelated business income tax (UBIT) on the net revenue of some intercollegiate teams at big-time athletic colleges.
On Friday the Wall Street Journal published online an article titled Tax-Smart Philanthropy Made Easy: Many Donors Should Consider a "Charitable Gift Trust" or "Donor Advised Fund". The article documents the continued growth of donor advised funds, with total assets reaching $26 billion as of June 30, 2014, with new contributions and grants for the 12 months before that date reaching $7.4 billion and $4.1 billion, respectively. The article also provides an interesting glimpse into the giving priorities of DAF donors, as the largest holder of DAFs - Fidelity Charitable - provided a breakdown by program area of where the $2.1 billion in grants it made in 2013 went. Over a third went to education, with the next biggest areas being religion (16%), "society benefit" (14%), and human services (10%). The article attributes the continued and indeed growing popularity of this vehicle to a bull market, increasing mergers and acquisitions, and the risk of future changes in the tax laws that make it particularly attractive to lock in a charitable contribution now while still being able to put off final decisions regarding where to give.
Over the summer the Freedom from Religion Foundation announced that it had agreed to the dismissal (without prejudice) of its lawsuit against the IRS alleging that the IRS had filaed to enforce against churches the prohibition on political campaign intervention. See previous post regarding the 2013 rejection of the IRS' motion to dismiss this case for more details. What is most dramatic about this development is the letter from the IRS to the DOJ attached to the Foundation's Memorandum in Support of Motion to Dismiss detailing the current audit activity relating to churches. Here is the substance of that letter:
1. Subsequent to the publication of proposed regulations on section 7611 of the Internal Revenue Code on August 5, 2009, the IRS has processed several cases involving churches using procedures designed to ensure that the protections afforded to churches by the Church Audit Procedures Act are adhered to in all enforcement interaction between the IRS and churches. The procedures require the reasonable belief determination under section 7611(a) to be made by the Commissioner, TEGE, either directly or as concurrence to the determination made by the Director, Exempt Organizations.
2. Our written procedures for our Dual Track process for information items (a.k.a. referrals) alleging violation of the political intervention prohibition of section 501(c)(3) require evaluation of the information item by our Review of Operations (“ROD”) unit and then the Political Activities Referral Committee (“PARC”). With regard to these referrals that concern violations by churches, the PARC has determined that as of June 23, 2014, 99 churches merit a high priority examination. Of these 99 churches, the number of churches alleged to have violated the prohibition during 2010 is 15, during 2011 is 18, during 2012 is 65, and during 2013 is one.
This comes after an apparent hiaitus in such activity, as detailed in a previous post. What is perhaps most surprising is that it has come without the finalization of the proposed regulations referenced in the above letter regarding exactly who, within the IRS, has sufficient authority to sign off on church tax inquiries and, if justified, church examinations.
Sunday, August 24, 2014
As reported in the Whidbey News-Times, one of two applicants for a recreational marijuana-based businesses on Whidbey Island, Washington, recently withdrew its application. The applicant, Salish Sea Industries (SSI), had proposed to build a 3,833-square-foot barn for the production and processing of marijuana but withdrew its land use permit because of conflicts with federal law.
A portion of the property at issue is encumbered by a conservation easement that was funded in part by the federal government. The executive director of the Whidbey Camano Land Trust, which holds the easement, notified SSI that the terms of the easement would not allow them to do something that is in violation of federal law. A spokesman for SSI explained that the entity withdrew its application because it did not wish to enter into a protracted legal battle with the federal government. While not all of SSI's property is encumbered by the easement, the marijuana production cannot take place on the unencumbered portion because the adjacent property is zoned rural residential and, per the Island County Code, marijuana-based businesses cannot operate in rural-residential areas.
Washington voters approved Initiative 502 in November 2012, legalizing recreational marijuana consumption and possession of up to one ounce. Under federal law, however, marijuana is still treated like every other controlled substance, such as cocaine and heroin.
Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law
Maine Supreme Judicial Court Holds that Conservation Lands Open to the Public are Exempt from Property Tax
In Francis Small Heritage Trust, Inc. v. Town of Limington, 2014 Me. 102 (Aug. 7, 2014), the Maine Supreme Judicial Court held that conservation lands owned in fee by a charitable conservation organization and open to public are eligible for a property tax exemption. The decision relies in part upon the recent similar holding of the Massachusetts Supreme Judicial Court in New England Forestry Foundation v. Board of Assessors of Town of Hawley, SJC-11432 (May 15, 2014). Both cases are examples of attempts by cash-strapped towns to limit the scope of the property tax exemption granted to charities.
Francis Small Heritage Trust (FSHT) is a charitable conservation organization, the mission of which is “to conserve natural resources and to provide free public access to those natural resources.” FSHT owns eleven contiguous parcels on and near Sawyer Mountain in the Town of Limington, Maine. Many of the parcels are protected by third-party, “forever-wild” conservation easements and a few are further protected by Department of Inland Fisheries and Wildlife easements.
FSHT’s properties are “used and operated as conserved wildlife habitat” and are open to the public 365 days a year. Local schools use the properties for field trips and environmental education, and the properties are open for hunting, fishing, hiking, cross-country skiing, and snowmobiling. FSHT has also engaged in other activities, such as sponsoring a Limington Boy Scout Troop, participating in a project with Maine Medical Center to research the risk of exposure to Lyme-disease-transmitting deer ticks, and conducting a workshop on invasive plants.
FSHT petitioned the Town of Limington for a charitable exemption from property taxes with respect to its properties. The Town denied the petition and FSHT appealed to the State Board of Property Tax Review. The Board sided with the Town, concluding that FSHT was not entitled to an exemption because “its activities are not restricted solely to benevolent and charitable purposes.” Among other things, the Board noted that FSHT’s Articles of Incorporation permitted the organization to engage in commercial activities such as farming and logging. FSHT appealed, and the trial court vacated the Board’s decision, finding that FSHT was entitled to the charitable exemption. The Town then appealed the trial court’s ruling.
The Two-Pronged Test
In holding that FSHT qualified for the charitable exemption with regard to its properties, the Maine Supreme Judicial Court explained that qualification for the exemption requires satisfaction of a two-pronged test under 36 M.R.S. § 652(1)(A), (C)(1):
- the organization claiming the exemption must be “organized and conducted exclusively for benevolent and charitable purposes,” and
- the property must be “owned and occupied or used solely for [the organization’s] own purposes.”
The Town did not argue that FSHT failed to satisfy the second prong of test. Accordingly, the court addressed only the first prong.
Organized and Conducted Exclusively for Charitable Purposes
The Legal Backdrop
In assessing whether FSHT is “organized and conducted exclusively for benevolent and charitable purposes” the Maine Supreme Judicial Court first discussed the “legal backdrop.”
Definition of "Charitable"
The court explained that an activity or purpose is “charitable” if it is
for the benefit of an indefinite number of persons, either by bringing their minds or hearts under the influence of education or religion, by relieving their bodies from disease, suffering, or constraint, by assisting them to establish themselves in life, or by erecting or maintaining public buildings or works or otherwise lessening the burdens of government.
This is the same definition of charitable quoted by the Massachusetts Supreme Judicial Court in NEFF v. Hawley.
The Quid Pro Quo Factor
The court explained that part of the rationale for granting an exemption to charitable institutions is that:
[a]ny institution which by its charitable activities relieves the government of part of [its] burden is conferring a pecuniary benefit upon the body politic, and in receiving exemption from taxation it is merely being given a “quid pro quo” for its services in providing something which otherwise the government would have to provide.
The court noted that providing opportunities for even “casual and limited group recreational and relaxation activities” can constitute a quid pro quo because it “provid[es] something that government would otherwise provide, through the government system of parks, public lands, and recreational facilities.”
The court acknowledged that it had not previously addressed whether land conservation constitutes a charitable purpose within the meaning of the tax-exemption statute. The court had, however, previously considered whether a wildlife refuge qualifies for exemption. In Holbrook Island Sanctuary v. Inhabitants of the Town of Brooksville, 161 Me. 476 (1965), a charitable organization sought an exemption for property that it operated as a wildlife sanctuary and to which the public was granted only very limited access. Only persons and organizations engaged in nature study were permitted in the sanctuary and they had to be accompanied by the sanctuary’s full-time warden. In addition, the sanctuary blocked off existing access roads on the property with the intention of permitting the roads to become overgrown and return to their natural state. The court concluded that the wildlife sanctuary was not “charitable,” because it was “nothing in substance more than a game preserve,” the purpose of which was “plainly to benefit wild animals”; it provided “no benefit to the community or to the public”; and it was contrary to public policy favoring state-regulated game management areas.
In FSHT v. Limington, amici urged the court to overrule or limit Holbrook, citing the following scholarly criticism of the decision:
[Holbrook ‘s] holding, that a benefit to wild animals did not equate to a benefit to the community and was therefore not charitable, might be assessed differently by a court with a modern awareness of the public benefits of ecosystem preservation.
The court chose to distinguish rather than overrule Holbrook. It explained that Holbrook was based on the absence of any benefit to the public from a game preserve operated in a manner that (i) heavily restricted public access and (ii) was contrary to public policy, and that neither rationale applied to FSHT’s properties. FSHT’s properties are freely open to the public 365 days a year and their operation is consistent with public policy as expressed by the Maine legislature in numerous statutes.
Other Appellate Court Decisions
The court explained that numerous appellate courts from other jurisdictions have held that “land conservation is a charitable purpose, at least when coupled with public access, or where conservation of the land otherwise confers a public benefit.” The court quoted NEFF v. Hawley, in which the Massachusetts Supreme Judicial Court of held that a nonprofit land conservation organization’s purposes were charitable because
the environmental benefits of holding land in its natural state ‘inure[d] to an indefinite number of people,’ and because the organization ‘lessen[ed] the burdens of government’ by ‘assist[ing] the State in achieving its conservation policy goals.’
The court also explained that the Maine legislature has “enunciated a strong public policy in favor of the protection and conservation of the natural resources and scenic beauty of Maine” and “recognized the important role played by conservation organizations in achieving these goals.”
Having discussed the legal backdrop, the court next considered whether FSHT is organized and conducted exclusively for charitable purposes. The court explained that FSHT’s purpose is to conserve natural resources for the benefit of the public; FSHT opens its properties to the public year-round, free of charge; and FSHT permits school field trips, hunting, fishing, hiking, cross-country skiing, and snowmobiling. The court agreed with the trial court that FSHT “essentially operates its properties in the manner of a state park.” In doing so, said the court, FSHT “assists the state in achieving its conservation goals…and “provid[es] something that government would otherwise provide, through the government system of parks, public lands, and recreational facilities” (i.e., FSHT lessens the burdens of the government). Accordingly, the court held that, under the circumstances of the case, FSHT was organized and conducted exclusively for charitable purposes within the meaning of Maine’s tax-exemption statute.
The court dismissed the Board’s argument that FSHT was not entitled to the charitable exemption because a special statute relating to the taxation of open space land “preempted” the charitable exemption with regard to such land. The court explained, citing in part to NEFF v. Hawley, that the open space taxation statute and the charitable exemption statute “are distinct in their scope and purpose,” and nothing in the language or legislative history of the open space taxation statute indicated in intent to preempt or otherwise displace the charitable exemption, the origins of which can be traced back to the 1800s.
The court also dismissed the Board’s argument that tax-exemption should be denied because FSHT’s Articles of Incorporation permitted it to engage in logging, farming, and other “compatible commercial activities” (i.e., that it was not organized or conducted "exclusively" for charitable purposes). The court first noted that the Articles of Incorporation provide that one of FST's purposes is to “protect” appropriate uses such as logging, farming and other compatible commercial activities (i.e., the Articles do not directly authorize or require such activities). There also was no evidence that FSHT had engaged in any purely commercial activities on the properties. Rather, the court found that FSHT’s plan to harvest trees as part of a sustainable forestry education program, with any revenue therefrom to be used by FSHT in accordance with its purposes, was consistent with the organization’s charitable purposes. The court also noted that, even if the Articles of Incorporation permitted FSHT to engage in nonexempt uses, “incidental, nonexempt use of property will not render the property ineligible for exemption.”
Compare In re Grandfather Mountain Stewardship Foundation, 2014 WL 4071200 (Ct. Appeals N.C. 2014), in which the Court of Appeals of North Carolina denied property tax exemptions to a charitable foundation with regard to three properties because the properties were not “wholly and exclusively used” for nonprofit educational or scientific purposes. Although The Nature Conservancy holds a conservation easement on the propertes and the foundation uses the properties for educational and scientific activities, the court found that the foundation also operates the properties to some extent as a for-profit tourist attraction, charging market-rate admission fees and generating more than $1 million annually from retail sales of items such as hiking equipment, souvenirs, and snacks.
In sum, in Maine, a nonprofit conservation organization’s lands that are used for conservation purposes and open to the public are eligible for a property tax exemption, even if the lands are or could be used for incidental nonexempt purposes. If the organization denies public access to its conservation lands, however, it would have to make the case that “conservation of the land otherwise confers a public benefit.” While the Maine Supreme Judicial Court did not indicate how that might be done, in NEFF v. Hawley the Massachusetts Supreme Judicial Court explained that the organization would have to present “compelling facts” demonstrating that exclusion of the public is necessary to enable the organization to achieve a public benefit through other activities carried out on the land. The court further explained that such “other activities” may often be time-limited—e.g., exclusion of the public may be necessary only during a timber harvest for safety reasons, or only during the nesting period of a vulnerable species to ensure the species is not disturbed.