June 15, 2012
Bishop: Sectorization & L3C Regulatory Arbitrage of Joint Ventures with Nonprofits
Carter G. Bishop (Suffolk) has posted Sectorization & L3C Regulatory Arbitrage of Joint Ventures with Nonprofits on SSNR. Here is the abstract:
The raison d’etre for the nascent low-profit limited liability company (L3C) is to stimulate collaboration (“sectorization”) among government, private and charitable sectors in order to redirect for-profit capital models into the nonprofit sector. The hope is that the L3C will not only generate additional resources for charitable purposes, but also fundamentally transform business culture by signaling a more efficient way to “do good while doing well.” The L3C has been criticized for targeting only private foundation program related investments, a capital pipeline already exhausted by existing profit entity models. When compared to the existing nonprofit joint venture, the L3C emerges as a less efficient arbitrage model for stimulating profit sector investment in charitable enterprises. A comparative analysis yields instructive lessons regarding deficiencies in federal tax regulation of program related investments and joint ventures. In both cases, the federal tax rules utilize a differing “control test” to assure the exempt entity directs assets toward its charitable mission and away from private benefit to profit sector participants. This Article provides the first comprehensive comparative theory that the existing nonprofit-profit joint venture model is a more efficient solution to assuring compliance with the charitable mission when blending market returns to market capital investors. This theoretical framework exposes why L3C statutory operating procedures unnecessarily cripple profit efforts, undermine its effectiveness, and present policy dilemmas less prevalent in joint ventures where the nonprofit must exercise control over the business entity rather than simply an investment in the entity. As a result, program related investments should be scaled back and limited to determining only whether an investment jeopardizes a foundation’s exempt mission where the scale of the investment has a self-limiting role.
Galle: Charities in Politics
Federal law significantly limits the political activities of charities, but no one really knows why. In the wake of Citizens United, the absence of any strong normative grounding for the limits may leave the rules vulnerable to constitutional challenge. This Article steps into that breach, offering a set of policy reasons to separate politics from charity. I also sketch ways in which my more-precise exposition of the rationale for the limits helps guide interpretation of the complex legal rules implementing them.
Any defense of the political limits begins with significant challenges because of a long tradition of scholarly criticism of them. Critics of the limits suggest that the “market failures” that justify tax subsidies for charity also afflict group efforts to monitor politicians and organize politically, so that the subsidy should extend to cover those activities. These claims, though, overlook a series of additional issues suggested by transaction cost economics and other aspects of economic theory.
Most significantly, even if lobbying and electioneering should be subsidized, it does not follow that these functions should be carried out by charities. I argue that combining politics with charity produces a set of diseconomies of scope, including higher agency costs, diminished “warm glow” from giving, and greater inframarginality of deduction recipients. In addition, I argue that the economically ideal tools for reaching the socially optimal levels of charity and lobbying are incompatible with one another. While there are also off-setting gains from the combination, many of these gains further exacerbate the diseconomies.
Viola: Abandoning Property Taxes Assessed on Fallow Nonprofit Property
Brittany L. Viola (J.D. 2012, Illinois) has published an interesting note titled Abandoning Property Taxes Assessed on Fallow Nonprofit Property (2012 U. Ill. L. Rev. 287). Here is the abstract:
Financial distress has led to a rise in the shuttering of tax-exempt property owned by non-profit organizations. Typically, nonprofits are not subject to property taxes if they use their properties for charitable purposes. Because these now-fallow properties are no longer being used, a debate has emerged over whether to assess them a property tax. On one side of the debate are those who argue for a strict construction of “charitable use”—one that would exclude non-fallow properties from exemption. Proponents of this construction argue that fallow nonprofit property should be taxed to share the burden of cash-strapped local governments. On the other side of the debate are those who argue for a broad construction of “charitable use”—one that reflects the purposes of nonprofit tax exemptions by excluding fallow nonprofit property from taxation. Proponents of the broad exemption argue that taxing these properties only serves to further strain financially troubled nonprofits, leading to fewer services for the people these nonprofits serve, and in turn placing greater demand on the government. Further complicating the issue is the diverse construction of tax exemptions across the fifty states. This Note examines the varying constructions and purposes of property tax exemptions for nonprofits. The Note concludes by suggesting a simple, more uniform system of taxing nonprofit property under the broad construction of “charitable use” so that fallow nonprofit property remains exempt. This approach would best serve the purposes of nonprofit tax exemptions and the people nonprofits serve.
Harrison & Seim: Nonprofit Tax Exemptions and Market Structure
Theresa Harrison and Katja Seim (University of Pennsylvania) have posted Nonprofit Tax Exemptions and Market Structure: The Case of Fitness Centers on SSRN. Here is the abstract:
Nonprofits are increasingly present in industries with a large for-profit sector, raising questions about their competitive advantage afforded by the nonprofit tax exemption. We estimate an equilibrium model of market structure for recreation/fitness centers to assess whether nonprofit and for-profit firms compete directly for the same customer base. Our results suggest that the two ownership types serve independent markets. Consequently, nonprofits do not meaningfully crowd out for-profit competitors. We find that local property taxes, as a proxy for a firm’s tax burden, significantly affect for-profit entry and that nonprofit entry would fall by 25%, without affecting for-profit entry, if the same property tax liability was imposed.
Zelinsky: Do Religious Tax Exemptions Entangle in Violation of the Establishment Clause?
Edward A. Zelinsky (Cardozo) has posted Do Religious Tax Exemptions Entangle in Violation of the Establishment Clause? The Constitutionality of the Parsonage Allowance Exclusion and the Religious Exemptions of the Individual Health Care Mandate and the FICA and Self-Employment Taxes on SSRN. Here is the abstract:
In Freedom From Religion Foundation v. Geithner, the Freedom From Religion Foundation (FFRF) argues that Code Section 107 and the income tax exclusion that section grants to “minister[s] of the gospel” for parsonage allowances violate the Establishment Clause of the First Amendment. This case has important implications for a new federal law mandating that individuals maintain “minimum essential” health care coverage for themselves and their dependents. That mandate contains two religious exemptions. One of these exemptions incorporates a pre-existing religious exemption from the federal self-employment tax. These sectarian exemptions raise the same First Amendment issues as does the Code’s exclusion from gross income of clerical housing allowances.
I ultimately find unpersuasive the indictment of Section 107 as constitutionally entangling. For the same reasons, I also conclude that the religious exemptions of the Social Security taxes and of the individual health mandate pass First Amendment muster. In the modern world, extensive contact between tax systems and religious institutions is unavoidable. Whether religious entities and actors are taxed or exempted, there are inevitable tensions between the contemporary state and sectarian institutions and their personnel. Whether religious entities and actors are taxed or exempted, there are no disentangling alternatives, just imperfect trade-offs between different forms of entanglement.
Thus, Section 107 and the exclusion from gross income it grants to clerical recipients of housing and parsonage allowances are constitutionally permitted, though not constitutionally required, responses to the problems of entanglement inherent in the relationship between modern government and religion. Similarly, the Code’s sectarian exemptions from the individual health care mandate and from the FICA and self-employment taxes are acceptable, though not obligatory, means under the First Amendment of managing the inevitable contacts and tensions between the contemporary state and the religious community.
However, as a matter of tax policy, the exclusion of Section 107(2) for cash parsonage allowances stands on weaker ground than does the exclusion of Section 107(1) for in-kind housing provided to “minister[s] of the gospel.” The taxation of such cash allowances, in contrast to the taxation of housing provided in-kind, does not involve problems of valuation or of taxpayer liquidity and is thus more practicable as a matter of tax policy.
June 14, 2012
Bad News for Political 501(c)(4)s: 4th Circuit Upholds "Major Purpose" Test for Political Committees
In a case with potentially major ramifications for politically active section 501(c)(4) organizations, the U.S. Court of Appeals for the Fourth Circuit has upheld the Federal Election Commission's "major purpose" test for determining whether an organization is a political committee or PAC and so subject to extensive disclosure requirements. As described in the opinion, under the major purpose test "the Commission
first considers a group’s political activities, such as spending on a particular electoral or issue-advocacy campaign, and then it evaluates an organization’s 'major purpose,' as revealed by that group’s public statements, fundraising appeals, government filings, and organizational documents" (citations omitted). The FEC's summary of the litigation details the challenge made in this case:
A group or association that crosses the $1,000 contribution or expenditure threshold will only be deemed a political committee if its "major purpose" is to engage in federal campaign activity. [The plaintiff] claims that the FEC set forth an enforcement policy regarding PAC status in a policy statement and that this enforcement policy is "based on an ad hoc, case-by-case, analysis of vague and impermissible factors applied to undefined facts derived through broad-ranging, intrusive, and burdensome investigations . . . that, in themselves, can often shut down an organization, without adequate bright lines to protect issue advocacy in this core First Amendment area." [The plaintiff] asks the court to find this "enforcement policy" unconstitutionally vague and overbroad and in excess of the FEC’s statutory authority.
In a unanimous opinion, the court concluded that the FEC's current major purpose test is "a sensible approach to determining whether an organization qualifies for PAC status. And more importantly the Commission's multi-factor major-purpose test is consistent with Supreme Court precedent and does not unlawfully deter protected speech." In doing so, the court chose to apply the less stringent "exacting scrutiny" standard instead of the "strict scrutiny" standard because, in the wake of Citizens United, political committee status only imposes disclosure and organizational requirements but no other restrictions. While the plaintiff here (The Real Truth About Abortion, Inc., formerly known as The Real Truth About Obama, Inc.) is a section 527 organization for federal tax purposes, the same test would apply to other types of politically active organizations, including section 501(c)(4) entities.
Hat Tip: Election Law Blog
IRS Provides New Information for Credit Unions Facing Automatic Revocation of Exemption
The IRS has provided new information for federal and state credit unions that have had either their own tax-exempt status revoked automatically for failure to file annual returns for three years or have received a notification that their parent organization has been subject to such revocation. The new information addresses three common situations:
- When a federal credit union has had its tax-exempt status revoked even though it is not required to file an annual return (letter to IRS asserting federal credit union status required).
- When a state credit union, which is required to file an annual return, has had its tax-exempt status revoked (application for reinstatement of tax-exempt status required if the credit union was required but failed to file annual returns for three consecutive years).
- When a credit union has been notified that its parent organization has lost its tax-exempt status (noting a situation that has arisen because some state agencies that had previously filed group information returns on behalf of all exempt state-chartered credit unions under their control and supervision have ceased to do so).
June 13, 2012
NY Threatens to Strike 1,649 Deliquent Charities from State Rolls
The NY Post reports that New York Attorney General Eric Schneiderman is planning to send letters this week to 1,649 charities threatening them with cancellation of their registrations with the state unless they submit late reports within 20 days. If the AG cancels their registrations, the charities will no longer be legally eligible to raise funds in the state from either private or government sources. The New York registration and reporting requirements are enforced by New York's Charities Bureau, housed in the AG's office.
Another 501(c)(4), But This Time In NY and Supporting a Democrat
The NY Times reports that the section 501(c)(4) Committee to Save New York, organized at the urging of Governor Andrew Cuomo to promote his policies and praise his performance, received $17 million last year. Only now it has come to light that among the Committee's financial supporters is the New York Gaming Association, a trade group that supports expanding legalized gambling, that contributed $2 million. That information was apparently not known before because the Committee, like all section 501(c)(4) organizations generally, is not required to publicly disclose its donors. The NY Times is urging Gov. Cuomo to push the Committee to reveal all of its donors, especially giving the Governor's recent support for pro-gambling measures.
"Campaign Finance: The Nonprofit World's New Weapon" (Roll Call)
Eliza Newlin Carney has written a column in Roll Call highlighting the growing impact on tax-exempt nonprofit organizations of their new found freedom to be involved in elections. Besides summarizing the current debate over the benefits and risks of greater disclosure for such organization, the column also highlights the negative effects of this more prominent role on both nonprofits and entities that support them, including business corporations. For example, some donors to the U.S. Chamber of Commerce and trade groups are barring the use of their contributions for election-related or political ads. Other donors are adopting their own disclosure policies, and most businesses are apparently avoiding donations to superPACs. Nevertheless, spending by groups other than candidates and political parties continues at an unprecedented pace; the Center for Responsive Politics's data shows such spending is approaching $150 million, or more than double the amount spent by this date in 2008, the next highest year for such expenditures. And these figures do not capture spending for activities that fall outside of the relatively narrow federal and state law definitions of election-related efforts.
June 12, 2012
Questioning the Charitable Contribution Deduction
Three recent news stories highlight the growing debate regarding the tax benefits enjoyed by nonprofits and particularly charities. The most recent Economist has an article titled Sweetened Charity: The Idea that the State Should Subsidise Giving to Good Causes is Resilient, But Not Easily Justified. The Wall Street Journal has an article titled Invasion of the Charity Snatchers focusing on the use and possible abuse of donor-advised funds. And finally Tax Notes (subscription required) features a special report from the European Association of Tax Law Professors congress on What Should the Tax-Exempt Sector Look Like?, looking not only at the laws in the U.S. but also in various European countries. In a time of economic uncertainty and strained government budgets such a focus is not surprising. The question is whether it will lead to sensible modifications of the existing rules.
For Lack of the Right Paperwork, $18.5 Million in Charitable Contribution Deductions Lost
I often tell my tax students that part of their job is to get the paperwork right. I now have a new illustration of the importance of doing so from the Tax Court's decision in Mohamed v. Commissioner. As the court details, there was no question regarding the contributions themselves and initially the dispute was solely over their value - which the court concluded may very well have been more than the claimed $18.5 million. The ultimately fatal problem, however, was the paperwork documenting the real estate contributions at issue. Specifically, the court found that the taxpayers failed to obtain a qualified appraisal before the due date of the relevant returns, which appraisal had to be from an appraiser other than the donor or taxpayer, and failed to attach an appraisal summary to those returns. Here the donor and taxpayer, who is a certified real-estate appraiser, had appraised the properties himself and, relying solely on the Form 8283 without consulting the instructions for that form, had failed to conform the statement he attached to the returns to the appraisal summary requirements. The taxpayers' attempts to challenge the validity of the regulations imposing these requirements and to claim "substantial compliance" with those requirements were unsuccessful. The court therefore regretfully denied the deductions, concluding:
We recognize that this result is harsh--a complete denial of charitable deductions to a couple that did not overvalue, and may well have undervalued, their contributions--all reported on forms that even to the Court’s eyes seemed likely to mislead someone who didn’t read the instructions. But the problems of misvalued property are so great that Congress was quite specific about what the charitably inclined have to do to defend their deductions, and we cannot in a single sympathetic case undermine those rules.
For news coverage of the decision, see the Wall Street Journal.
ACT Urges Improvement of the IRS 501(c)(3) Application Form and Process
The Advisory Committee on Tax Exempt and Government Entities (ACT) released its eleventh report last week. The Exempt Organizations portion of the report focused on IRS Form 1023 - the Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. Here are their specific recommendations for improving the process by which more than 55,000 organizations per year seek section 501(c)(3) tax-exempt status from the IRS:
- the IRS should expedite the internal processes and commit the necessary resources (human, financial, and technical) to transform Form 1023 to an interactive Web-based Form e-1023 that can be filed electronically and stored, transmitted, and disseminated in an electronic database format. This information will serve as the electronic gateway for IRS knowledge about tax-exempt organizations;
- the IRS should redesign Form 1023 with four primary objectives: to make the form (i) effective at identifying whether organizations meet the requirements for recognition of exemption; (ii) consistent with the structures and definitions of Form 990; (iii) simple by using a short core form with supplemental schedules that will ease the filing burden on small and/or less complex organizations; and (iv) educational by organizing questions based on substantive exemption requirements and including explanatory information;
- the IRS should develop more educational tools about Form 1023 including tips for filing Form 1023, and more information about the substantive requirements for recognition of exemption. The development of these tools, coupled with the redesign of Form 1023, should obviate the need for a separate “Form 1023-EZ” for small organizations. The ACT does not recommend the development of such a form;
- the IRS should coordinate with the Department of the Treasury and the Office of Chief Counsel on the issuance of precedential guidance about tax-compliant alternatives to the creation of new Section 501(c)(3) organizations, such as fiscal sponsorships and donor-advised funds;
- the IRS should carefully examine recurrent complaints about the Form 1023 filing and review process and take appropriate and expeditious steps to improve the effectiveness, efficiency, and timeliness of that process; and
- the IRS should expand its use of the Review of Operations (ROO) program (to follow up on Section 501(c)(3) organizations whose 1023 forms indicate potential future compliance issues), and should consult with state charity regulators regarding indicia that may warrant such follow-up.