Monday, September 24, 2018
Charitable Contributions, State Tax Credits, and Return Benefits: IRS Proposed Regs, IRS Announcement, and Much Commentary
The Treasury and IRS proposed regulations to address the attempts by states to create a way for their residents to get around the cap on the state and local tax (SALT) deductions by facilitating charitable contributions that would qualify the donors for state tax credits. The proposed regulations would treat the state tax credits as return benefits, thereby requiring a reduction in any otherwise available charitable contribution deduction. The proposed regaultions raise a range of issues, including:
- whether this approach should apply more broadly to all third-party-provide benefits not just state tax credits (see comments of Lawrence Zelenak (Duke); hat tip: TaxProf Blog);
- whether a substance-over-form approach would have been better (see a pre-proposed regs article by Joseph Bankman (UCLA) and Darien Shanske (UC Davis); Zelenak also flagged this issue);
- how to treat the state tax credits if they are later sold or expire (see comments by Andy Grewal (Iowa));
- administrative concerns (see a pre-proposed regs article by David Gamage (Indiana University)), which are partially addressed by a de minimis exception for both state tax credits of up to 15% and state tax deductions resulting from charitable contributions; and
- political issues, in that the proposed regulations do not differentiate the recent SALT cap workaround efforts from the 100 or more pre-tax legislation state programs that provided state tax credits in exchange for contributions to certain types of charities (see a pre-proposed regs State Tax Notes article (subscription required) by eight tax academics that includes an appendix listing those existing programs).
Earlier articles raising these and other issues include: Joseph Bankman et al., Caveat IRS: Problems with Abandoning the Full Deduction Rule, State Tax Notes (2018); Roger Colinvaux (Catholic), Failed Charity: Taking State Tax Benefits Into Account for Purposes of the Charitable Deduction, 66 Buffalo Law Review 779 (2018); and Andy Grewal, The Charitable Contribution Strategy: An Ineffective Salt Substitute, Virginia Tax Review (2018).
An added wrinkle is that shortly after the issuance of the proposed regulations the IRS issued an announcement stating that "[b]usiness taxpayers who make business-related payments to charities or government entities for which the taxpayers receive state or local tax credits can generally deduct the payments as business expenses." While meant as a clarification, this announcement may not in fact have clarified very much or may indeed have created a significant loophole, as Andy Grewal has noted.
Friday, July 6, 2018
The news cycle may have moved on from the New York Attorney General's lengthy Petition against the Donald J. Trump Foundation and Donald, Donald Jr., Invanka, and Eric Trump, but the legal cycle continues. It is therefore worth considering what is the most important question that Petition raises - did now President Trump break any criminal laws through his Foundation?
First, a mea culpa is owed. When I first, very quickly (and in the Newark airport on my smart phone, which is not a great way to review legal documents), read the Petition and related materials, I missed the not-so-subtle hints that the AG included suggesting that the answer to this question is yes. As way of explanation but not excuse, this was in part because I did not then know that she generally lacka authority to bring criminal charges herself. But more importantly, in my quick read I missed both the occasional "willful" or "willful and knowing" language - particularly with respect to the alleged use of the Foundation to benefit his campaign - and, most damning, the copying of officials at the U.S. Department of Justice Criminal Division's Public Integrity Section on the FEC referral letter. So I apologize for anyone I talked to in the hours after the petition became public for not catching those hints.
But of course the fact that New York AG thinks they may have been one or more violations of criminal law does not necessarily make it so, even assuming the accuracy of the facts she alleges. There has already been a debate among tax scholars regarding whether those facts justify referral for a criminal investigation by the IRS - see Phil Hackney in the NY Times (yes) and Brian Galle in Medium (maybe, but probably not). I lean more toward Brian's side of this debate, with the kicker being that all of the funds distributed by the Foundation went to charities even if those contributions actually benefitted Mr. Trump, his business interests, or his campaign (with the exception of one $25,000 political organization donation in 2013, which plausibly was an inadvertent error and the false reporting of which could not be pinned on Mr. Trump by the AG). People who have been prosecuted (successfully) for using charitable assets for their own benefit, including former Representatives Corrinne Brown, Chakah Fatah, and Steve Stockman, have usually actually spent charitable funds on personal expenses or given it to their businesses or campaigns. And criminal prosecutions for false statements on annual information returns (the Form 990, or here the Form 990-PF) have tended to focus on not reporting material support for terrorist organizations and similar matters.
As the AG's copying of the DOJ Criminal Division indicates, the alleged illegal in-kind donation by the Foundation to the Trump campaign in violation of federal election law is probably the more likely candidate for a criminal charge. But election law experts contacted by N.Y. Times reporter Kenneth Vogel could not agree on whether any federal investigators would pursue such a charge, even assuming impartial consideration by career DOJ attorneys. And as noted in that article, ignorance might be a good defense here, "willful and knowing" language notwithstanding.
Perhaps the most intriguing suggestion to date is the one by David Cay Johnston in the N.Y. Times two days ago. He suggested that either the bringing of criminal charges - state or federal - or even civil tax charges - again, state or federal - against Mr. Trump, including ones based on the NY AG's allegations, could force the public disclosure of Mr. Trump's personal income tax returns (remember those?). Given the range of government officials who could pursue some such charges, it will be interesting to see if any of them take up this suggestion.
Thursday, July 5, 2018
In its 2018 Report of Recommendations, the Exempt Organizations Subgroup of the Advisory Committee on Tax Exempt and Government Entities (ACT) reiterated its strong support for e-filing of Form 990 series returns, which the 2015 ACT report also had supported. As detailed in that earlier report, increased e-filing would increase the ability of the IRS to review such returns, improve the completeness and accuracy of such returns, and provide greater public access to return data. While there are security and technology issues raised by e-filing as detailed in the 2018 report, these exist for the currently e-filed returns and appear to be manageable.
As ACT recognizes, mandatory, universal e-filing would require legislative action. While legislative proposals along these lines have been around for a number of years, including a bill introduced in the current session of Congress, it is far from clear that such legislation will become law. In the absence of legislation, the 2018 report urges the IRS to pursue various other measures, including eliminating the $10 million threshold for requiring e-filing and so require all exempt organizations that are required to file at least 250 returns (e.g., Forms W-2, 1099-Misc) to e-file. More controversially, the report suggests that Treasury should consider either exempting e-filers from having to file Schedule B (identifying relatively large donors) or eliminating that schedule altogether since it creates concern about public release of such information (the schedule is not subject to public disclosure under current law, but there have been rare instances when it has become public).
Tuesday, July 3, 2018
- In Revenue Procedure 2018-32, the IRS replaced previous Revenue Procedures 81-6, 81-7, and 2011-33 relating to grantor and contributor reliance on IRS databases of organizations eligible to receive tax-deductible contributions under Internal Revenue Code section 170. It also updated the rules from that previous guidance to reflect the creation of the new Tax Exempt Organization Search function on the IRS website and the elimination of the public support advance ruling process.
- In Revenue Ruling 2018-14, the IRS obsoleted Revenue Ruling 68-59 relating to excluding the unrelated business taxable income $1,000 specific deduction from net operating loss computations because the Tax Reform Act of 1969 (!) had amended section 512(b)(12) to disallow this deduction from that computation. Better late than never, I guess (plus maybe this counts as repealing a regulation?).
- In Revenue Ruling 2018-15, the IRS obsoleted five revenue rulings relating to the public support advance ruling process in light of the adoption of final regulations in 2011 eliminating that process. Organizations applying for recognition of exemption under section 501(c)(3) and to be classified as not a private foundation because of public support can now obtain the latter classification by showing that they reasonably expect to receive the requisite public support during their first five years of existence.
In their first piece of official guidance for tax-exempt organizations in the wake of the 2017 tax legislation, the Treasury and IRS in Notice 2018-55 granted a favorable (and, in my view, correct) interpretation of new Internal Revenue Code section 4968 that imposes a 1.4 percent excise tax on private college and university investment income. Following Congress' direction in the new statute to apply rules "similar to the rules of section 4940(c)" when determining the amount of investment income subject to tax, the Treasury and the IRS followed section 4940(c)(4) and the regulations implementing that provision by effectively excluding pre-2018 appreciation from the new tax. They did this by stating they will issue proposed regulations that attribute to property held as of December 31, 2017 a basis of no less than the fair market value of such property on that date (subject to later required adjustments) for purposes of determining the gain on the disposition of such property. Normal basis rules would apply for purposes of determining loss from the disposition of such property. Interestingly, the Joint Committee on Taxation does not appear to have taken the possibility of such an interpretation into account in its estimated budget effects for this provision, in that it projected a flat $0.2 billion revenue increase from this tax for the ten years. (Unless JCT assumed that the tax revenues would be $0.2 billion in 2018 and all subsequent years even without any pre-2018 appreciation subject to tax, which seems unlikely.)
Tuesday, May 1, 2018
The IRS Tax-Exempt/Government Entities (TE/GE) Division released its compilation of Fiscal Year 2017 Accomplishments shortly before the IRS released the broader 2017 Data Book. Together these two documents provided a number of significant statistics regarding tax-exempt organizations related IRS activity for October 1, 2016 to September 30, 2017, including:
- There are 1.65 million tax-exempt organizations under Code section 501(c), including 1.29 million 501(c)(3)s. See Data Book Table 25.
- The IRS completed 6,101 examinations, a plurality of which (2,332) related to filing, organizational, and operational issues but which also involved employment tax issues (1,905), unrelated business income (602), and inurement/private benefit (109).
- Providing a different breakdown, the Data Book (Table 13) reports 2,375 Forms 990, 990-EZ, and 990-N examined, 608 Form 990-Ts examined, and 302 Forms 990-PF, 1041-A (relating to trust accumulation of charitable amounts), 1120-POL, and 5227 (relating to split-interest trusts) examined.
- While not completely clear from the Accomplishments document, it appears that 1,400 of these examinations were a statistical sampling of organizations that had had their applications for recognition of exemption approved through a streamlined process (with 43% resulting in changes, and 14 organizations revoked or terminated).
- It also appears another 565 of these examinations were part of a statistically valid random sample of Form 1023-EZ filers (with 51% resulting in organizing documents amendments or written advisories and five organizations revoked or terminated).
- The IRS revoked the tax-exempt status of 63 organizations, the majority (36) for not operating for an exempt purpose.
- The IRS received 95,177 applications for recognition of exemption, approving 86,669 applications, denying 68 applications, and closing 6,238 applications for other reasons such as withdrawal by the applicant or missing required information; most (85,553) of the closed applications were under Code section 501(c)(3), as were most (42) of the denials and other resolutions (5,812). See Data Book Table 24a. The IRS also received 2,182 Notices of Intent to Operate Under Section 501(c)(4), acknowledged 1,908 such notices and rejected 474 such notices (according to the Accomplishments report, most commonly for "failure to pay the user fee and unnecessary notification (e.g. the organizations were already exempt)"). See Data Book Table 24b.
- The IRS received 1.5 million tax-exempt organization returns, including primarily Form 990 series information returns (so not including the Form 990-T unrelated business income tax return) but also including Form 4720 (excise tax return), Form 5227 (split-interest trust information return), and Form 8872 (political organization report). See Data Book Table 2.
- The IRS collected $882 million in tax-exempt organization unrelated business income tax. See Data Book Table 1.
- The IRS reported 114 technical activities, all relating to Congressional correspondence. See Data Book Table 22.
There is a lot of urgently needed guidance relating to tax-exempt organizations. Fortunately there are plenty of opportunities for organizations and their representatives to tell the IRS and Treasury what is needed, including by submitting recommendations for the 2018-2019 Priority Guidance Plan as requested in Notice 2018-43. Here is an overview of the most pressing issues:
Late last year the IRS released Notice 2017-73, requesting comments on issues relating to the issuance of regulations under Code section 4967. Those comments are now flowing in, including from the ABA Section of Taxation, the Council on Foundations, Fidelity Charitable, and the New York Bar Association Tax Section. Issues that were of particular interest to the IRS are the treatment of recommended distributions from a DAF to support a charitable event or fundraiser, or to pay membership fees, especially when benefits received in return by a donor advisor are more than incidental, the treatment of recommended distributions that satisfy a pledge by the donor advisor, and also how distributions from a DAF interact with the public support tests for a recipient public charity.
Many others are exploring in detail the uncertain application of tax reform provisions relating to tax-exempt organizations. See, for example, the Exempt Organizations Committee schedule for the ABA Section of Taxation May Meeting, and the numerous summaries of relevant provisions prepared by both accounting firms (e.g., KPMG) and law firms (e.g., Ropes & Gray). That said, the most pressing issues appear to relate to the "basketing" of unrelated trades or businesses such that the losses from one such trade or business cannot offset the income of another such trade or business (Code section 512(a)(6)), the UBIT exposure of certain fringe benefits (Code section 512(a)(7)), the new excise tax on $1 million+ compensation paid by tax-exempt organizations (Code section 4960), and the new excise tax on the net investment income of private colleges and universities with relatively large endowments (Code section 4968).
Not that the lack of guidance has prevented speculation about possible issues and workarounds. For example, one workaround for the new UBIT basketing rule might be to place all unrelated trades or businesses in a single taxable subsidiary (perhaps further divided into single-member limited liability companies owned by the subsidiary for liability siloing purposes). And there has already been speculation regarding whether the excise tax on compensation applies to compensation paid by public colleges and universities as well.
Church Tax Audits
The still pending nature of proposed regulations (issued 8/5/09) regarding what specific official within the IRS has the authority to begin a church tax inquiry under Code section 7611 has now arisen with a vengeance. In United States v. Bible Study Time, Inc., a federal district court recently concluded that such an inquiry (and therefore the subsequent church tax examination) had not been properly initiated because it was not approved by a sufficiently highly ranked IRS official. The decision also throws into doubt whether the proposed regulations are correct in giving this authority to the Director, Exempt Organizations, as the court found that position is not of sufficient rank under the relevant provision of section 7611.
And There's More
The February 2018 Update to the 2017-2018 Priority Guidance Plan included not only many of the above issues but also the following:
- Charitable contributions of inventory (Code section 170(e)(3)) as part of reducing regulatory burdens.
- Final regulations under Code section 170 relating to substantiation and reporting requirements for charitable contributions (proposed regulations issued 8/7/08).
- Updating revenue procedures on grantor and contributor reliance under Code sections 170 and 509, including updating Revenue Procedure 2011-33 (relating to EO Select Check).
- Final regulations on Code section 509(a)(3) supporting organizations (proposed regs issued 2/19/16).
- Final regulations under Code section 512 relating to computations for Code section 501(c)(9) voluntary employees' beneficiary associations (proposed regs issued 2/6/14).
- Also under Code section 512, allocation of expenses relating to dual use facilities.
- Final regulations on the fractions rule under Code section 514(c)(9)(E).
- Investments by private foundations in partnerships in which disqualified persons are also partners under Code section 4941 (relating to self-dealing).
- Updating Revenue Procedure 92-94, relating to grants by private foundations to foreign grantees under Code sections 4942 and 4945.
- Final regulations relating to disclosure of information to state officials under Code section 6104(c) (proposed regulations issued 3/15/11).
- Unspecified guidance relating to church plans.
And I am ignoring planned or needed guidance on issues that have a more indirect effect on tax-exempt organizations, such as guidance relating to tax-exempt bonds. Things should be busy at Treasury - even with the new IRS Commissioner (Charles Rettig) and new IRS Chief Counsel (Michael Desmond) nominees still awaiting Senate confirmation.
Friday, February 23, 2018
Successful Applicant for Recognition of Exemption Fails in Claim for Administrative and Litigation Costs
The U.S. Tax Court issued an opinion this week denying a motion for reasonable litigation or administrative costs arising out of the filing of an application for recognition of exemption under section 501(c)(3) (Form 1023) and a subsequent successful petition for declaratory judgment. The motion arose out of a relatively common situation. Friends of the Benedictines in the Holy Land, Inc. filed a Form 1023 in July 2012. After more than a year had passed without any IRS action, and after an inquiry to the IRS resulted in a response that said there was no date certain by which a ruling or determination would be issued, the organization filed a petition for a declaratory judgement that it was exempt under section 501(a). Two days later the IRS issued a favorable determination letter, and after some negotiation the IRS, the organization, and the court resolved the declaratory judgment action through a stipulated decision. Subsequently, the organization sought an award of its reasonable litigation and administrative costs pursuant to section 7430 and Rules 230 and 231.
Given that the organization had prevailed in the underlying dispute, why did its motion for these costs fail? With respect to the administrative costs, while the Tax Court concluded the application process was an administrative proceeding and so could give rise to an award of administrative costs, it found that the organization had failed to provide any evidence of those costs and so had failed its burden of proof in this regard. With respect to the litigation costs, the Tax Court held that the Commissioner's prompt concession of the case - before the filing of an answer contesting the organization's claims - meant that the Commissioner's position in the litigation (that the organization did in fact qualify for exemption) was substantially justified and so there was no basis for awarding such costs. In doing so, the Tax Court rejected the approach taken by some other federal courts what had awarded litigation costs in similar situations, albeit not in the application for recognition of exemption context.
Wednesday, February 21, 2018
Exemption Application Changes: IRS Removes Need to Reapply for Exemption for Some Changes in Legal Form & Revises Application Forms, Fees
The IRS has recently made a number of significant changes to the process for applying for recognition of exemption under Internal Revenue Code section 501. Probably the most important is found in Revenue Procedure 2018-15, which provides that the IRS will not require a new exemption application from a domestic section 501(c) organization that merely changes its legal form or legal place of organization in many situations. This welcome change obsoletes Revenue Rulings 67-390 and 77-469, which generally required a new application under these circumstances. As detailed in the new Revenue Procedure, changes that generally will no longer require a new exemption application assuming no change in purposes include:
- an unincorporated nonprofit organization becoming incorporated,
- a corporation formed under the laws of one state reincorporating under the laws of a different state,
- a corporation formed under the laws of one state filing articles of domestication under the laws of a different state, and
- mergers of two corporations.
Changes that generally will still require a new exemption application include:
- a charitable trust becoming incorporated,
- any change where the surviving organization is a disregarded entity, limited liability company, partnership, or foreign business entity,
- any change where the surviving organization obtains a new employer identification number, and
- any change involving a foreign entity becoming a domestic entity.
While not addressed specifically in the Revenue Procedure, it appears that if a corporation becomes a charitable trust a new exemption application would be required because a charitable trust is not considered a business entity for federal tax purposes.
The IRS has also:
- revised Form 1023 (application for recognition of exemption under section 501(c)(3) of the Internal Revenue Code), although the changes appear relatively minor
- revised Form 1023-EZ (streamlined application for recognition of exemption under section 501(c)(3) of the Internal Revenue Code) as explained here by the IRS, including adding a request for a brief description of the organization's mission or most significant activities
- finalized new Form 1024-A (application for recognition of exemption under section 501(c)(4) of the internal revenue code)
- in Revenue Procedure 2018-5, changed the user fee for all exemption applications other than Form 1023-EZ to $600, updated the procedures for requesting relief to limit retroactive revocation of modification of a determination letter, and added organizations applying for retroactive reinstatement after being automatically revoked for failure to file required annual information returns to the list of entities ineligible to submit Form 1023-EZ
Sunday, November 19, 2017
LDF trusts raise questions as to tax treatment of the trust, whether the trust can take advantage of special rules applicable to political organizations, whether contributions to the LFD trusts can be deemed gifts excluded from the official’s income, whether donors to LDF trusts are subject to gift tax liability, whether the government official must report amounts distributed from the fund for legal expenses as income, and the extent to which deductions are available to the government officials for amounts expended from the trust on his or her behalf.
Saturday, November 18, 2017
First, two months ago the U.S. Department of Justice announced that it would not reopen the criminal investigation of former IRS Exempt Organizations Director Lois Lerner, to howls of fury from her critics in Congress.
Then the Treasury Inspector General for Tax Administration released a new report that found a number of left-leaning organizations that had applied for section tax-exempt status had also had their applications subject to additional review and/or been subject to unnecessary questions. The report did not undermine TIGTA's previous finding that the IRS had used inappropriate criteria to identify applications for additional scrutiny, or that many right-leaning organizations had been selected as a result of that criteria, but it muddied the waters regarding how politically biased the application process actually was and provided further support for the argument that the problems with that process likely reflected incompetence more than malevolent intent. (More coverage: Washington Post.)
Late last month the U.S. Department of Justice announced the settlement of two pending lawsuits relating to the controversy, including the one class action suit. According to a report by a CNN, the settlements did not involve the payment of any monetary damages but included an apology from the IRS. The NY Times later reported, however, that one of the settlements involved a seven-figure payment, although the exact amount and other details were not available. The two settled cases (assuming court approval of the settlement in the class action case) are NorCal Tea Party Patriots v. IRS (the class action) and Linchpins of Liberty v. United States. (More coverage: Fox News, Washington Post.) By my count there is still a pending lawsuit brought by True the Vote against the IRS, as well as Freedom Path's lawsuit against the IRS (set for trial in summer 2018), so this settlement is not quite the end of all litigation.
Finally, earlier this month IRS Commissioner John A. Koskinen reached the end of his 5-year term. Despite calls for his removal or even impeachment because of the IRS' handling of the controversy's investigation, President Trump chose not to ask him to step down and Congress did not take any steps to begin the impeachment process. The Administration has not nominated his successor, with Assistant Secretary for Tax Policy David Kautter currently serving as interim IRS Commissioner. Coverage: N.Y. Times.
Friday, November 17, 2017
Last month the Department of the Treasury and the IRS released their 2017-2018 Priority Guidance Plan, listing the projects they hope to complete by June 30, 2018. A little over a month earlier the IRS had released its Tax Exempt and Government FY 2018 Work Plan. Together these documents provide a roadmap for most if not all that we are likely to see from Treasury and IRS relating to tax-exempt organizations, other than urgent guidance growing out of either current events or the passage of tax reform or other tax legislation.
The Priority Guidance Plan lists the following items specifically relevant to tax-exempt nonprofit organizations that are still in process:
- Updated revenue procedures on grantor and contributor reliance under sections 170 and 509, including updating to Revenue Procedure 2011-33 for EO Select Check.
- Finalization of regulations (proposed 8/7/08) under section 170 relating to substantiation and reporting of charitable contributions.
- Guidance under section 170(e)(3) regarding charitable contributions of inventory.
- Guidance related to church plans.
- Finalization of the regulations (proposed 2/19/16) relating to section 509(a)(3) supporting organizations.
- Guidance under section 512 regarding methods of allocating expenses relating to dual use facilities.
- Finalization of the regulations (proposed 2/6/14) under section 512 relating to computation of unrelated business taxable income for section 501(c)(9) employees' beneficiary associations.
- Guidance under section 4941 regarding a private foundation's investment in a partnership in which disqualified persons are also partners.
- Guidance regarding the excise taxes on donor advised funds and fund management.
- Finalization of the regulations (proposed 3/15/11) under section 6104(c) relating to state requests for information relating to tax-exempt organizations.
- Finalization of the regulations (proposed 8/5/09) under section 7611 relating to church tax inquiries and examinations.
The Plan also included what is now Revenue Procedure 2017-53, which updated Revenue Procedure 92-94 relating to equivalency determinations for foreign grantees under sections 4942 and 4945.
The Work Plan includes numerous projects for the 2017-2018 year, including:
- Implementing revisions to Form 1023-EZ, including a required activity description and additional questions on gross receipts, asset thresholds, and foundation classification, as well as continuing pre-determination reviews of a statistical sample of Form 1023-EZ applications.
- Continued movement of information from the Internal Revenue Manual to the Audit Technique Guides (ATGs) for Exempt Organizations webpage.
- Enhancement of compliance efforts through certain emphases (supporting organizations, previous for-profit entities, and private benefit/private inurement indicators), data-driven approaches, and referrals.
Thursday, November 2, 2017
As reported in the October 23rd edition of Tax Notes, IRS is now reviewing tax-exempt hospitals to ensure their compliance with the §501(r) regulations issued in 2015. At the American Health Lawyers Association meeting on October 19th, a tax law specialist in the IRS Tax-Exempt and Government Entities Division Reviews conveyed that the IRS is uncovering compliance issues regarding the financial assistance policy (FAP) and community health needs assessment requirements. Agents also are inquiring as to whether patients eligible under the hospital's FAP are not excessively billed. In addition, the tax law specialist reported non-contact reviews taking place in 2014 to 2016 resulted in several hundred examinations, most from the absence of required documents on the hospital's website. The specialist also revealed that unrelated business income and excess benefit transactions were also sources for examinations.
(Hat tip: Fred Stokeld at Tax Notes)
Thursday, August 17, 2017
Both Terri Helge and Joseph Mead previously reported in this space on the tax benefits that many organizations often identified as "hate groups" enjoy because of the broad and vague requirements for qualifying as an educational organization under Internal Revenue Code sections 501(c)(3) and 170(c)(2). Not surprisingly, the events in Charlottesville have led to a renewed discussion of this topic. Recent coverage includes a Business Insider story on this topic and a fascinating blog post by Sam Brunson (Loyola Chicago) on the conflict almost a hundred years ago between the IRS and the KKK (and from which the photo shown here is borrowed).
Wednesday, August 16, 2017
Over the summer, the United States Tax Court in RERI Holdings I, LLC v. Commissioner upheld the disallowance of a $33 million charitable contribution deduction because of the failure of RERI Holdings I, LLC to state on its required Form 8283 appraisal summary the "Donor's cost or other adjusted basis" for the property. The court further held that the failure could not be excused by substantial compliance because the omission "prevented the appraisal summary from achieving its intended purpose" of alerting the IRS of potential overvaluations of contributed property (and thereby deterring taxpayers from claiming excessive deductions). In this instance the omitted basis would have been approximately $3 million, or roughly one-tenth the value claimed for the contributed property.
While failures to substantiate charitable contributions adequately occur frequently in tax cases, they usually do not affect such large claimed deductions because presumably as the numbers get larger the care and expertise of the professionals involved becomes greater. There may have been more going on here, however. At least one commentator, Peter J. Reilly over at Forbes, concludes that the "brazeness of the charitable plan . . . revealed in the Tax Court RERI Holdings I decision is stunning" in an article titled Billionaire Stephen Ross And the Ten for One Charitable Deduction. Assuming the IRS took a similar view, it very well could have been looking for any possible flaw in the deduction that could be used to disallow it, and the substantiation omission provided a simple way to do so (as opposed to getting into a messy valuation dispute, although the court's opinion goes there anyway in order to determine if certain penalties applied).
No word yet on whether RERI Holdings I will appeal.
How large is the potential for hard-to-detect and even harder-to-counter abuse when it comes to the federal income tax deduction for "qualified conservation contributions" under Internal Revenue Code section 170(h)? As Peter J. Reilly highlights at Forbes, the potential appears to be pretty large based on early responses to Notice 2017-10's addition of syndicated easements to the list of listed transactions that must be reported to the IRS. In a July 13, 2017 letter to Senator Ron Wyden, ranking member of the Senate Finance Committee, IRS Commissioner Koskinen reported that the 40 fully completed and processed reporting forms, out of 104 processed and 200 received to date, showed an aggregate charitable contribution deduction of over $217 million with preliminary calculations finding that the average deduction was nine times the amount of the investment in the transaction. Other coverage: Tax Analysts.
Such syndicated easements are only part of the conservation easement universe, but the continuing stream of federal court decisions rejecting in whole or in part deductions claimed for such easements highlight the broader issues with this deduction. For example, the U.S. Court of Appeals for the Eighth Circuit recently affirmed disallowance of a $16.4 million deduction for a failure to protect the conservation purpose in perpetuity (RP Golf v. Commissioner). Not all IRS challenges are necessarily successful, however; for example, the U.S. Court of Appeals for the Fifth Circuit recently reversed disallowance of $15.9 million in deductions, although the court remanded the case for consideration of additional reasons for disallowance asserted by the IRS (BC Ranch II, L.P. v. Commissioner).
Recent reports also highlight the broader concerns with such deductions. In May, Adam Looney of the Brookings Institute issued Charitable Contributions of Conservation Easements, listing general tax policy concerns that predated the recent surge in such contributions:
- "Donations are concentrated in transactions that seem unrelated to conservation benefits," including with respect to type of transaction, geographic area, and donee organizations.
- "A small handful of donee organizations are responsible for a disproportionate share of donations," with 25 organizations (as compared to 1,700 land trusts nationwide) receiving between 2010 and 2012 about half of all such contributions, measured by dollar value.
- "Most organizations that receive donations of easements do not report them as gifts or revenues on their public tax returns," impeding transparency, public accountability, and IRS enforcement.
- "Donations of 'partial interests' are difficult to administer," including with respect to determining the fair market value of the contribution for deduction purposes.
The report is also available through the Urban Institute & Brookings Institution Tax Policy Center.
Nancy McLaughlin (Utah) has also continued her excellent coverage of this topic. Here is the abstract for her latest article, Tax Deductible Conservation Easements and the Essential Perpetuity Requirements, Virginia Tax Review (forthcoming):
Property owners who make charitable gifts of perpetual conservation easements are eligible to claim federal charitable income tax deductions. Through this tax-incentive program the public is investing billions of dollars in easements encumbering millions of acres nationwide. In response to reports of abuse in the early 2000s, the Internal Revenue Service (Service) began auditing and litigating questionable easement donation transactions, and the resulting case law reveals significant failures to comply with the deduction’s requirements. Recently, the Service has come under fire for enforcing the deduction’s “perpetuity” requirements, which are intended to ensure that the easements will protect the subject properties’ conservation values in perpetuity and that the public’s investment in the easements will not be lost. Critics claim that the agency is improperly discouraging easement donations by denying deductions for technical foot faults, and some have called for a change to the law that would allow taxpayers to cure their failures to comply with the perpetuity requirements if they are discovered on audit.
This Article illustrates that noncompliance with the perpetuity requirements should not be viewed as technical foot faults. To the contrary, compliance is essential to the integrity of the tax-incentive program and the easements subsidized through the program. In addition, allowing taxpayers to cure failures to comply with the perpetuity requirements if they are discovered on audit would significantly increase noncompliance and abuse and, given the reliance nationwide on deductible easements to accomplish conservation goals, risk fatally undermining an entire generation of conservation efforts. This Article recommends a more prudent approach: the Treasury’s issuance of guidance that would greatly facilitate compliance with the perpetuity requirements, reduce transaction costs for taxpayers, and significantly shore up the integrity of the program.
Thursday, June 22, 2017
No one knows what is going to happen with tax reform, which means now is the perfect time to speculate wildly about how Congress may help or hurt tax-exempt nonprofits if and when it actually does something.
Tax Simplification: If Congress follows the President's lead and simplifies in part by sharply increasing the standard deduction, it will make the charitable contribution deduction irrelevant to an even greater proportion of U.S. households as the number of itemizers shrinks significantly. According to an Indiana University Lilly Family School of Philanthropy report, this change alone could reduce charitable giving by an estimated $11 million annually, and if combined with a lower top tax rate of 35% they could together reduce charitable giving by $13.1 billion. To put these figures in perspective, the most recent Giving USA report reported $282 billion in donations from individuals for 2016.
Non-Itemizer Deduction: One proposal to counter this effect is a charitable contribution deduction for non-itemizers, as long advocated for by Independent Sector among others. The Lilly Family School of Philanthropy report estimates that allowing non-itemizers to deduct their charitable contributions would more than offset the negative effect on contributions from the standard deduction increase and rate reduction proposals. That said, it is hard to see how this proposal could have much chance of success given both its revenue cost and the administrative and enforcement complexity it introduces, particularly in an era of reduced IRS examinations. For an analysis of some of these issues, see this October 2016 Urban Institute report.
The Ghost of Rep. Camp: While Dave Camp is not dead he is no longer in Congress, which you would think would limit his influence over current tax legislation. But he did something brilliant when he was driving the tax reform bus as Chair of the House Ways & Means Committee several year ago: he went through the laborious process of actually drafting legislative language and having the result analyzed and scored by the Joint Committee on Taxation. This means that both the specific language and revenue effects of each provision of the Tax Reform Act of 2014 is available to be pulled off the shelf and deployed immediately as part of any current tax reform legislation. As detailed on pages 535-598 of the JCT report, this includes numerous provisions relating to tax-exempt organizations, including a number of limitations on the existing charitable contribution deduction. Especially if some revenue raisers are needed to pay for other aspects of tax reform, I expect to see some of Rep. Camp's proposals reappear in current legislation.
The Charities Helping Americans Regularly Throughout the Year Act of 2017: Given the uncertainty about the content, timing, and even liklihood of major tax reform legislation, it is a good idea to have a backup plan. The CHARITY Act (I do not know where they got the "I" from) is a modest, bipartisan attempt to tweak the existing tax laws for tax-exempt charities. Its provisions include simplifying the private foundation investment tax under section 4940, making donor advised funds eligible for IRA rollover contributions, increasing the mileage rate applicable to personal vehicle use for volunteer charitable activities, creating an exception to the private foundation excess business holdings rules under section 4943 (can you say Newman's Own Foundation?), and an electronic return filing requirement for all tax-exempt nonprofits.
I look forward to months if not years of further crystal ball gazing on these topics.
Journalists have a constant interest in charity private benefit stories, particularly ones with a political angle. And unfortunately they seem to be able to find them. Recent reports raising questions about plain vanilla (non-political) private benefit have focused on a variety of donors and charities, including New England Patriots' quarterback Tom Brady, the James G. Martin Memorial Trust in New Hampshire, and billionaire Patrick Soon-Shiong. But not surprisingly reporters have paid even greater attention to situations relating to politics and politicians, including ones involving the Eric Trump Foundation, Boston mayoral hopeful Tito Jackson, President Trump's chief strategist Stephen Bannon, and the Daily Caller News Foundation. These stories are distinct from ones relating to the use (and possible misuse) of charities for political purposes more generally, such as the recent article regarding the David Horwitz Freedom Center.
I should emphasize that none of these situations have resulted so far in any apparent civil or criminal penalties, and in some instances the facts described may not cross any legal lines. Indeed, the only one of these situations that appears to have drawn government scrutiny so far is the one involving the Eric Trump Foundation, which New York Attorney General Eric Schneiderman has said his office is looking into.
The same cannot be said of three other situations that involve the possible misuse of charitable assets. One, relatively minor situation relates to the admitted access of the Missouri Governor's political campaign to a charity's donor list without apparently the charity's knowledge or permission. Two other situations are more serious in that they each involve hundreds of thousands of dollars. In March, a federal grand jury indicted former U.S. Representative Stephen Stockman and an aide on charges relating to the alleged theft of hundreds of thousands of dollars from conservative foundations to fund campaigns and pay for personal expenses. (More coverage: DOJ Press Release.) And last month a federal jury convicted former U.S. Representative Corrine Brown of raising hundreds of thousands of dollars for a scholarship charity, funds that she then used for her own personal and professional purposes. (More coverage: N.Y. Times.)
The various lawsuits that grew out of the IRS exemption application controversy continue their slow grind with discovery ordered in the Linchpins of Liberty and True the Vote cases (which are before the same judge in the U.S. District Court for the District of Columbia), a protective order keeping the depositions of Lois Lerner and Holly Paz confidential in the class action NorCal Tea Party Patriots case in the U.S. District Court for the Southern District of Ohio, a court-ordered July 24th mediation conference in the same case, and an April 21st hearing on the motion for partial judgment pending in the Freedom Path case in the U.S. District Court for the Northern District of Texas, at which apparently nothing exciting happened as I could not find any media coverage of the hearing. In fact, as far as I can tell no one is paying any attention to these cases at this point except for the parties, their lawyers, a few minor conservative news outlets, and the Bloomberg BNA Daily Tax Report (the last two links are to stories by them (subscription required), and even they ignored the April 21st hearing).
In related news, the Federal Election Commission's inspector general's office recently concluded that FEC employees did not violate any rules when they communicated with the IRS about politically active groups. (More coverage: Bloomberg BNA (subscription required)). And Congress extended the various budget-related provisions it created in the wake of the controversy, including the prohibition on using any funds to issue guidance under section 501(c)(4) for the rest of the current fiscal year (so through September 30, 2017). Finally, the American Center for Law and Justice (which is representing the plaintiffs if some of the above lawsuits) announced that the Tri-Cities Tea Party received a favorable determination letter from the IRS under section 501(c)(4) seven years after filing its application.
Wednesday, June 21, 2017
While the IRS is underfunded and Congress is deadlocked, this does not mean there is no action by the federal government with respect to tax-exempt nonprofit organizations. For starters, the IRS' continues to report data like clockwork, including the always informative Data Book. Highlights from the FY 2016 Data Book include the miniscule examination rate (only 2,956 annual returns examined, including Forms 990, 990-EZ, 990-N, 990-PF, 1041-A, 1120-POL, and 5227), continued strong closures of exemption applications (92,129 for the year, of which the IRS approved 86,406, disapproved 54, and had another 5,669 closed for other reasons, including withdrawals), and now almost 1.6 million organizations recognized as exempt under section 501(c).
The IRS Advisory Committee on Tax Exempt and Government Entities has also had its charter renewed for two more years, and released its sixteenth Report of Recommendations earlier this month. The Committee has been restructured in a way that many of its current members feel is not helpful, as they shared at length in the report. More specifically, the Committee is now divided into subgroups not based on functional areas but instead on subject areas, specifically FICA Replacement Plans, Online Accounts, and, ironically, Future of the ACT.
Finally, the IRS and other federal authorities continue to pursue the most egregious wrongdoing by actors at tax-exempt nonprofits, including criminally. Recent news reports include two major stories along these lines. One involves a federal indictment against a bank officer and her husband who are alleged to have transferred embezzled funds from Bank of America totalling $1.2 million to a variety of charities, possibly in exchange for return payments or other benefits from those charities, according to reports in the Atlanta Journal-Constitution and the Boston Globe. The other, separate situation involves a search by IRS and U.S. Postal Service investigators at the headquarters of televangelist Benny Hinn, as reported by the Dallas Morning News. No further public information is currently available regarding this investigation.