Friday, November 21, 2008
Ken Starr, Dean of Pepperdine Law School and now the lead counsel for Vision Services Plan in its appeal from the 9th Circuit decision upholding its loss of tax exempt status under 501(c)(4), has released a video update on the case, available here.
For those late to the VSP saga, Vision Services Plan is a nonprofit HMO-like provider of vision care services. The largest part of VSP's activities involve offering vision health services plans to employers for their employees. The employers or individual members pay a flat fee to VSP for the plan services. The IRS granted VSP exempt status under 501(c)(4) in 1960; it revoked that status in 2003, arguing that VSP no longer was engaged in benefitting the general social welfare, but rather primarily served the private interests of its members. Links to the various opinions in the case (district court and 9th Circuit) and more background can be found in this prior blog post.
Though the VSP case does not deal with charitable exemption under 501(c)(3), it is a poster child for the problems with exempting nonprofit health care organizations generally. The baseline question is the same today as it was when the IRS issued Rev. Rul. 69-545, regarding 501(c)(3) exemption for nonprofit hospitals: what, exactly, distinguishes these organizations, which largely operate by charging fees for their services, from for-profit businesses other than the fact that they are organized as a nonprofit? Some academics in the health care world (e.g., Jill Horwitz of Michigan, Mark Schlesinger of Yale, Brad Gray at the Urban Institute) argue strongly that the nonprofit form itself causes health care providers to act differently than for-profit counterparts. They maintain that substantial empirical evidence supports their position - Jill Horwitz, for example, has done extensive work showing that nonprofit hospitals are more likely to offer unprofitable services than for-profits, and are slower to abandon low-profit services for high-profit ones. On the other hand, I'm a "show me the money" guy. I want individual nonprofits to detail exactly what it is they do differently for their communities than for-profit competitors, and I want exemption standards that require this differential behavior, not standards that hand out exemption to nonprofits under the hope that they will "act better." And I'm middle-of-the-road compared to some, who would grant exemption to health care providers only if they provide free care to the uninsured poor in an amount at least equal to the financial benefit of their exemption. In any event, this issue isn't likely to be resolved any time soon - particularly because a lot of the action today has shifted to the states and state property-tax exemption standards.
An article from Bloomberg News presents more evidence of how the economic downturn is causing pain for many nonprofit hospitals. The article notes that "hundreds" of the country's nonprofit, acute-care hospitals are "cutting services as tightening credit, lagging government payments and a rise in uninsured patients create record losses." The article also cites a study by the American Hospital Association that found hospitals lost $831.5 million on investments in the third quarter compared with an overall gain of $396.1 million in 2007.
Thursday, November 20, 2008
Reports from the tech world (see here, here and here) are that the IRS is investigating the tax status of the nonprofit Mozilla Foundation. Apparently, the issue is whether the foundation qualifies as a public charity or private foundation, and central to the dispute is the fact that last year the Foundation received 88% of its revenues from Google as part of an agreement that causes the Firefox browser to default to a Google search page. The Mozilla Foundation apparently is taking the position that these revenues are "royalties" and thus are excluded from the public support test for public charity status under Code Section 509(a)(1) via 170(b)(1)(A)(vi). Though the IRS has not yet taken a position, apparently the Foundation is worried that the Service will view these payments as unrelated business income (from advertising); the Foundation has sufficient doubt about this issue that they have set aside $100,000 to cover taxes that would be applicable if the IRS finds that these are advertising revenues and switches the Foundation's status to that of a private foundation.
The issue regarding whether certain payments are "royalties" or unrelated business income has come up in a major way before. The key case in this area is Sierra Club v. Commissioner, 86 F.3d 1526 (9th Cir. 1996) in which the 9th Circuit held that "royalties" in § 512(b) "are defined as payments received for the right to use intangible property rights and that such definition does not include payments for services." The IRS had maintained that Sierra Club's income from renting mailing lists and from its "affinity card" arrangements with credit card companies were unrelated business income; the IRS ended up losing on both counts (the 9th Circuit held for Sierra Club on the mailing list issue; the IRS lost on the credit card issue on remand).
From 1994-1998, the IRS tussled with AARP over whether AARP's receipts from insurance companies for AARP "approved" insurance polices were royalties; eventually AARP and the IRS settled the case with AARP agreeing to restructure and move business services into a for-profit subsidiary, but the IRS agreeing that AARP's insurance-company payments qualified as royalty income.
My guess is that the IRS is going to classify this income as UBI, not royalties, but there's certainly enough doubt about the definition of royalties that I wouldn't bet much on it.
The Minneapolis Star-Tribune reports that a U.S. district magistrate judge sided with Mac Hammond's Living Word Christian Center in a dispute with the IRS. The IRS had requested information regarding the compensation of the church's senior pastor, Mac Hammond. The church refused to comply on the grounds that the IRS request was not made by a "high-ranking official" as required by the church audit provisions of the Internal Revenue Code (Section 7611). The IRS sued to enforce its request, but the magistrate judge has issued a recommendation siding with the church.
Frankly, I think the special audit rules for churches are an embarrassment, as is the exception for churches from filing the Form 990 required of all other exempt organizations. This special treatment for churches means that we have virtually no information on what they do, how they spend their money, etc. If churches want special tax treatment (e.g., exemption), it's not too much to ask them to let us know what they are doing with their financial resources. Yes, I understand the arguments regarding "excessive entanglement" and the free exercise clause, but you're going to have a hard time convincing me that neutral application of tax procedure to a church results in a violation of the First Amendment. Tell you what: let's change the law to require it, let churches litigate a test case, and see what the Supreme Court says about it, OK?
Wednesday, November 19, 2008
A report from Crane's Chicago Business notes that the economic downturn is forcing nonprofit hospitals to put capital projects on hold as investment portfolio losses mount and interest rates soar on nonprofit bonds. Advocate Health has postponed $150 million in capital spending, and Provena Health has halted building several planned outpatient facilities.
The crunch isn't limited to Chicago. The Sacramento Bee reports that California hospitals are facing the same problems. One recent bond issue required an interest rate of 6.9%, considerably higher than the 4.5% the hospital hoped for. Loma Linda University Medical Center ended up offering investors 8.25% on its bonds, nearly twice the going rate of a few months ago.
As circulation and advertising revenue continue to decline, some in the newspaper industry see nonprofit form as providing a viable model to stay in business. This article in the on-line National Journal Magazine explores how some regional newspapers are using an on-line only, nonprofit structure for their business. These new nonprofit news ventures include the MinnPost in Minneapolis, voiceofsandiego.org in San Diego; the Chi-Town Daily News in Chicago; Gotham Gazette in New York City; the New Haven Independent in Connecticut; and the St. Louis Beacon. The trend is examined in more depth in this article in the Carngie Reporter, and a Google search on "nonprofit journalism" will yield several more articles on the subject.
The Christian Science Monitor is one long-time example of a nonprofit news organization, organized in 1908. Recently, the Monitor discontinued its paper publishing business in favor of a completely on-line operation, which by all accounts has been successful. And National Public Radio, (a private nonprofit formed in 1970 pursuant to the Public Broadcasting Act) has become the news outlet of choice on radio for a significant segment of the population. The IRS, meanwhile, has long recognized that magazines and newspapers can qualify as tax-exempt educational organizations under 501(c)(3) (though occasionally the IRS has become a bit overzealous in trying to regulate viewpoint-pushing by such publications; one of the most famous cases dealing with exemption for educational organizations involved IRS attempts to revoke exemption for a feminist publication. The D.C. Circuit in Big Mama Rag v. United States, 631 F.2d 1030 (1980) held that the IRS's "full and fair exposition" test for educational organizations was unconstitutional, leading the IRS to promulgate a new "methodology" paradigm for exempting viewpoint-pushing educational organizations in Rev. Rul. 86-43).
While we may not soon see the New York Times, Chicago Tribune, Washington Post or L.A. Times adopt nonprofit form, it is clear that this is becoming a significant trend in the news-gathering and reporting world. The trend, moreover, lends some credence to the "market failure" theories of nonprofits and tax-exemption espoused by Henry Hansmann and yours truly: as the market becomes incapable of providing a service, nonprofits funded by donations step in to fill the hole.
Tuesday, November 18, 2008
The Vancouver Sun reports that the Canadian Revenue Agency (CRA) has revoked the charitable status of a foundation that participated in a tax shelter scheme. Here is the Sun's description of what was going on (this description was taken from the foundation's own web site - which strikes me as similar to putting a sign on your front door proclaiming "Illegal Tax Evasion Schemes Available Here"):
An unidentified Bahamian resident donates the right to use condominium units at the Regattas of Abaco, a resort in the Bahamas, to a Canadian trust called the Regattas Trust. The trust then identifies "suitable beneficiaries" to whom it donates the property. The beneficiary, however, must promise to repay a loan for $8,000. The beneficiary then donates the property to Pinnacle at its fair market value, which is said to be $26,560. This generates a tax refund of about $12,000 which, after repaying the $8,000 loan, leaves the donor with a $4,000 profit.
The CRA has targeted these charitable tax schemes, which almost invariably contain an offshore component and an "independent" appraisal generating a tax refund that exceeds the donor's out-of-pocket costs, and the agency has announced it is reassessing thousands of taxpayers because of donations that have resulted in the issuance of hundreds of millions of dollars worth of tax receipts.
The past election cycle brought a lot of attention (see prior blog posts here and here) to the issue of churches intervening in "any political campaign on behalf of (or in opposition to) any candidate for public office . . .," what we in the tax-exemption world call the political campaign prohibition. But it appears that the passage of Proposition 8 in California (making same-sex marriage illegal in the state) has caused some folks in the blogosphere to rediscover the other limitation on political activity in Code Section 501(c)(3): the requirement that "no substantial part" of the activities of an exempt organization can be for the purpose of "carrying on propaganda, or otherwise attempting, to influence legislation . . ." (what we call the lobbying limitation).
Some bloggers and web sites (see here, here and here for a representative sample) have pointed out that the Church of Latter Day Saints expended a lot of money and effort in support of Proposition 8, and believe that LDS should be stripped of its exempt status under the "no substantial part" test for lobbying. But this argument misapprehends the law in this area. First of all, there is no specific standard for what constitutes a "substantial part" of an organization's activities. For example, the 10th Circuit Court of Appeals in Christian Echoes National Ministry v. United States, 470 F.2d 849 (1972) refused to adopt a bright-line mathematical test for "substantiality," instead focusing on the centrality of lobbying to the overall mission of the organization in question:
The political activities of an organization must be balanced in the context of the objectives and circumstances of the organization to determine whether a substantial part of its activities was to influence or attempt to influence legislation. A percentage test to determine whether the activities were substantial obscures the complexity of balancing the organization's activities in relation to its objectives and circumstances. An essential part of the program of Christian Echoes was to promote desirable governmental policies consistent with its objectives through legislation. The activities of Christian Echoes in influencing or attempting to influence legislation were not incidental, but were substantial and continuous. The hundreds of exhibits demonstrate this.
470 F.2d at 855-56. Note the court's reference to the lobbying activities of Christian Echoes as "substantial and continuous" and the "hundreds of exhibits." I think it is fair to say that based on the case record, virtually the entire message of Christian Echoes had lobbying overtones. In contrast, the major denominational churches in the U.S., such as the Catholic Church and LDS, do many, many other things than lobby. Each would undoubtedly take the position that their primary purpose is to spread their religious message, and that this is what they do on a daily basis (along with programs to help the poor, promote social justice and so forth). And in fact, such a statement is true. LDS's (and the Catholic Church's) involvement with Proposition 8 in "the context of [its] objectives and circumstances" was simply a small, incidental part of their ministry, particularly when compared to the record in Christian Echoes.
Second, even though the 10th Circuit declined to adopt any kind of mathematical test, it is almost certainly the case that the amount of time, money, and other resources spent on lobbying at least would be probative of the "substantiality" of lobbying to the overall mission of the organization in question. And again, on this front whatever efforts were expended by the LDS on Proposition 8 pale in comparison to the size of their overall operation. Aside from the fact that the time frame for this activity was limited, one blogger reports that the Church spent $5 million on efforts to pass Proposition 8. Financially, that's probably a rounding error for LDS. While churches do not have to file a Form 990 with the IRS (a travesty that should be corrected by Congress), and thus there is no public record of the assets or income of LDS, there are some informed estimates. For example, a 1997 Time Magazine article estimated the assets of LDS as between $25-35 billion. Richard Ostling's book Mormon America, which grew out of the Time article and was published in 1999, estimated LDS revenues at $5.9 billion annually. And all this was over a decade ago. So . . . some friendly advice for those folks who think they've got a legitimate shot at getting the IRS to revoke LDS's exemption based on its Proposition 8 activities: find a more productive use of your time.
Of course, all this begs more serious legal and policy questions, which are (1) whether we should have political restrictions on charities at all and (2) if so, why do the rules permit some ("insubstantial") lobbying but absolutely prohibit political campaign activity. My own view is that if one of the reasons we grant tax-exemption to charities is because of their role in promoting a pluralistic society (a common explanation for exemption, which I don't necessarily adhere to entirely), I can't understand why we would remove from them the main method by which a minority (I'm using this term in its broadest sense to mean any political minority) can influence policy: petitioning their government. But I understand that this is an issue on which reasonable people (and many unreasonable ones) differ.
Monday, November 17, 2008
Grassley Responds to Chronicle Report Showing Public University Presidential Salaries Increased by Nearly 8% Last Year
In a press release issued today, Senator Charles Grassley responded to a Chronicle of Higher Education Report showing that presidents and other top hats at public universities will have a very merry Christmas as a result of getting raises averaging nearly 8%. The release states, in part:
For public research universities, executive pay increased 7.6% (FY ‘07-’08). And while
total compensation held steady for leaders of private research institutions, presidential
pay at private master’s and bachelor’s institutions climbed 6% (FY ’06-’07). The salary
gap is closing for public research university presidents and their private counterparts:
Those paid over $700,000 nearly doubled from the year before – from 8 to 15. And
nearly one-third of presidents at public research institutions now make over $500,000.
“Salaries of college presidents always get scrutiny,” said Jeffrey J. Selingo, editor of The
Chronicle of Higher Education, which first published the executive compensation survey
in 1989, and has done so annually since 1993. “But this year, students, parents, trustees,
and lawmakers are likely to take a closer look at whether presidents are worth the cost
given how worried families are about affording tuition as everyone is feeling a bit
A news report in Modern Healthcare (registration required) says that "Seventeen chief executive officers from some of the largest safety net hospitals in the country appealed to House Speaker Nancy Pelosi (D-Calif.) to increase funding for the nation’s healthcare safety net in crafting an economic stimulus package."
It is clear that some hospitals are facing major increases in uninsured patients. An article Friday in the Nashville Business Journal reports that Nashville's hospitals faced a 140% increase in uncompensated care over the past five years, the largest part of which was shouldered by Vanderbilt's medical center. On the other hand, the Chronicle of Philanthropy reports that NYU's Langone Medical Center has just received two big pledges totaling $260 million for capital expansion and renovation. Wonder if the new patient facility funded by one of the gifts ($150 million from Helen L. Kimball) will have wide-screen TV's like Ascension Health's new facilities in suburban Detroit (see prior blog post here)?
An interesting opinion piece by Jeff Brooks on his Donor Power Blog about particularly stupid ad campaigns by charities. His number 1 target is Goodwill Industries for an ad about Sarah Palin's wardrobe (offset with one about Obama's suits). But his ire is international: he also disses the British Humanist Society for ads on London buses. His conclusion? "Some nonprofits just shouldn't be allowed to have ad budgets." Amen.
Sunday, November 16, 2008
Another day, another story about how the economic downturn is affecting charities. This time, it's St. Louis, where according to this story in today's Post-Dispatch, the Children's Museum is facing its first operating deficit in its entire 29-year history. The article also details how a number of St. Louis charities, particularly in the arts and culture sector, have cut back hours, shelved capital projects, and are otherwise retrenching. The bad part is that I don't think we've seen the worst yet . . .