Thursday, March 21, 2013
As some of you may have heard, the charity set up by NJ first lady Mary Pat Christie to provide Hurricane Sandy relief is under fire from watchdog groups. It has raised around $32.0 million so far, but hasn't made any distributions in the four months from the date of the storm (as of the March 11 article). This article in the Asbury Park Press raises a number of questions about the fund:
- Why is it taking so long?
- Why are you running it when you have no charity background?
- Why did you hire your protocol assistant as ED?
- Why is she getting paid $160,000 a year?
- Why aren't you giving funds to individuals?
- Is this all just a political stunt for your husband?
The article compares the fund to other organizations that have moved more quickly to provide Sandy relief, such as the Robin Hood Foundation. In response to all of these questions, Mrs. Christie answers that, unlike the Robin Hood Foundation, her organization is new. They have a small administrative budget and small staff. In discussing the delay in distributing funds, she cites the learning curve in getting a charity up and functioning and the lessons learned from other disaster relief organizations. She also indicates that she plans to be around for at least two or three years while the clean up continues.
I will take it as a given that she is trying to doing something good for her state with only the best of intentions. I also think that many of these questions have legitimate answers - four months from start up isn't a long time at all in the grand scheme of the life cycle of a charity. Fair enough. But given these answers, why didn't the reporter ask the question that first jumped out to me:
- Why was it necessary to set up a new organization in the first place?
If the problem is that you have new people setting up a new charity and that's why you are slow - you had an option. That option would have been to utilize an existing charity with established procedures and experienced people? Were there really no existing charities in the state of New Jersey that would have been willing to work with the Governor and the First Lady to set up a structure to address the needs of the population after a disaster of epic proportions? Maybe someone who has more experience with the New Jersey charitable community can tell me otherwise, but a quick Google search brought me here, for example.
In practice, I lamented the proliferation of charities - in the best of circumstances, these new charities were the products of good intent, unbridled optimism, and poor planning. I often tried to talk clients out of setting up new charities by encouraging them to find a partner with whom to work (what lawyer tries to talk herself out of work!), but I was rarely successful. Now that I can think about the sector more holistically, it has caused me to wonder whether we should be making it more difficult to set up a new charity. In looking at the recent efforts of the IRS, it seems to me there has been a trend to making it less difficult - the Form 1023 online project, the removal of the advance ruling period, the increase in the filing limits for the various flavors of the Form 990, to think of a few items off the top of my head.
Of course, the benefit of a lower barrier to exemption access is that it encourages innovation and experimentation in the sector - a potentially inefficient but worthy outcome. The cost of raising the barrier of access would be the "conglomeration" of charities. Is that an acceptable price to pay to address the issue of duplicative administrative costs and the need efficient and timely operations - especially in a time when private charity plays an increasing role in the delivery of social services? Would it really be any better?
I don't know. Just throwing it out there. EWW
Wednesday, March 20, 2013
From The Chronicle of Philanthropy comes a report on the Charitable Driving Tax Relief Act, filed in the House of Representatives last month. According to the report, the bill would increase the charitable volunteer per mile deduction rate of 14 cents per mile up to the rate for employee reimbursements, which is currently 56.5 cents per mile. The IRS' latest on standard mileage rates can be found here.
Accordingly to Thomas.gov, the bill is H.R. 1212, although the text of the legislation is not yet upload. I will keep checking back and provide a link when it is available.
Monday, March 18, 2013
A hot topic in legal education recently has been the concept of law schools opening affiliated law firms as a way to "bridge the gap" from law school to practice. For several links about the concept, visit Paul Caron's Tax Prof Blog and Johnny Buckles' prior post (along with the perceptive comment) here.
Would law schools opening law firms for students create tax exemption problems? My view is "almost certainly not" though the issues depend in part on the exact structure involved. While I could probably write a book-length post about this, I'll try to simply highlight what I see as the key issues and a few thoughts.
First, I'll address a situation in which a law school operates a law firm as a part of the law school (e.g., the firm is not a separate legal entity).
The main question raised by this structure (a law school operating law firm as an "operating division" of the school itself) is whether the "commerciality" limitation somehow imperils the law school's tax exemption (this is probably only an issue if the law school is a private institution; state university law schools generally do not have to rely on Section 501(c)(3) for tax exemption; state universities are exempt either under Section 115 of the code as an "instrumentality" of state government or by simple constitutional principles of federalism; Ellen Aprill at Loyola Los Angeles has written the bible about this issue).
While the commerciality limitation is very complex, I have little doubt that it poses no trouble for law schools running law firms. Commercial activity raises essentially two issues for charities. The first is whether the activity endangers their tax exemption. The second is whether, if the activity is OK from an exemption standpoint, the activity will nevertheless be subject to tax under the Unrelated Business Income Tax (UBIT). These issues are related, but not the same.
Let's concentrate on the exemption issue. The regulations make clear that charities can engage in some activity that is not itself charitable. The way the regulations put it is that a charity must engage "primarily" in activities that further its charitable purpose and cannot engage in more than an "insubstantial" amount of activities that are not "in furtherance of" a charitable purpose. See Treasury Regulations 1.501(c)(3)-1(c)(1).
While there is some disagreement regarding what the phrase "in furtherance of" means in this regulation, the way I analyze these problems is by first classifying commercial activity as "related" or "unrelated" activity per the unrelated business income tax. If a commercial activity is "related" under the UBIT, then it is no problem whatsoever for the charity, because the test for relatedness under the UBIT requires "functional" relatedness - that is, the commercial activity has to be closely connected to the charity carrying out its exempt purpose. This test is not met simply because an activity provides an income source for the charity to spend on charitable works; the regulations state that to be related, there must be a "causal connection" between the activity and the charitable purpose. Regs. 1.513-1(d)(2). A commercial activity that meets this test for UBIT purposes is virtually certain to be an activity that is "in furtherance of" a charity's charitable purpose for purposes of Regs. 1.501(c)(3)-1(c)(1), and hence is not a problem. In fact, Example 1 in the regulations, dealing with a performing arts school that charges admission for student performances, isn't far-removed from the law school law firm.
If an activity is unrelated, then in theory that activity can create exemption problems for the charity. This is where those of us that work in the area disagree; some people believe that an unrelated activity must be "insubstantial" (whatever that may mean) in order to avoid exemption problems. I take a different view: I think that an unrelated activity can be "unlimited" in size as long as revenues from that activity are being used by the charity to expand charitable outputs. See, e.g., John D. Colombo, Reforming Internal Revenue Code Provisions on Commercial Activity by Charities, 76 Fordham L. Rev. 667, 671-74 (2007).
But I don't think we get to that latter question here. If law schools operate a law firm as part of the educational enterprise to bridge the gap between law school and practice, I have little doubt that the law firm would be viewed as "related" activity under the UBIT, and hence simply not a problem. The law-school-operated-firm is pretty clearly advancing the educational mission of the law school; if an art museum can sell art reproductions in its museum store as a means of furthering its educational mission (see Rev. Rul. Rev. Rul. 73-104, 1973-1 C.B. 263), there really isn't much to argue about with the law-school law firm. (Another relevant precedent is the "medical practice plan" used by some medical schools for their faculty to practice medicine as a means of both supplementing their salary and sharpening their practice skills; while the IRS at one time challenged exemption for these practice plans, the agency lost a series of cases and eventually gave up. See, e.g., University of Massachusetts Medical School Group Practice Plan v. Comm'r, 74 T.C. 1299 (1980). If a medical school can open a for-profit medical clinic for its faculty, I don't see a law school opening a law firm for its students/recent graduates as much of an issue).
So my conclusion is that a law-school operated law firm is a "related" activity under the UBIT, and therefore poses no commerciality problems to the law school's underlying exemption. That conclusion also means that the revenues from the firm would not be taxed under the UBIT.
A more interesting question arises if the law firm is a separately-incorporated entity. In this case, the issue would be whether this separate entity would qualify for a charitable tax exemption at all. I personally find this a closer case. The IRS's position is that separate corporate entities must "stand on their own" for exemption purposes - the law firm in this case would have to have its own charitable purpose. One possibility, of course, is that the law firm would be exempt as an educational organization - after all, the purpose here is still an educational one: to give third-year students or recent graduates specific skills training as a bridge to private practice. But the IRS takes a dim view of organizations claiming exemption when all they do is operate a for-profit business. While a law firm whose primary purpose was to represent the poor would have an easy claim to exemption, the IRS's general view is that providing services to people who can pay for them, like the middle class, isn't a charitable purpose. See Rev. Rul. 70-585, 1970-2 C.B. 115, Situation 4, where the IRS held that an organization whose purpose was to build affordable middle-class housing in an otherwise wealthy neighborhood was NOT a charitable purpose. Even nonprofit hospitals must provide "something extra" beyond simply providing health services to paying patients to qualify for exemption. See IHC Health Plans v. Comm'r, 325 F.3d 1188 (10th Cir. 2003). So I'm not entirely sure that a separately-incorporated "bridge" law firm would get exemption. It would be very interesting to see how the IRS would rule on such a creature.
But if the law school operates the firm as part of the law school legal entity, I just don't see much of a problem from an exemption perspective. Perhaps some others would like to chime in via the comments section with their own analysis (the comments are moderated, so it might take a day or so for them to show up).
Our most current installment, courtesy of the Senate Democrats in their 2014 Budget Proposal:
The Senate Budget calls for deficit reduction of $975 billion to be achieved by eliminating loopholes and cutting unfair and inefficient spending in the tax code for the wealthiest Americans and biggest corporations. It recognizes that the Finance Committee, which has jurisdiction over tax legislation, could generate this additional revenue through a variety of different methods.
One potential approach is an across‐the‐board limit on tax expenditures claimed by high‐income taxpayers (specifically, the top two percent of income earners). This could take the form of a limit on the rate at which itemized deductions and certain other tax preferences can reduce one’s tax liability, a limit on the value of tax preferences based on a certain percentage of a taxpayer’s income, or a specific dollar cap on the amount of allowable deductions. In assessing any such across‐the‐board limit, Congress should consider the extent to which each proposal would retain a marginal tax incentive to engage in the affected activities and investments.
Another potential approach by which Congress could increase tax fairness and reduce the deficit is by reforming the structure of particular tax expenditures. The Simpson‐Bowles illustrative tax reform plan, for example, proposed to convert certain itemized deductions into limited tax credits, which more equitably deliver tax benefits and, because only about one‐third of taxpayers itemize their deductions, are often better for targeting tax incentives at low‐income and middle class families. Reforms like these could also generate substantial new revenue for deficit reduction.
See Foundation for Growth: Restoring the Promise of American Opportunity, page 66 (emphasis added). As a reminder, the charitable deduction is an "itemized deduction." Therefore, the charitable deduction will be limited by any indiscriminate cap on itemized deductions, whether expressed as a percentage of income or a specific dollar cap. One could guess that the caution highlighted above in bold might have been aimed specifically at the chartiable deduction, although the mortgage interest deduction might lay a claim to such specific attention. The nonprofit sector may have the most about which to worry, as charitable contributions are voluntary and easy to eliminate out of one's personal budget, if a taxpayer choose not to spend above the allowable deduction cap.
Future installments to follow, no doubt.