Friday, June 28, 2013
One had to figure this was coming sooner or later: a lawsuit challenging state property tax exemption for Princeton University, which a state trial judge has refused to dismiss. The arguments in the case appear familiar: the lawyer for the plaintiffs (property owners in Princeton, N.J.) contends that many of Princeton's buildings are used for commercial purposes, and should be put back on the property tax rolls. To quote the story:
“In 2011 Princeton University received $118 million in patent royalties and distributed $30 million from the profits to faculty members,” Afran [the lawyer for the plaintiffs] said. “Under the law they are not even entitled to a tax exemption because they are engaged in commercial patent licensing, and the school give out a percentage of profits to faculty. Under the law in New Jersey, if a nonprofit gives out profits, it is not entitled to an exemption at all.”
The final quote sort of sums it all up:
“In many ways these modern universities have become commercial enterprises.”
Wednesday, June 26, 2013
The Huffington Post reports that in a speech to a group of Southern Baptist ministers in Houston on Monday, Mike Huckabee said that churches should consider giving up exempt status. "I think we need to recognize that it may be time to quit worrying so much about the tax code and start thinking more about the truth of the living God, and if it means that we give up tax-exempt status and tax deductions for charitable contributions, I choose freedom more than I choose a deduction that the government gives me permission to say what God wants me to say." Huckabee confirmed his views in a tweet Tuesday evening.
I don't think I've ever uttered the words "I agree with Mike Huckabee," but there's a first time for everything. So here goes: I agree with Mike Huckabee. The primary issue, of course, is the ability of churches to engage in political campaign activity, the same issue at the core of the 501(c)(4) mess. But in the 501(c)(3) category, we have a nice, bright line: political campaign activity is completely banned. Nevertheless, that hasn't kept churches and their ministers (on both the right and the left of the political spectrum, by the way) from blatantly violating the law (for examples, see my prior posts here and here).
My view on the relationship of churches to 501(c)(3) has always been the same: if they want 501(c)(3) status, they need to play by the rules. If they don't want to play by the rules, give up 501(c)(3) status, and engage in politics to their hearts content. They don't get to break the rules and then whine that the government is picking on them, any more than 501(c)(4)'s should get to blatantly break the rules and whine that the government is picking on them. So - quit whining, and suck it up. Make your choice and live with it. Be like Mike (Huckabee).
Tuesday, June 25, 2013
In Graev v. Commissioner, 140 T.C. No. 17 (June 24, 2013), the Tax Court sustained the IRS’s disallowance of deductions claimed with regard to the donation to the National Architectural Trust (NAT) in 2004 of both a façade easement valued at $990,000 and an accompanying $99,000 cash endowment. NAT had written a side letter to Mr. Graev, the donor, promising that, if the deduction for the easement is disallowed, NAT would “promptly refund [Mr. Graev’s] entire cash endowment contribution and join with [him] to immediately remove the facade conservation easement from the property’s title.” The Tax Court found that the gifts were conditional and, at the time they were made, the possibility they would be “defeated” was not so remote as to be negligible.
In explaining its holding, the Tax Court noted that IRC § 170 and the corresponding Treasury Regulations provide instructions and limitations that, at least in part, ensure that a donor will be able to deduct only what the donee organization actually receives. Three such limitations effectively provide that no deduction for a charitable contribution will be allowed unless, on the date of the contribution, the possibility that the donee’s interest in the contribution would be defeated is “so remote as to be negligible.” See Treasury Regulation § 1.170A-1(e) (pertaining to conditional gifts); § 1.170A-7 (pertaining to partial interest gifts); § 1.170A-14(g)(3) (pertaining to gifts of conservation easements).
Based on the specific facts in Graev, the court found that, on the date of the contributions, the possibility the IRS would disallow the easement deductions and NAT would return the cash to Mr. Graev and remove the easement (i.e., the gifts would be defeated) was not so remote as to be negligible. The facts the court found persuasive included the IRS’s announced intention to scrutinize deductions for facade easement donations; Mr. Graevs’ insistence that NAT issue the side letter; NAT’s practice of issuing side letters, the very essence of which “implies a non-negligible risk;” and NAT’s incentive to honor its promises in the side letter so as not to undermine its reputation and impair its ability to obtain future contributions.
The Tax Court specifically declined to address the hypothetical circumstance in which a “hyper-cautious” donor conditions his gift on non-disallowance where the possibility of disallowance is so remote as to be negligible. However, the standard for finding that the possibility of defeat of a conditional gift is so remote as to be negligible is very high. The court explained:
In prior cases, we have defined “so remote as to be negligible” as “‘a chance which persons generally would disregard as so highly improbable that it might be ignored with reasonable safety in undertaking a serious business transaction.’”… Stated differently, it is “a chance which every dictate of reason would justify an intelligent person in disregarding as so highly improbable and remote as to be lacking in reason and substance.”
In Graev, the Tax Court noted: “the mere fact that he required the side letter is strong evidence that, at the time of Mr. Graev’s contribution, the risk that his corresponding deductions might be disallowed could not be (and was not) ‘ignored with reasonable safety in undertaking a serious business transaction.’” Obtaining the side letter also indicated that Mr. Graev did not disregard the chance of disallowance "as so highly improbable and remote as to be lacking in reason and substance." Accordingly, the mere fact of obtaining a side letter such as that at issue in Graev might be deemed a tripwire that destroys deductibility.
Graev is the latest in a series of cases in which deductions for façade easement donations to NAT have been disallowed on a variety of grounds. See Herman v. Commissioner, T.C. Memo. 2009-205; 1982 East LLC v. Commissioner, T.C. Memo. 2011-84; Friedberg v. Commissioner, T.C. Memo. 2011-238; Dunlap v. Commissioner, T.C. Memo. 2012-126; Rothman v. Commissioner, T.C. Memo. 2012-218; Scheidelman v. Commissioner, T.C. Memo. 2013-18. See also Kaufman v. Shulman, 687 F.3d. 21 (1st Cir. 2012)(remanding to the Tax Court on the issue of valuation and noting that, because of local historic preservation laws, the Tax Court might well find that the façade easement donated to NAT was worth little or nothing). NAT also was the subject of a 2011 Department of Justice lawsuit alleging that NAT was engaged in abusive practices. The suit settled with NAT denying the allegations but agreeing to a permanent injunction prohibiting it from engaging in the practices.
Belk v. Commissioner - Tax Court Reaffirms its Holding that “Floating” Conservation Easements Are Not Deductible
In Belk v. Comm’r, T.C. Memo 2013-154 (June 19, 2013) (Belk II), the Tax Court denied the taxpayers’ motion for reconsideration, rejecting all three of the taxpayers’ arguments and expanding upon its holding in Belk I.
Tax-Deductible Conservation Easements Must Protect Identifiable, Specific Pieces of Property
The taxpayers first argued that, as long as the taxpayer agreed not to develop 184.627 acres of land, neither the court nor the IRS should be concerned with what land actually comprises the 184.627 acres. The Tax Court disagreed, holding, as it had in Belk I, that a “floating” easement is not eligible for a deduction under § 170(h), and § 170(h)(2)(C) requires that taxpayers donate an interest in an “identifiable, specific piece of real property.”
This holding is consistent with the legislative history of § 170(h), in which Congress indicated its desire to limit the deduction to “the preservation of unique or otherwise significant land areas” (see Senate Report No. 96-1007, Sept. 30, 1980). It also is consistent with the elaborate threshold conservation purposes and other requirements of § 170(h) and the Treasury Regulations. For example, it would make little sense to require that the donee be given baseline documentation establishing the condition of the specific property encumbered by the easement at the time of the donation only to have the parties remove that property from the easement in exchange for the addition of some other property (which may or may not have similar characteristics and for which there is no requirement of a baseline). Similarly, it would make little sense to require that the taxpayer obtain a subordination agreement from a lender holding an outstanding mortgage on the specific property encumbered by the easement at the time of the donation only to have the parties remove that property from the easement in exchange for the addition of some other property (which may or may not itself be subject to a mortgage and for which there is no requirement of subordination).
The Tax Court in Belk II also noted, citing Treasury Regulation § 1.170A-14(c)(2), that the regulations permit substitutions under limited circumstances, and the easement at issue did not limit substitutions to those circumstances. Treasury Regulation § 1.170A-14(c)(2) provides that, to be eligible for a deduction, the instrument of conveyance must prohibit the donee from transferring the easement except to another eligible donee that agrees to continue to enforce the easement. A limited exception to this rule is provided, however, for extinguishments (i.e., transfers) that appear to have to meet the requirements of Treasury Regulation § 1.170A-14(g)(6)(i) and (ii) (the extinguishment and proceeds regulations), which, among other things, require the payment of proceeds to the holder to be used "in a manner consistent with the conservation purposes of the original contribution." In other words, the regulations appear to permit “substitutions” under the limited circumstances described in the extinguishment and proceeds regulations. (Note: although Treasury Regulation § 1.170A-14(c)(2) cross-references to -14(g)(5)(ii), the proper cross-reference is to -14(g)(6)(ii); the Treasury failed to update the cross-references when it finalized the proposed regulations in 1986.)
Limited Amendment Clause Did Not Nullify Substitution Provision
The taxpayers next argued that the conservation easement did not permit substitutions despite the detailed provisions in the deed expressly authorizing substitutions. They pointed to the amendment provision included in the deed, which provides that the holder cannot agree to amendments that would result in the easement failing to qualify for a deduction under § 170(h). The Tax Court again dismissed this argument, finding, as it had in Belk I, that the amendment and substitution provisions were in conflict, and the parties’ intent to permit substitutions controlled. The court also rejected the taxpayers’ argument that, because they intended to make a deductible contribution under § 170(h), the easement deed should be interpreted not to permit substitutions. The court explained that “matters of taxation must be determined in light of what was actually done rather than the declared purpose of the participants.”
Not an Impossible or Impractical Requirement
The taxpayers’ final argument was that the court imposed an impossible and impractical requirement on donors and donees because the parties purportedly could change the property subject to the easement under state law and, thus, should not be penalized for including substitution provision in the easement deed. The IRS disagreed, stating that the taxpayers’ interpretation of state law “as giving parties unfettered ability to modify contracts is nonsensical and would make all conservation easements meaningless.” The court held against the taxpayer, noting that “we do not consider whether the parties could have substituted property by mutual agreement without a substitution provision but simply look to the fact that the conservation easement agreement contained such a provision.” Because the easement contained a substitution provision, the court found that the taxpayers “did not agree to restrict their use of the golf course in perpetuity.”
The taxpayers in Belk II also argued, citing to Comm’r v. Simmons, 646 F.3d 6 (D.C. Cir., June 21, 2011), aff’g Simmons v. Comm’r, T.C. Memo. 2009-208 (Sept. 15, 2009), that the Tax Court in Belk I failed to consider “that an element of trust and confidence is placed in a qualified organization that it will continue to carry out its mission to protect and conserve property.” The Tax Court responded that, while the taxpayers were correct that courts trust qualified organizations to fulfill their responsibilities, that trust is based on the requirements imposed on the qualified organization by the conservation easement and local law. The court pointed out that, in Simmons, although the conservation easement deed contained a clause granting the holder the right to consent to changes or abandon its rights under the easement, the Court of Appeals found that both the easement deed and local historic preservation laws prevented the donee from consenting to any changes that were inconsistent with the conservation purposes of the easement. Moreover, if the donee dissolved (thereby abandoning the easement), the easement would be transferred to the District of Columbia to be reassigned to similar organization. Accordingly, “the conservation purpose was protected at all times.” The same was not true in Belk, where the easement granted the parties the right to agree to substitutions and, thus, “there is no restriction on the golf course in perpetuity that we can trust [the holder] to enforce.”
Although not at issue in Belk, charities and government entities that solicit and accept charitable gifts to be used for specific purposes are obligated under state law to administer those gifts consistent with their terms and purposes, and the state attorney general can generally call a holder to account for failing to do so. In Carpenter v. Commissioner, T.C. Memo 2012-1 the Tax Court held, in part, that the tax-deductible conservation easements at issue in that case were restricted charitable gifts, or “contributions conditioned on the use of the gift in accordance with the donor’s precise directions and limitations.” Accordingly, the holder of a tax-deductible perpetual conservation easement, whether a government entity or nonprofit, should be required under state law to administer the easement consistent with its terms and charitable conservation purpose, including the terms included in the deed to satisfy federal tax law requirements.
Finally, the holding in Simmons regarding the grant to the holder of the right to consent to changes to two façade easements should be confined to its facts because it was based, in part, on (i) a regulation applicable only to historic preservation easements (see Treasury Regulation § 1.170A-14(d)(5)(i)), (ii) the presence of “appropriate” federal, state, and local historic preservation laws, and (iii) the provisions of the deeds at issue, which (consistent with the regulation) specifically required that any work done on the properties had to comply with applicable federal, state, and local historic preservation laws, whether the holder consented or not. As the Tax Court in Simmons explained, although the easements grant the holder the right to consent to changes, they also require that any rehabilitative work or new construction on the facades comply with the requirements of all applicable federal, state, and local government laws and regulations, and Treasury Regulation § 1.170A-14(d)(5)(i) specifically allows a donation to satisfy the conservation purposes test even if future development is allowed, as long as that development is subject to appropriate local, state, and federal laws and regulations. The D.C. Circuit in Simmons similarly explained, in part, that “any change in the façade to which [the holder] might consent would have to comply with all applicable laws and regulations, including the District's historic preservation laws” and, thus, “the donated easements will prevent in perpetuity any changes to the properties inconsistent with conservation purposes.” The backstop of “appropriate local, state, or Federal standards” for development is generally not present in the context of conservation easements encumbering land donated for outdoor recreation or education, open space, or habitat protection conservation purposes because such easements typically do not merely duplicate or supplement federal, state, or local zoning or other laws. Moreover, the regulations interpreting the outdoor recreation or education, open space, and habitat conservation purposes do not similarly provide that a deduction will be allowed provided the terms of the easement require that future development conform with appropriate local, state, or federal standards.
Monday, June 24, 2013
The IRS has issued its report on the (c)(4) "targeting" issue, available here. The report concludes that while there were "significant management and judgment failures," there is no evidence of intentional wrongdoing. The report indicates that senior IRS staff responsible for the determinations process have been replaced, and that the IRS will take a number of steps to insure similar situations do not recur.
Perhaps the most interesting part of the report is Appendix E, which provides an expedited review process for (c)(4) organizations whose applications for exempt status have been pending for more than 120 days. This process establishes a safe harbor presumption that the organization is engaged "primarily" in promoting social welfare if the organization certifies under penalties of perjury two items: The Appendix further defines relevant concepts as follows:
1. During each past tax year of the organization, during the current tax year, and during each future tax year in which the organization intends to rely on a determination letter issued under the optional expedited process, the organization has spent and anticipates that it will spend 60% or more of both the organization’s total expenditures and its total time (measured by employee and volunteer hours) on activities that promote the social welfare (within the meaning of Section 501(c)(4) and the regulations thereunder).
2. During each past tax year of the organization, during the current tax year, and during each future tax year in which the organization intends to rely on a determination letter issued under the optional expedited process, the organization has spent and anticipates that it will spend less than 40% of both the organization’s total expenditures and its total time (measured by employee and volunteer hours) on direct or indirect participation or intervention in any political campaign on behalf of (or in opposition to) any candidate for public office (within the meaning of the regulations under Section 501(c)(4)).
The Appendix further defines relevant concepts as follows:
For purposes of these representations, activities that promote the social welfare do not include any expenditure incurred or time spent by the organization on--
- Any activity that benefits select individuals or organizations rather than the community as a whole;
- Direct or indirect participation or intervention in any political campaign on behalf of (or in oppositionto) any candidate for public office;
- Operating a social club for the benefit, pleasure, or recreation of the organization’s members; and
- Carrying on a business with the general public in a manner similar to organizations operated for profit.
For purposes of these representations, direct or indirect participation or intervention in any political campaign on behalf of (or in opposition to) any candidate for public office (“candidate”) includes any expenditure incurred or time spent by the organization on:
- Any written (printed or electronic) or oral statement supporting (or opposing) the election or nomination of a candidate;
- Financial or other support provided to (or the solicitation of such support on behalf of) any candidate, political party, political committee, or Section 527 organization;
- Conducting a voter registration drive that selects potential voters to assist on the basis of their preference for a particular candidate or party;
- Conducting a “get-out-the-vote” drive that selects potential voters to assist on the basis of their preference for a particular candidate or (in the case of general elections) a particular party;
- Distributing material prepared by a candidate, political party, political committee, or Section 527 organization; and
- Preparing and distributing a voter guide that rates favorably or unfavorably one or more candidates.
In addition, solely for purposes of determining an organization’s eligibility under this optional expedited process, direct or indirect participation or intervention in any political campaign on behalf of (or in opposition to) any candidate includes any expenditure incurred or time spent by the organization on:
- Any public communication within 60 days prior to a general election or 30 days prior to a primary election that identifies a candidate in the election. For this purpose, “public communication” means a communication by means of any broadcast, cable, or satellite communication; newspaper, magazine, or other periodical (excluding any periodical distributed only to the organization’s dues paying members); outdoor advertising facility, mass mailing, or telephone bank to the general public; and communications placed for a fee on another person’s Internet website;
- Conducting an event at which only one candidate is, or candidates of only one party are, invited to speak; and
- Any grant to an organization described in Section 501(c) if the recipient of the grant engages in political campaign intervention.
Given my earlier post on the Bright Lines project, I find it particularly interesting that the IRS has defined the relevant standard by reference to BOTH expenditures AND employee/volunteer time. Hmmm . . . .
(Hat tip to Evelyn Brody)
Although some of the hubbub about 501(c)(4)'s and political activity has settled over the past couple of weeks, we shouldn't overlook the fact that the central fault leading to this mess was (and is) a set of un-administrable (and therefore unenforceable) rules regarding political campaign activity by exempt organizations.
In my back and forth with Rosemary Fei on 501(c)(4)'s, she mentioned that she was part of a group trying to provide better guidance on the line between prohibited political activity and permitted legislative lobbying or issue advocacy activity. This work is called The Bright Lines Project, and a full draft of their effort as of May, 2013, is available here.
In many ways, the project advances the IRS's own guidance on political activity by 501(c)(3) organizations published in Revenue Ruling 2007-41, but provides additional bright lines (pun unavoidable) on what is permitted and what isn't. It is a very thoughtful effort, modeled after the regulations on what constitutes lobbying expenditures under Section 4911 and the 501(h) election and fills some nagging holes in the IRS's guidance in Rev. Rul. 2007-41.
But I do think the project makes one mistake and ignores another very deep problem in this area. The one mistake is a sort of "pulpit speech" exception that is referred to as an exeption for "personal, oral remarks at official meetings." The project's explanation of this exeption is as follows:
Oral remarks made by anyone (other than a candidate) who is present in person at an official meeting of an organization held in a single room or location, so long as no announcement of the meeting refers to any candidate, party, election, or voting. This exception covers only oral remarks about candidates made by and to persons in attendance, not any other form of communication of those remarks, whether written, electronic, recorded, broadcast, or otherwise transmitted. A prominent disclaimer must be made to those attending, stating that such remarks are the speaker's personal opinion and are not made on behalf of the organization, and that the speaker is not advocating any of the actions set forth in Rule 3 [e.g., expressly calling for the election or defeat of a specific candidate or political party]
In it's examples, the Project notes that this rule would "permit a pastor to express his or her personal views on candidates from the pulpit. It would also allow parents at a PTA meeting, including officers, to express their views on candidates for school board. It would permit speeches, sermons, or discussions at any meeting of any tax-exempt organization to include expressions of opinion on those running for public office in upcoming elections, so long as such views were not made officially or on behalf of the organization."
My own view is that this exception is a huge mistake, because it will be exploited to the hilt by organizations intent on "having their say" about candidates. Face it - a Catholic priest, giving his "opinions" on candidates at Mass on the Sunday before the election will be viewed as an official church position, regardless how strong the "disclaimer" is that is attached to the remarks. We actually have a useful bright line on this kind of activity right now under Rev. Rul. 2007-41: you can't do it. The revenue ruling makes clear that speech such as this at an official function of an organization is prohibited, whether a disclaimer is attached or not. That seems to me to be an excellent bright line, and we should not replace it with an exploitable exception that is hardly a bright line.
The second major problem with the project is that it says nothing about the core problem that plagues 501(c)(4)'s (and 5's and 6's), which is "how much political activity is too much?" The project makes no attempt to set a bright line for when political activity becomes a "primary purpose" or otherwise address the "how much" issue.
This is a critical failing. The (c)(4) problem is as much (in my opinion, more) about how much political activity is permitted as it is in the dividing line between issue advocacy and campaign activity. Right now, we have nothing other than the vague notion that a (c)(4)'s "primary purpose" can't be political campaign activity - but there is no standard for judging "primary purpose."
So why not adopt a very clear bright line on this latter issue: the amount of political campaign activity permitted by (c)(4)'s, (5)'s and (6)'s is . . . zero. None. Absolute prohibition. Many of my colleagues believe there should be some "de minimis" amount of campaign activity permitted. I've heard things like "15%" thrown around, for example. But here's the problem: 15% OF WHAT? Of expenditures? Which expenditures? Of employee time? What if volunteers are used? Is the 15% per year or on a 4-year rolling average that we use elsewhere in 501(c)? If it's a 4-year average, that means an organization can "save up" for the presidential campaigns that happen every four years. Providing a de minimis exception is hardly a "bright line" in this area, unless one is going to couple it to a specific mathematical test like that provided in 501(h)/4911 for lobbying by 501(c)(3)'s. And anyone who's worked with that regime will tell you that it is incredibly complex, particularly when it comes to allocating expenditures (and I'd argue that the test doesn't account for volunteers or the fact that modern communication - e-mail and web sites - cost very little but have major communications impact). Do we REALLY want to go down that road? And if so, why? What is gained by such a rule other than complication and confusion? What part of "NONE" is so hard to understand or hard to comply with that we need an exception of some kind?
So I'll say it again. If we're really concerned about political campaign activity by (c)(4)'s, (5)'s and (6)'s, prohibit it; any organization that engages in political campaign activity in any amount that wants exemption should be subject to disclosure rules as Lloyd Mayer and others have argued - that is, shuffle them to 527 or some similar regime.
To actually solve the problems that led to the current mess, we need both bright line tests to distinguish between issue advocacy and political activity AND we need a bright line on how much activity is permitted. In the case of political campaign activity, "NONE" is a nice bright line that is mostly (not completely, I'll admit) incapable of exploitation . . .
[This represents a bit of change to my position, by the way - I'm actually OK with a 501(c)(4) category for organizations whose primary purpose is issue advocacy, including lobbying, IF such organization is prohibited from ANY campaign activity. It's probably a good thing to have such an organization that is also prohibited from receiving deductible contributions under 170 in order to avoid having (c)(3)'s used to end-run the 162(e) limits on the deductibility of lobbying expenses, and I'm also convinced there is a useful public benefit to issue advocacy.]