Thursday, March 17, 2011
A report in today's BNA Daily Tax report is sending shivers down the spines of tax-exempt organizations. Sen. Charles Grassley, who has often used his perch as either the ranking majority or minority member of the Senate Finance Committee to impose reforms on (or to attack unnecessarily, depending on your viewpoint) tax-exempt organizations, is at it again. The BNA report indicated that Grassley wants an estimate of the cost of tax exemption and wants to put the issue of tax exemption on the table in the ongoing budget/tax-reform talks. (The BNA Daily Tax Report is a subscription-only service; the citation for those of you who have access is 49 DER J-1, March 14, 2011).
Grassley's immediate target appears to be exempt organizations that engage in fee-for-service activities (he apparently cited the case of OCLC, an Ohio nonprofit provider of library sofetware services, which has been the subject of a lawsuit filed by California-based for-profit SkyRiver Technology Solutions), but his request that Congress estimate the cost of tax-exemption and treat it as a "tax expenditure" has far-reaching implications.
Unlike the deduction for charitable donations under Section 170, tax exemption has never been treated as a "tax-expenditure" in the budget process. Though the whole concept of "tax-exependiture" is still somewhat controversial, it has been a part of the budget and tax policy landscape since Stanley Surrey pushed the concept during his tenure as Assistant Secretary for Tax Policy at the Treasury Department in the late 1960's and oversaw the first tax expenditure budget in the US in 1968. In general, the concept of a "tax-expenditure" is based on the notion that certain tax benefits are the equivalent of government grants - that they are in essence "expenditures" by the government cloked in the form of tax benefits. Thus the tax expenditure budget includes items such as the charitable deduction, the home mortgage interest deduction, and similar items that are widely accepted today as "government subsidies" and deviations from the normative base for the income tax.
But exempt status under 501(c)(3) has never been considered a tax expenditure, in part because characterizing exemption as a "subsidy" or "deviation" from the normative tax base has always been a controversial issue among tax policy experts. It is not clear whether exemption is a "deviation" from the normative tax base or simply a part of defining that base. For example, would one consider our decision not to impose tax on the partnership as a separate taxable entity a "deviation" from the normative tax base (since we do impose an entity-level tax on most corporations)? Or would we just say that considering partnerships pass-through entities is simply a part of the overall definition of the normative base? And isn't it a little odd to call tax-exemption a "subsidy" for organizations that spend all their income on a charitable class like the poor?
While I am certainly sympathetic to Grassley's comment that some "charities" today look an awful lot like for-profit businesses, Grassley's request to estimate the cost of exemption seems to move in the direction of including exemption as a tax expenditure, and is a really, really big deal from the tax theory/policy side.
For those of you interested in exploring a bit more of the theoretical debate here, I recommend a relatively short and very readable article by Professor Dan Halperin at Harvard in the Exempt Organization Tax Review (also subscription-only, though it is also available on Lexis): Tax Policy and Endowments - Is Excessive Accumulation Subsidized? (Part I), 67 Exempt Org. Tax Rev. 17 (Jan. 2011), and Part II, 67 Exempt Org. Tax Rev. 125 (Feb. 2011).
(Hat tip to Evelyn Brody for spotting this in the Daily Tax Report)