January 17, 2013
IRS Inaction on Noncash Charitable Contributions Resulting in Lost Revenue
As reported by The Chronicle of Philanthropy and BNA Daily Tax Report, a recent Treasury Inspector General for Tax Administration report estimates that approximately 60% of of claimed noncash charitable contributions (e.g., cars, boats, artwork, real estate) are reported incorrectly with little to no IRS enforcement. The report further estimates that more than 273,000 taxpayers erroneously reported $3.8 billion in noncash contributions in taxable year 2010 (i.e., the proper paperwork and appraisals were not filed), resulting in potentially $1.1 billion in lost revenues to the federal government. The IRS disputes the amount of revenue loss.
One of the primary areas of concern centers on car/vehicle donations. Although taxpayers are generally allowed to deduct the fair market value of property donated to qualified charitable donees, there are further limitations on car donations. Specifically, a car donor must substantiate, and not deduct more than, the amount the charity received from selling the car for cash. The report concluded that the IRS is not effectively enforcing compliance with the reporting requirements for motor vehicle donations. Over 35,846 tax returns filed for 2011 claiming $77 million in charitable donations of cars failed to comply with reporting requirements.
Senator Charles Grassley (R-Iowa), who chaired the 2005 law changes requiring greater taxpayer substantiation of the value of donated items, criticized the Obama administration's push to raise taxes on higher-income taxpayers, while "giving a free pass to those claiming high-value deductions for donations of vehicles, art, or securities.”
Hall: PILOTs - Congress's Flawed Solution to Burden of Federal Land Ownership
Dayton L. Hall (Washburn, 2013 JD Candidate) has posted Payments in Lieu of Taxes: Congress's Flawed Solution to the Burden of Federal Land Ownership on Counties to SSRN. Here is the abstract:
The federal government makes Payments in Lieu of Taxes (“PILT”) to local governments to help ease the tax burden of federal ownership of land. Because federally owned land is nontaxable, PILT payments are intended to compensate local governments for losses in property taxes due to federal ownership of land within local governments’ boundaries. This Article explains the history and application of the PILT program, analyzes the equity and efficiency of the legislation, concludes that certain aspects of the PILT Act are both inequitable and inefficient, and proposes appropriate revisions. Specifically, this Article concludes and proposes the following: (1) shifting to a tax equivalency payment system based on states’ property valuation laws would be too complicated and inefficient, despite the benefit that such a program might provide more consistent, foreseeable payments to local governments; (2) PILT payments unjustifiably discriminate against less populated counties that contain substantial federal acreage, so the PILT calculation method should be revised to remedy this discrimination; (3) PILT distribution methods creates an inefficient incentive for states to form alternative political subdivisions to maximize payments, so this incentive should be eliminated; and (4) Congress must find a long-term funding solution so that local governments can rely on PILT payments in their long-term planning endeavors.
January 15, 2013
Overvaluation of Gifts in Kind
An interesting article in Forbes online caught my eye today. The article, entitled "Charity Eyes Quarter-Billion-Dollar Write-Down In Value of Goods Handled" discusses one large charity's recent disclosure that it overvalued gifts in kind by $250 million. "The epic restatement downward would rank among the biggest ever by a single charity and is the latest chapter in a festering controversy over the way some nonprofits value and account for noncash d0onations known as gift-in-kind, or GIF." We all know the incentives individual taxpayers might have to overstate the value of donated goods -- a bigger charitable contribution deduction, for one -- but what are some of the reasons a charity would overstate the value of non-cash contribution? Forbes implies that the charity may have been motivated by the "ranking game," something we Law Schools would never do of course. The valuation, reported on the charity's 990 made it the 51st largest charity in the United States, as measured by private donations received in 2011. See here for a list of the largest U.S. Charities for 2012. A charity's over-valuation could both help or hurt its status. Too much from one person might push the charity into the private foundation quagmire. Too little might have the same effect. In any event, Forbes makes it seem like overvaluation is a real problem in the charitable world:
The situation also underscores one of the dirty but legal secrets of the GIK word: Multiple charities often claim credit for the same noncash gift as it moves from one nonprofit to another to another in a “daisy chain” that makes each seem bigger and more financially efficient. However, at the same time charity experts say it often takes the efforts of several nonprofits to collect, move and distribute the same batch of goods to locations domestic and foreign.
Valuation is a problem in pretty much all areas of taxation. Those seeking to reduce tax liability will either understate the value of something (when it comes to reporting income) or overstate the value of something (when it comes to claiming a deduction). And there are plenty of rules relating to valuation, just look at the regulations under IRC 170. But it never occurred to me that mis-valuation might be a problem for nonprofits. I wonder what other potential benefits -- other than a higher ranking -- might be had from overvaluation of charitable gifts.
January 14, 2013
In one way or another, nonprofit organizations are continually required to justify their own existence. That is, as organizations exempt from taxation. The Catch 22 in responding to the mandate is that nonprofits implicitly justify the unstated question: "Are you even worth it?" Nonprofits either justify the question or appear to "protest too much." Better to just address the question head on if you ask me but not through boilerplate That's the question, after all, implicit in local municipalities' continuing efforts to impose PILOTS on nonprofits. Pittsburgh, Pennsylvania, for example, recently appointed another PILOT task force whose ultimate charge is to determine whether nonprofits are "worth it?" "Well . . . are you!?" asks Pittsfied, Massachussetts' Mayor, according to this report. Meanwhile, local nonprofit organizations continually issue those boring and, even worse, less convincing studies designed to show their significant positive impact on local economies. North Dakota, Idaho, Kentucky, Nebraska, New Hampshire and Oregon are just some of the states adhering to the same old tired playbook. Meanwhile, local governments push ahead with their plans, slowly but continually eroding tax exemption on the local level. Deservedly so, if all nonprofits can do is issue reports that don't get to the real question; "what exactly does the tax exempt nonprofit sector provide that cannot be had from the taxable for profit sector?" I think this is the nagging question that follows nonprofits from 2012 and into 2013. Justify thyself.
[See Payroll tax would elicit some cash from large Pittsburgh nonprofits (Pittsburgh Post-Gazette)]
Charities Still Leery After Fiscal Cliff Deal
In an article entitled "Charitable groups fear tax victory in 'fiscal cliff' deal will prove hollow," The Hill reports that, despite the preservation of the charitable contribution deduction in the recent American Taxpayer Relief Act of 2012, charitable organizations are still concerned about their future due to debt ceiling negotiations and other automatic spending cuts still to be addressed by Congress. The article discusses that charities should take heart in recent Tax Policy Center estimates that charitable giving will increase approximatley 1 percent in 2013 and the reenacted "Pease" limitation on itemized deductions should have "negligible effects on the tax incentive for charitable giving." Nevertheless, charities are concerned that the Obama Administration will continue to push for limits on deductions for wealthy taxpayers, thereby resulting in decreased charitable donations overall.
[See also, "Catholic Charities and Others Fretting over Tax Plight of the Wealthy" in Nonprofit Quarterly]
Owley: The Future of the Past regarding Historic Preservation Easements
Jessica Owley (SUNY-Buffalo) has posted The Future of the Past: Historic Preservation Easements (Zoning Law & Practice Report, Nov. 2012) to SSRN. Here is the abstract:
This brief article summarizes recent case law related to historic preservation easements. As historic preservation easements and other conservation easements age, the number of legal disputes involving them has grown. Challenges to historic conservation easements generally arise in the tax court because many of them are donations. The IRS is taking a close looks at conservation easements generally, appearing to focus particularly on façade easements.
Most states (and the IRS) require historic preservation easements to be perpetual. Courts are beginning to scrutinize what perpetuity means and are looking closely at easement language regarding mortgage subordination, condemnation, and extinguishment. This move by the IRS should indicate to landowners, land trusts, and funders that historic preservation easements should be carefully written to comply with all state and federal regulations with an eye to ensuring their long-term viability. Additionally, the IRS and courts have been particularly concerned with the accuracy of appraisals, which reach millions of dollars. Appraisals need to delineate their method and basis for calculation. The IRS’ scrutiny, however, has been tougher than the courts’. While the Tax Court has often sided with the IRS (on issues of perpetuity, particularly), the circuit courts seem to err in favor of upholding conservation easements and allowing deductions.
Galle and Walker: Constraining Executive Compensation - Evidence from University President Pay
Brian D. Galle (Boston College) and David I. Walker (Boston University) have posted Does Stakeholder Outrage Constrain Executive Compensaton: Evidence from University President Pay to SSRN. Here is the abstract:
We analyze the determinants of the compensation of private college and university presidents from 1999 through 2007. We find that the fraction of institutional revenue derived from current donations is negatively associated with compensation and that presidents of religiously-affiliated institutions receive lower levels of compensation. Looking at the determinants of contributions, we find a negative association between presidential pay and subsequent donations. We interpret these results as consistent with the hypotheses that donors to nonprofits are sensitive to executive pay and that stakeholder outrage plays a role in constraining that pay. We discuss the implications of these findings for the regulation of nonprofits and for our broader understanding of the pay-setting process at for-profit as well as nonprofit organizations.
Weisbord: Charitable Insolvency and Corporate Governance in Reorganizations
Reid K. Weisbord (Rutgers-Newark) has posted Charitable Insolvency and Corporate Governance in Bankruptcy Reorganization to SSRN. Here is the abstract:
Poor corporate governance is pervasive in the charitable nonprofit sector and, in numerous cases, mismanagement and abuse have led to the financial distress or failure of charitable nonprofit firms. The rich literature on nonprofit law has considered the need for better corporate governance and enforcement of fiduciary duties, but the scholarship has yet to address the implications of financial distress and insolvency on corporate governance. This Article fills that void and argues that, when a charity encounters financial distress and approaches the point of insolvency, features of nonprofit and bankruptcy law tend to exacerbate rather than ameliorate the corporate governance problem. In particular, charitable insiders who breach their fiduciary duties are in a better position to entrench themselves and avoid termination than their for-profit counterparts. In the for-profit sector, three constraints tend to regulate corporate governance by helping oust fiduciaries responsible for financial distress: (1) bank monitoring of commercial loan covenants; (2) absolute priority and the transfer of ownership in bankruptcy; and (3) involuntary bankruptcy proceedings. In the nonprofit sector, however, those constraints are either less effective or do not apply. As a result, blameworthy charitable fiduciaries are better able to entrench themselves and, absent new leadership, financially distressed charities are less likely to achieve a full and sustainable financial recovery. This Article suggests that the law might better protect the public interest in charitable assets from waste and abuse by presumptively appointing bankruptcy examiners in all Chapter 11 reorganization proceedings involving substantial charitable assets. Once appointed, bankruptcy examiners would be tasked with identifying the cause of insolvency and individuals responsible for the charity’s financial distress.
Wolf: Religious Giving as Guide to Good Taxation
Robert Wolf (Wisconsin-La Crosse, Finance Dept.) has posted Religious Giving as a Guide to the Principles of Good Taxation (Journal of Accounting, Ethics, and Public Policy, 2012) to SSRN. Here is the abstract:
The principles of good taxation are a set of guiding values necessary for any responsible state to consider in constructing their tax policy. The principles are derived from various philosophical and economic discussions including but not limited to the role of the state, ownership of natural resources, the optimal size of the state, the emphasis on individual versus community rights, and what is reasonable. Adam Smith (1776) initiated the discussion on the principles of good taxation including equality, certainty, convenience and economy. Others have expanded and articulated the principles to include reasonable and neutral. Curran (2001), Hamill (2006), and others have considered the principles of good taxation from a religious viewpoint. Along different lines, Croteau (2005) develops the principles of giving for a religious institution. As religious institutions rely on giving in a similar manner that states rely on taxes, it is useful to review the principles of good taxation in comparison to the principles of giving. This research finds strong consistency between the principles of good taxation and the principles of giving. Additionally, the principles of giving make a strong argument for elevating the importance of effective allocation of tax revenues as a principle of tax collections.
McLaughlin: Extinguishing and Amending Tax-Deductible Conservation Easements
Our contributing editor, Nancy A. McLaughlin (Utah), has posted Extinguishing and Amending Tax-Deductible Conservation Easements: Protecting the Federal Investment after Carpenter, Simmons, and Kaufman (Florida Tax Review, 2012) to SSRN. Here is the abstract:
Taxpayers are investing billions of dollars in conservation easements intended to permanently protect unique or otherwise significant land areas or structures through the federal charitable income tax deduction available to easement donors under Internal Revenue Code § 170(h). Astounding amounts of governmental and judicial resources are also being expended to ensure that the easements are not overvalued, that they satisfy elaborate conservation purposes and other threshold requirements, and that the donations are properly substantiated. This enormous up-front investment will be for naught, however, if the purportedly permanent protections prove to be ephemeral because government and nonprofit holders are able to release, sell, swap, or otherwise extinguish the easements in disregard of the restriction on transfer, extinguishment, division of proceeds, and other perpetuity-related requirements in § 170(h) and the Treasury Regulations. The Tax Court’s holding in Carpenter v. Commissioner was an important victory for the IRS and the public because it provides some key guidance regarding compliance with § 170(h)’s perpetuity-related requirements. However, Carpenter has also engendered some confusion and speculation, and recent Circuit Court decisions have compounded the problem by undermining the IRS’s efforts to enforce the perpetuity-related requirements. This article examines these cases against the backdrop of the legislative history of § 170(h), state law, and public policy. It concludes that clear federal rules regarding the transfer, amendment, and extinguishment of tax-deductible conservation easements are needed because, without such rules, the purportedly perpetual protections will erode over time and the enormous public investment in the easements and the conservation values they are intended to protect for the benefit of future generations will be lost.
Brewer: Strengthening the L3C
The raison d’être for the low-profit limited liability company (“L3C”) is to encourage program-related investments (“PRIs”) by private foundations. PRIs are special types of investments that can be both charitable and profitable. PRIs have been embraced by knowledgeable scholars, practitioners, foundation managers, and even the U.S. Treasury Department. Further, the L3C and PRIs are associated with the growing “social enterprise” movement. The L3C thus would seem to be in the right place at the right time and should have the full support of the charitable sector, practitioners, and lawmakers.
Yet, after a fast start, adoption of L3C legislation across the U.S. has stalled. In fact, several states recently have considered L3C legislation and have either rejected it outright or deferred its passage indefinitely. Many highly-regarded scholars and practitioners adamantly oppose the L3C, even though those scholars and practitioners generally endorse PRIs. This slow pattern of adoption and strong opposition to the L3C contrasts sharply with the rapidly increasing acceptance of another type of “social enterprise” entity, the benefit corporation.
Why is L3C legislation languishing? Because the L3C suffers from the following fundamental defects: (i) except in name, the L3C is indistinguishable from a regular LLC; (ii) without any type of statutory enforcement mechanism, the L3C lacks accountability and transparency; and (ii) because the L3C promises more than it can deliver absent new federal legislation, the L3C fails of its essential purpose of encouraging PRIs. Given these defects, the L3C’s opponents maintain that the L3C is a well-intentioned but nonetheless failed experiment that should be abandoned.
This article argues that even though the L3C in its current form is defective, the L3C should not be abandoned. Instead, the L3C can be a viable tool for tax-exempt organizations and PRIs if the current statutory framework is strengthened and improved. With the foregoing premise in mind, this article proposes seven relatively simple but impactful changes that would strengthen and improve the L3C statutory framework. If the L3C becomes more than just a brand, then perhaps the L3C can fulfill its raison d’être.