Thursday, January 24, 2013
For a number of years, I've espoused the view that we should expand the unrelated business income tax to a "commercial activity" tax - that is, a charity engaged in any commercial activity should pay taxes on any net revenues from that activity, whether or not the activity is "related" in some way to the organization's charitable purpose. See, e.g., John D. Colombo, Commercial Activity and Charitable Tax Exemption 44 WM. & MARY L. REV. 487 (2002). I've also opined that if we did this, we could grant tax exemption rather broadly to permit organizations with some legitimate charitable purpose the ability to get tax-deductible contributions for their charitable activities, while still fully taxing any commercial activity. I believe this would simplify current law and compliance. For example, museum gift shop revenues would be fully taxable, instead of having to parse whether specific sales were "related" or "unrelated" as is currently the case (e.g., an art museum gift shop can sell replicas of art, art books, "arty" postcards and the like without UBIT liability, but sales of science books or "I Love NY" coffee mugs are subject to the UBIT; see, e.g., Rev. Rul. 73-104). A charity that operates a pay garage would pay taxes on the garage revenues as a whole, without allocating between parking receipts that are "related" to charitable activities and those that are not. I readily admit there are still some interpretive issues (are museum admission charges "commercial" revenues?), but I think these issues would be fewer and easier to resolve than esoteric questions of "relatedness."
It appears that a recent decision by the Supreme Court of the Philippines interpreting its statutory law with respect to charities has more or less adopted my approach with respect to nonprofit hospitals (to be clear, they didn't do this because they read anything I wrote; still, this indicates my approach isn't completely crazy). In Commissioner of Internal Revenue vs. St. Luke's Medical Center, Inc., G.R. No. 195909, September 26, 2012 (full opinion here; an excellent summary is available here), the Philippine Supreme Court held that Philippine law distinguished between a fully exempt "charitable" hospital or educational institution (whose activities must be exclusively charitable) and a private nonprofit hospital or educational institution engaged in some charitable and some commercial activity. With respect to the latter, the organization is required to pay income tax on their commercial revenues (albeit at a reduced rate as provided in Philippine law), but not required to pay tax on revenues resulting from charitable activities. In the context of the private nonprofit hospital at issue, the court held that revenues from paying patients would be taxable (again, at the reduced rate provided for by Philippine law), because these revenues were part of a for-profit business.
The Court finds that St. Luke’s is a corporation that is not “operated exclusively” for charitable or social welfare purposes insofar as its revenues from paying patients are concerned. This ruling is based not only on a strict interpretation of a provision granting tax exemption, but also on the clear and plain text of Section 30(E) and (G). Section 30(E) and (G) of the NIRC requires that an institution be “operated exclusively” for charitable or social welfare purposes to be completely exempt from income tax. An institution under Section 30(E) or (G) does not lose its tax exemption if it earns income from its for-profit activities. Such income from for-profit activities, under the last paragraph of Section 30, is merely subject to income tax, previously at the ordinary corporate rate but now at the preferential 10% rate pursuant to Section 27(B).
In other words, revenues from commercial (e.g., for-profit) activity (in this case, paying patients) are taxable, but the organization remains tax-exempt on its actual charitable activities. There is no "relatedness" test here as under our UBIT; the only question is whether an activity is for-profit (commercial).
While this decision obviously is the result of the sui generis statutory law in the Philippines, if it works there, I don't see any reason why it couldn't work here . . . the description of St. Luke's operations in the opinion sounds like a pretty typical nonprofit hospital here in the U.S. (We'll have to talk, though, about this preferential rate stuff . . .).
Tuesday, January 22, 2013
A key finding is that half the chief fundraisers -- or “development directors” as they're known in the nonprofit world -- expect to leave their current jobs within two years due to an assortment of pressures, including a frequent feeling that they’re out on a limb because they're expected to produce results without having enough backup from bosses and boards that haven’t managed to put effective, systematic fundraising plans and approaches in place. Only 58% of the development directors rated their organizations’ fundraising as “effective” or “very effective,” compared with 83% of the chief executives, and nearly a third of the fundraisers said they’d been given “unrealistic” goals. Their average annual pay ranged from $49,141 at organizations with budgets under $1 million to $100,127 when budgets exceeded $10 million.
The report suggests that organizations typically leave the dirty job of asking for donations to one person and then put a lot of pressure on that one person to produce results. Seems a silly complaint if you ask me. After all, every Development Director I have known claim to be experts in, well, raising money! And most places actually discourage others in the organization from making money and charitable contribution pitches, lest they inadvertently bombard the target with multiple or conflicting messages. Or maybe its just that when Development Directors cultivate a potential benefactor and are ready to reel that benefactor in, they don't get the support from the top person they need. Its that top person, ultimately, that closes the deal after all.
Perpetual Conservation Easements: What Have We Learned and Where Should We Go From Here?
Friday, February 15, 2013, Noon-5:00 pm MSTWatch Live Online at ulaw.tv (the link to the live webcast will be posted on the day of the conference)
The public is investing billions of dollars in conservation easements, which now protect more than 18 million acres throughout the United States. But uncertainties in the law and abusive practices threaten to undermine public confidence in and the effectiveness of conservation easements as land protection tools. This conference will explore these issues, with the goal of minimizing abuse and helping to ensure that conservation easements actually provide the promised conservation benefits to the public over the long term. Leaders in their respective fields will address (i) the federal tax incentives offered with respect to easements donated as charitable gifts to certain qualified holders, (ii) the state conservation easement enabling statutes, (iii) federal and state oversight of charities, and (iv) the role of state attorney general offices in the charitable sector and in the protection of charitable assets on behalf of the public. For more information and a detailed agenda see Perpetual Conservation Easements.
Scheidelman v. Commissioner – A Long Journey to the Denial of a Deduction for a Facade Easement Donation
Scheidelman granted a façade easement encumbering a building located in a historic district in Brooklyn, New York, to the National Architectural Trust in 2004 and claimed a charitable deduction with regard to the grant on her 2004, 2005, and 2006 income tax returns. The IRS disallowed the deductions and, in Scheidelman v. Commissioner, T.C. Memo. 2010-151 (July 14, 2010), Tax Court sustained the disallowances. The Tax Court determined that the appraisal Scheidelman obtained to substantiate the deductions was not a “qualified appraisal” because it failed to state the method and basis of valuation as required by Treasury Regulation § 1.170A–13(c)(3)(ii)(J) and (K).
Two years later, in Scheidelman v. Commissioner, 682 F.3d 189 (2nd Cir., June 15, 2012), the Second Circuit vacated and remanded the case, holding that the appraisal sufficiently detailed the method and basis of valuation. The Second Circuit explained
[f]or the purpose of gauging compliance with the reporting requirement, it is irrelevant that the IRS believes the method employed was sloppy or inaccurate, or haphazardly applied—it remains a method, and [the appraiser] described it. The regulation requires only that the appraiser identify the valuation method “used”; it does not require that the method adopted be reliable.
However, the Second Circuit also noted that its conclusion that the appraisal met the minimal "qualified appraisal" requirements mandated neither that the Tax Court find the appraisal persuasive nor that Scheidelman be entitled to a deduction for the donation of the easement.
On January 16, 2013, the Tax Court issued its opinion on remand: Scheidelman v. Comm’r, T.C. Memo. 2013-18. The Tax Court acknowledged that “’ordinarily any encumbrance on real property, howsoever slight, would tend to have some negative effect on that property’s fair market value.’” The court concluded, however, that the preponderance of the evidence supported the IRS’s position that the easement had no value, and the IRS’s position was “the more persuasive, regardless of the burden of proof.” The court also had harsh words for the taxpayer’s expert at trial, stating
Ehrmann ignored studies suggesting a contrary result and adopted those supporting his client’s desired value. Ehrmann’s testimony had all of the earmarks of overzealous advocacy in support of NAT’s marketing program and, indirectly, [the taxpayer’s] tax reporting. His conclusion that the easement should be valued at $150,000 is unpersuasive and not credible.
Expert opinions that disregard relevant facts affecting valuation or exaggerate value to incredible levels are rejected. . . . An expert loses usefulness to the Court and loses credibility when giving testimony tainted by overzealous advocacy.NAMcL
A modestly-improving economy does not seem to have halted the trend of local property tax exemption fights. Here's a roundup of recent ones, to give a flavor of the scope of what's going on.
Vanderbilt University is seeking full property tax exemption for 11 fraternity/sorority houses. According to Vanderbilt, an agreement with the Greek organizations transferred full control over the property to Vanderbilt, and therefore the houses should be exempt like any other student housing. The move would save Vanderbilt (whose 2013 operating budget was $3.7 billion) $74,000 in annual property taxes. To paraphrase the late Senator Everett Dirksen, "$74,000 here and $74,000 there, and pretty soon you're talking about real money."
Meanwhile, the town of Hebron, Indiana, is fighting property tax exemption granted by the state to a set of apartment buildings. "Town Clerk-Treasurer Terri Waywood said the exemption was granted because the complex provides its tenants with classes in managing money and other services they can't get anywhere else in town." Sounds like a tax-exemption blueprint for all the apartment complexes in Indiana; heck, who doesn't need help managing their money? Even the folks on Downton Abbey could use some instruction on this front . . .
In Knoxville, Tennessee, a pair of golf courses are fighting to re-establish exempt status, and Texas State University's exempt status apparently is causing some budgetary headaches (heartache?) in San Marcos, Texas.
Some days I wonder whether the solution is just to get rid of all tax exemptions . . .
Monday, January 21, 2013
2013 promises to be another big year for cases involving challenges to charitable deductions claimed with regard to conservation easement donations. In the first of the year, Pesky v. United States, 2013 WL 97752 (D. Idaho, Jan. 7, 2013), the United States District Court for the District of Idaho held that the United States adequately pled a counterclaim for a civil fraud penalty under Internal Revenue Code § 6663 based on the Peskys’ allegedly fraudulently claimed charitable deduction for the conveyance of a conservation easement. The court did not determine that the Peskys were liable for the fraud penalty; it decided only that the case can proceed on the merits.
The U.S. alleges that Mr. Pesky, through his attorney, negotiated and eventually engaged in a quid pro quo transaction with The Nature Conservancy (TNC) whereby TNC gave the Peskys (i) an option to buy property located in Ketchum, Idaho (the Ketchum Property) and (ii) a perfected access easement for a driveway over the adjacent Hemingway Property (which was owned by TNC), in exchange for the Peskys giving to TNC (i) $400,000 and (ii) a conservation easement limiting development of the Ketchum Property. The U.S. also alleges that Pesky attempted to structure the transaction to hide its quid pro quo nature so that he could claim a $ 3 million charitable deduction based on the value of the conservation easement. Pesky allegedly exercised his option to purchase the Ketchum Property for $1.6 million and then eventually donated the conservation easement and sold the property (after the driveway easement was perfected) for around $7 million.
In an earlier case, United States v. Richey, 632 F.3d 559 (9th Cir. 2011), the Ninth Circuit overturned the district court's holding that the work file of Mark Richey, the appraiser of the conservation easement at issue in Pesky, was protected by the attorney-client privilege and by the work-product doctrine. The court remanded the case back to the district court for an in camera examination of the materials summoned by the IRS to determine which documents, if any, were protected from disclosure.
A number of news sources reported at the end of last week that President Obama was converting his campaign organization into a 501(c)(4) organization, "Organizing for Action." Apparently this has upset Mike Huckabee (who apparently had his own exempt PAC, as this article points out), but I'd note that that at least we have fair assurance that this new (c)(4) won't be a thinly-disguised campaign funding vehicle, since President Obama can't be re-elected. It also allows me to emphasize a point lost in most of the "(c)(4) and politics" discussion: (c)(4)'s can engage in essentially an unlimited amount of legislative lobbying, which the IRS views as a proper social welfare activity (see the IRS 2003 EO CPE text, available here), but in theory they cannot engage in an unlimited amount of candidate-for-public-office activity (unlike (c)(3) charities, which cannot engage in any candidate support activities, a (c)(4) can engage in some, as long as that is not their "primary purpose").
Still, I have become ever-more convinced that we should simply eliminate (c)(4) status from Section 501. Organizations that are truly supporting social welfare should be able to qualify as charitable organizations with some modest limits on their lobbying activity (add some educational functions, cut back a bit on lobbying, and you're probably there, since the IRS can't really enforce the "no substantial part" test under 501(c)(3) anyway). Everyone else either needs to admit they are a 527 political organization or go away.