Sunday, September 23, 2018
The recent Illinois Supreme Court decision in Oswald v. Hamer, which I discuss here, got me thinking about the meaning of an all-important word in charitable tax exemption. That word is “primary.” Almost all law dealing with charitable tax exemption includes a requirement that charitable activities be “primary” to the organization (or in case of property, the use of the property). The “primary” test usually is derived from the word “exclusively”: Section 501(c)(3) tells us that an organization is charitable if it is organized and operated “exclusively” for charitable purposes, but the IRS and courts have held that “exclusively” really means “primarily” – some non-charitable use is permissible. Similarly, the Illinois Supreme Court and virtually all other state supreme courts who have grappled with the issue have held that “exclusive charitable use” really means “primarily charitable use.” So the key word in establishing a right to charitable tax exemption, whether for federal income tax or state property (or other) tax is “primary.”
So how do we know when charitable activity is “primary”? Often, this is easy. Many charities literally do nothing but pursue their charitable purpose. The Salvation Army or Goodwill Industries may operate thrift stores, but that operation is solely to fund their charitable mission of helping the homeless, poor and disadvantaged. The Lincoln Center in New York City is all about advancing the performing arts. And so on.
But for some organizations, like nonprofit hospitals, “primary” is not so clear. If we believe that simply operating a hospital that provides health services to paying patients is a charitable purpose, then of course “primary” isn’t a problem. But although the IRS seemed to say exactly this in Rev. Rul. 69-545, we all know now that this isn’t true; the IRS has said many times since then that merely providing health services to paying patients isn’t enough. Similarly, if we believe that operating a community hospital “open to all without regard to ability to pay” is sufficient, then we don’t have to much worry about “primary” – all nonprofit hospitals claim this is true; if the claim and “official policy” is enough, the issue is decided.
But let us suppose that we want nonprofit hospitals to actually engage in some sort of specific activities that are observable and quantifiable. In that case, the first part of defining “primary” would be defining the activities one thinks are charitable. Unfortunately, there is little consensus on what those activities should be. Should charitable activities in the context of health care be limited to free or discounted care for the uninsured? Should it be expanded to a broad array of so-called “community benefits” which may include things like “health fairs,” community wellness seminars, and so forth? Should it be (as I once opined) things that expand access to health care for underserved populations or providing services that for-profit providers do not provide?
For purposes of this thought experiment, let’s assume that we define charitable activities for nonprofit hospitals as expanding access to underserved populations. Free care for uninsured poor obviously would count here, as would the costs of care below reimbursement for programs such as Medicaid that are aimed at poor populations. I might throw in educational seminars for at-risk populations and a few other things as well, but the specifics at this stage are unimportant. Let’s just focus for now on “expanding access” as the charitable goal, whatever the exact contours of that might be.
Fine, now we can move on to the even harder question. How do we assess whether a nonprofit hospital is “primarily” about such a charitable mission? Does this test require us to find that more than 50% of the hospital’s services go towards the expanding access goal? More than 50% of its revenues? What evidence would tell us that a hospital’s work is “primarily” charitable?
To think about this more, let’s abstract the problem – that is, take it out of the hospital context and think about a more familiar, but no less complex, context. Many of us (me included) would say that our families occupy a “primary” position in our lives. What does that mean? How does a human being illustrate that is true? Note that it probably does not mean that we spend more than 50% of our waking hours with our families. Many of us are at work more hours during the week, month or year than we spend interacting with our families yet our families really are “primary.” So a quantitative “51% of the time” test won’t work. But we might observe that the work is done so that we can support our families economically; our profit from work goes to making our families’ lives (as opposed to just our own) better. We might try to be as efficient as possible at work so that we can spend more time (maybe not that magic 51%) with our families. We might re-arrange our work schedules to attend important family events. If there is a family crisis, we might even leave in the middle of something very important work-wise to attend to that. So I would say that while “primary” in this abstracted context cannot be precisely defined quantitatively, it CAN be defined through a combination of quantitative (how much time/money to do you spend on your family) and qualitative (do you take actions that indicate that “family comes first”) factors.
Now let’s go back to the hospital context. If a hospital must engage “primarily” in charitable activities, and for this thought experiment, we define charitable activities as “expanding access,” then how would a hospital demonstrate that charity is “primary”? Certainly, the amount of money and time spent on expanding access would be important, but just like a person might spend more time at work than with family and still rightly claim family to be “primary,” we should not simply impose a “51%” test on hospitals. Time and money spent, nevertheless, are important, and we should demand that substantial time and money be spent. That in turn leads to a question of what would be “substantial.” Less that 50%, I should think, but enough that one could see importance to the endeavor. I’ve previously used 1/3 as a benchmark, but perhaps this is too much. The IRS has defined substantial as 10% in other contexts, and churches often frame tithing around a “10% of income to charity” obligation. We can argue about the number, and how to precisely define it, but if a hospital cannot show that at least 10% of its financial wealth and time are spent on charitable activities, then I have a hard time classifying such activities as “primary” no matter what else it does (and perhaps I'm being too generous with a 10% test).
But a quantitative 10% number should not be enough. Instead, we should also look for qualitative factors of “primary-ness.” These qualitative factors, I think, should revolve around a demonstration by management that charitable activities are of first importance. Do meetings of management focus on ways to expand access or are those meetings invariably about the profit margin? If the hospital has a “good year” financially, does management discuss how to devote more resources to the charitable mission, or are the discussions about raising salaries and salting away the money for a new building or new equipment that may or may not be necessary? Does management ask for reports from all of the hospital service departments on how they are working to expand access? Or are the reports about departmental margins and financial efficiency? Does the hospital “sell itself” to poor or at-risk patients, or does it try to hide that aspect of its operations as much as possible consistent with state law (e.g., does it go “above and beyond” legal requirements or do "the bare minimum")?
There was a time in our history (in the late 1800’s and early 1900’s) when hospitals clearly met both my quantitative and qualitative musings on “primary.” They were run primarily to serve the poor; if you were financially well-off, you had a personal physician who would treat you (and one hoped not kill you). If you were poor, you went to a hospital to be cared for by what were nearly always volunteers. But this is not the way hospitals operate today, and I suspect if we are serious about the word “primary” as a test of charitable exemption, most private nonprofit hospitals would fail that test. So be it.
Saturday, September 22, 2018
In his article, Sam Dick discusses how specific nonprofits, like Lexington’s Habitat for Humanity are affected by the recent tax reform in Kentucky. This past July, the new 6% sales tax on ticket sales for nonprofit fundraising events took effect. Lexington’s Habitat for Humanity explains how the tax is affecting their fundraising efforts. During their golf tournament in July, they absorbed the sales tax on 24 golf teams at one thousand dollars a piece. This lead to a decrease in funds raised for the charity. The small nonprofits are getting hit the hardest because not only do they have to charge sales tax on tickets, but they must hire CPAs to guide them and having to revamp their practices. Many nonprofit leaders are frustrated at how much the sales tax is hurting their organizations. If the organization’s profits are down, less people are being helped. To learn more about how the new sales tax is affecting Kentucky nonprofits, click here: https://www.wkyt.com/content/news/How-did-Kentucky-nonprofits-end-up-taxed-490192831.html
Friday, September 21, 2018
Yesterday (Sept. 20, 2018), the Illinois Supreme Court released its long-awaited opinion in Oswald v. Hamer, a case about the constitutionality of a statute the Illinois Legislature passed in 2012 in the wake of the Provena Covenant hospital tax exemption case decided in 2010. Unfortunately, the decision did not actually resolve the question of what a hospital must do in order to receive a property tax exemption, and in fact simply complicated that question.
Several prior blog posts detail the issues and final resolution of the Provena case, so I won’t go into detail on the background (see, e.g., here and here). Briefly, a plurality (not majority) of the Illinois Supreme Court held in Provena that the hospital in question failed the constitutional requirements of charitable property tax exemption because “both the number of uninsured patients receiving free or discounted care and the dollar value of the care they received” were de minimis. While the plurality in Provena did consider what kinds of things might qualify as “charitable use” (free or discounted care for the poor being the primary one), the plurality did not lay out any specific standard for “how much” charity care (or other activities) would be necessary for a hospital to meet the charitable use requirements. It simply said, more or less, that whatever that threshold might be, Provena did not meet it. And the two justices that concurred in the result but dissented from the plurality’s analysis of charitable use more or less took the position that simply operating a nonprofit hospital “open to all” would qualify for charitable use without regard to any specific amount of charity care or other activity.
After Provena, the Illinois Department of Revenue withheld tax exemption from a handful of hospitals pending further contemplation of the opinion, resulting in a great howl of anguish from the nonprofit hospital industry about the uncertainty created in the wake of the case. The Illinois legislature, largely guided by advice from the Illinois Hospital Association, responded by passing a statute providing a quantitative test for exemption: if the total value of certain services and activities (let’s call them “community benefit activities”) at least equals the property taxes that would be due on the hospital’s property, the hospital “shall be issued” a charitable exemption for its property.
The issue in Oswald was whether this statute was constitutional in light of prior Illinois Supreme Court interpretations of the constitutional requirements for charitable property tax exemption. In particular, the court has interpreted the Illinois constitution as requiring that property be used “exclusively” for charitable purposes in order to be exempt (though “exclusively” actually means “primarily” in this context). The plaintiff Oswald contended that the new Illinois statute violated the constitutional requirement of “exclusive charitable use” because it conferred tax exemption based upon a dollar standard that did not necessarily meet the “exclusive use” requirement. For example, under the statute, a nonprofit hospital could in theory qualify for exemption by writing a check in an amount at least equal to the hospital’s putative property tax to a community health clinic that served the poor, even if the hospital itself served no poor patients at all, and offered zero free or discounted care. In short, Oswald argued that since the statute permitted a charitable exemption without showing that the underlying property was in fact “exclusively” used for charitable purposes, the statute was unconstitutional.
The Illinois Supreme Court, however, held that the statute was constitutional, although the legerdemain required to reach this conclusion was substantial. In effect, the court concluded that if there was any way to interpret the statute as being consistent with the constitutional “exclusive use” requirement, the court would do so. Accordingly, the court stated that the statute was not really intended by the legislature to replace the exclusive use test; rather, the court essentially interpreted the statute as requiring an additional test for exemption for property owned by nonprofit hospitals: the property would have to meet both the exclusive use test, and the entity owning the property also would have to meet the monetary test of the statute. “Therefore, a hospital applicant seeking a section 15-86 charitable property tax exemption must document the services or activities meeting the statutory criteria. Additionally, the hospital must show that the subject property meets the constitutional test of exclusive charitable use.” [opinion page 13, emphasis added]. The word “shall” in the statute (“shall be issued a charitable exemption”) was not mandatory, according to the Court; rather, it was “permissive” – that is, despite the “shall” language, the Department of Revenue did not have to issue an exemption if the statute’s requirements were met but exclusive charitable use was lacking. I guess that in an area of law where “exclusively” means “primarily,” interpreting “shall” to mean “you can if you want to” isn’t all that surprising.
So where does the court’s opinion leave Illinois nonprofit hospitals? My interpretation is that it leaves them mostly back where they were after the Provena decision. The court in Oswald did not shed any light on how a nonprofit hospital would meet the “exclusive use” test, beyond referring to current precedents, including Provena and earlier exemption cases. About the only thing that is clear is that in light of Oswald, hospitals cannot simply rely on the statute to get exemption. Meeting the statutory requirements, according to the court, is only half the battle (maybe in fact, only a tiny part of the battle since the statutory standard is relatively easy to meet, as one might expect from a statute drafted by the industry itself); the other half is showing that the property in question is “exclusively” (remember, really “primarily”) used for charitable purposes. Does the exclusive use test require some minimum amount of charity care? Some evidence that hospital operations are primarily designed to serve the poor? Or is simply operating a community hospital “open to all” itself a charitable endeavor regardless the amount of charity care actually provided (as the two partially-dissenting justices in Provena suggested)? Oswald did not answer this question, and since Provena was a plurality opinion, the really important issue – what qualifies property as being “exclusively” used for charity in the hospital context – remains as cloudy today in Illinois as it was after the Provena decision in 2010. And that, in turn, means that more litigation is inevitable – in fact, a case involving Carle Foundation Hospital is proceeding in Champaign County Circuit Court that may be the vehicle that eventually will force the Illinois Supreme Court to actually answer the substantive question regarding what a nonprofit hospital must show to establish “exclusive charitable use.” That case is scheduled for trial in January 2019; perhaps in a couple of years, after various appeals, we will finally have a definitive answer.
Monday, July 16, 2018
ABA's Business Law Section Recognizes Ellen Aprill with the 2018 Outstanding Nonprofit Academic Award
I am very pleased to share the news that Ellen Aprill has been given the Outstanding Academic Award for 2018 for distinguished academic achievement in the nonprofit section by the Nonprofit Organizations Committee of the American Bar Association's Business Law Section - although we all know that her academic achievements should be recognized well beyond just the nonprofit sector. For anyone involved in nonprofit legal issues, especially in the area of political activity and advocacy, Ellen's work is required reading. I have had the privilege of knowing Ellen from our work at the ABA before I became an academic. Now that I am part of the academy, she has always been available for the random bit of advice or for expert scholarly opinion. I personally can't imagine anyone more deserving. From the ABA announcement:
Ellen Aprill is the John E. Anderson Chair in Tax Law at Loyola Law School in Los Angeles and is the
founding director of its Tax LLM program. She has been a member of the Loyola Law School faculty since
Professor Aprill is one of the founders of the Loyola Law School Western Conference on Tax Exempt
Organizations, considered by many to be the premier nonprofit law conference on the West coast. She
has co-hosted this conference for twenty years and has been instrumental in bringing together leaders in
government, academia and the nonprofit law bar each year for this conference.
Professor Aprill has written extensively on issues of nonprofit law and is a reliable source of knowledge
both for her students and the public. Her other accomplishments include serving as a fellow of the
American College of Tax Counsel and the American Law Institute, and serving as a member of the
Executive Committee of the USC Federal Tax Institute and the Academic Advisory Board of the
Tannenwald Foundation for Excellence in Tax Scholarship. She is a former Chair of the Los Angeles
County Bar Tax Section, which has honored her with the Dana Latham Award for outstanding contribution
to the community and to the legal profession in the field of taxation.
Congratulations to Ellen and to all of the other individuals recognized by the ABA (including Greg Colvin and Eve Borenstein (among others), who many of us in this community know as well) on their honors.
See also a similar write up on our sister Tax Prof Blog.
Tuesday, July 10, 2018
I am pleased to cross post this article by the very wonderful Joan Heminway (University of Tennessee) from our sister blog, the Business Law Prof Blog, entitled "A Lawyer Helping Wounded Warriors, One House at a Time"
As a legal advisor to both for-profit and not-for-profit ventures for more than 30 years, I have had to learn about the business operations of new clients many, many times. The facts are so important in these knowledge acquisition processes (which generally take time to complete). The more experienced one is as a business lawyer, the more adept one is at getting the right facts--and analyzing the legal risks, rights, and responsibilities they represent or signal.
As a law professor, I have had many opportunities to experience joy from the work of my students. They do such amazing things! As the careers of my former students lengthen and deepen, my pride in them often exponentially increases.
With all that in mind, I bring you today a podcast featuring one of my beloved former students. She doesn't work for a law firm or a major multinational corporation. She is not a general counsel. Instead, she works for a relatively small nonprofit organization in a broad-based planning and development role.
Jump on over to the Business Law Prof Blog for the rest of the article and the link to the Podcast for a great reminder of why it is we do nonprofit work.
Saturday, July 7, 2018
Last fall the NYU Law School's National Center on Philanthropy and the Law focused its annual conference on section 501(c)(4) social welfare organizations. The conference papers will be published in the NYU Journal of Legislation & Public Policy, but for those who can't wait the following papers are now available on SSRN (in the order they were presented at the conference):
David S. Miller, Advice for Jeff Bezos: Social Welfare Organizations as Grantmakers
Lloyd Hitoshi Mayer, A (Partial) Defense of Section 501(c)(4)'s "Catchall" Nature
For those particularly interested in the use of 501(c)(4)s as part of a group of affiliated organizations engaged in advocacy and other political activity, the Alliance for Justice has recently released the 4th edition of The Connection: Strategies for Creating and Operating 501(c)(3)s, 501(c)(4)s, and Political Organizations (written by B. Holly Schadler).
The much discussed attempts by high-tax states to find a way for their residents to continue to contribute to state and local coffers without running smack into the new $10,000 limit on deducting state and local taxes (SALT) raises an important issue relating to the charitable contribution deduction - when, if ever, is a SALT reduction a return benefit that reduces or eliminates the deduction for the "charitable" contribution that triggered the SALT reduction? While the Treasury Department has expressed its disapproval of such workarounds, its task is complicated by the fact that there were more than a 100 state charitable tax credit provisions in place across 33 states before the recent federal tax legislation.
For the arguments in favor of permitting the charitable contribution deduction under these circumstances (and a list of the previously existing state charitable tax credits), see Joseph Bankman et al., State Responses to Federal Tax Reform: Charitable Tax Credits, published in Tax Notes, April 30, 2018. Here is the abstract:
This paper summarizes the current federal income tax treatment of charitable contributions where the gift entitles the donor to a state tax credit. Such credits are very common and are used by the states to encourage private donations to a wide range of activities, including natural resource preservation through conservation easements, private school tuition scholarship programs, financial aid for college-bound children from low-income households, shelters for victims of domestic violence, and numerous other state-supported programs. Under these programs, taxpayers receive tax credits for donations to governments, government-created funds, and nonprofits.
A central federal income tax question raised by these donations is whether the donor must reduce the amount of the charitable contribution deduction claimed on her federal income tax return by the value of state tax benefits generated by the gift. Under current law, expressed through both court opinions and rulings from the Internal Revenue Service, the amount of the donor’s charitable contribution deduction is not reduced by the value of state tax benefits. The effect of this "Full Deduction Rule" is that a taxpayer can reduce her state tax liability by making a charitable contribution that is deductible on her federal income tax return.
In a tax system where both charitable contributions and state/local taxes are deductible, the ability to reduce state tax liabilities via charitable contributions confers no particular federal tax advantage. However, in a tax system where charitable contributions are deductible but state/local taxes are not, it may be possible for states to provide their residents a means of preserving the effects of a state/local tax deduction, at least in part, by granting a charitable tax credit for federally deductible gifts, including gifts to the state or one of its political subdivisions. In light of recent federal legislation further limiting the deductibility of state and local taxes, states may expand their use of charitable tax credits in this manner, focusing new attention on the legal underpinnings of the Full Deduction Rule.
The Full Deduction Rule has been applied to credits that completely offset the pre-tax cost of the contribution. In most cases, however, the state credits offset less than 100% of the cost. We believe that, at least in this latter and more typical set of cases, the Full Deduction Rule represents a correct and long-standing trans-substantive principle of federal tax law. According to judicial and administrative pronouncements issued over several decades, nonrefundable state tax credits are treated as a reduction or potential reduction of the credit recipient’s state tax liability rather than as a receipt of money, property, contribution to capital, or other item of gross income. The Full Deduction Rule is also supported by a host of policy considerations, including federal respect for state initiatives and allocation of tax liabilities, and near-insuperable administrative burdens posed by alternative rules.
It is possible to devise alternatives to the Full Deduction Rule that would require donors to reduce the amount of their charitable contribution deductions by some or all of the federal, state, or local tax benefits generated by making a gift. Whether those alternatives could be accomplished administratively or would require legislation depends on the details of any such proposal. We believe that Congress is best situated to balance the many competing interests that changes to current law would necessarily implicate. We also caution Congress that a legislative override of the Full Deduction Rule would raise significant administrability concerns and would implicate important federalism values. Congress should tread carefully if it seeks to alter the Full Deduction Rule by statute.
For a contrary view, see Roger Colinvaux, Failed Charity, Taking State Tax Benefits into Account for Purposes of the Charitable Deduction, Buffalo Law Review (forthcoming). Here is the abstract:
The Tax Cuts and Jobs Act (TCJA) substantially limited the ability of individuals to deduct state and local taxes (SALT) on their federal income tax returns. Some states are advancing schemes (CILOTs) to allow taxpayers a state tax credit for contributions to a 501(c)(3) organization controlled by the state. The issue is whether CILOTs are deductible as charitable contributions on federal returns. Under a general rule of prior law – the full deduction rule – state tax benefits were ignored for purposes of the charitable deduction. If the full deduction rule is applied to CILOTs, then the SALT limitation can successfully be avoided. This article explains that after the TCJA, state tax benefits are more valuable and it no longer makes sense to ignore them for purposes of determining whether a taxpayer has made a charitable contribution. To allow a charitable deduction for payments that make a taxpayer better off would undermine a fundamental purpose of the charitable deduction: that it is meant to encourage personal sacrifice, not tax avoidance. Thus, CILOTs likely fail as charitable contributions. Further, by changing the economics of state tax benefits, Congress inadvertently has called into question the deductibility of a variety of other payments that trigger state tax benefits and that previously have been deducted as charitable contributions.
The recently enacted federal excise tax on private college and university endowments may not be the last congressional word relating to such endowments. Research relating to such endowments, including a recent Congressional Research Service report and a recent report out of the Federal Reserve Bank of Cleveland therefore may have important policy implications.
The CRS report is titled College and University Endowments: Overview and Tax Policy Options. Here is the Summary:
Colleges and universities maintain endowments to directly support their activities as institutions of higher education. Endowments are typically investment funds, but may also consist of cash or property. Current tax law benefits endowments and the accumulation of endowment assets. Generally, endowment fund earnings are exempt from federal income tax. The 2017 tax revision (P.L. 115-97), however, imposes a new 1.4% excise tax on the net investment earnings of certain college and university endowments. Taxpayers making contributions to college and university endowment funds may be able to deduct the value of their contribution from income subject to tax. The purpose of this report is to provide background information on college and university endowments, and discuss various options for changing their tax treatment.
This report uses data from the U.S. Department of Education, the National Association of College and University Business Officers (NACUBO) and Commonfund Institute, and the Internal Revenue Service to provide background information on college and university endowments. Key statistics, as discussed further within, include the following:
In 2017, college and university endowment assets were $566.8 billion. Endowment assets have been growing, in real terms, since 2009. Endowment asset values fell during the 2007-2008 financial crisis, and took several years to fully recover.
Endowment assets are concentrated, with 12% of institutions holding 75% of all endowment assets in 2017. Institutions with the largest endowments (Yale, Princeton, Harvard, and Stanford) each hold more than 4% of total endowment assets.
The average spending (payout) rate from endowments in 2017 was 4.4%. Between 1998 and 2017, average payout rates have fluctuated between 4.2% and 5.1%. In recent years, institutions with larger endowments have tended to have higher payout rates.
In 2017, endowment assets earned a rate of return of 12.2%, on average. Larger institutions tended to earn higher returns. Larger institutions also tended to have a larger share of assets invested in alternative strategies, including hedge funds and private equity.
Changing the tax treatment of college and university endowments could be used to further various policy objectives. Current-law tax treatment could be modified to increase federal revenues. The tax treatment of college and university endowments could also be changed to encourage additional spending from endowments on specific purposes (tuition assistance, for example).
Policy options discussed in this report include (1) a payout requirement, possibly similar to that imposed on private foundations, requiring a certain percentage of funds be paid out annually in support of charitable activities; (2) modifying the excise tax on endowment investment earnings; (3) a limitation on the charitable deduction for certain gifts to endowments; and (4) a change to the tax treatment of certain debt-financed investments in strategies often employed by endowments.
The Federal Reserve Bank report is authored by one the Bank's Senior Research Economists and titled simply College Endowments. Here are the first three paragraphs (footnotes omitted):
The Tax Cuts and Jobs Act (Public Law 115-97) was signed into law by President Trump on December 22, 2017. Among the law’s numerous provisions is a new 1.4 percent tax on the investment income of private colleges and universities enrolling at least 500 students and with assets of at least $500,000 per student.
Opinions on this “endowment tax” vary. Some commentators argue that it makes it more difficult for colleges and universities to fulfill their educational missions, while others feel that it rightly incentivizes them to spend endowment funds on beneficial research and teaching rather than receiving tax advantages to invest their endowments in risky assets.
No matter what the case may be, now is an opportune time to take a deeper look at college endowments. What are endowments, and what is their purpose? How have the values of endowments at US colleges fluctuated over time, and what is their distribution currently? How many colleges will be affected by the new law? I consider these questions using data on college endowments from the National Center for Education Statistics’ Integrated Postsecondary Education Data System.
Two important recent reports provide information regarding trends in charitable giving, the annual Giving USA report and a report from the American Enterprise Institute on the likely effects of the recent federal tax legislation on charitable giving.
The Giving USA 2018 report shows continued growth in charitable giving, by 5.2 percent (3.0 percent adjusted for inflation) over 2016 to an estimated $410.02 billion in 2017. Individuals continue to provide most of the giving (70 percent), although foundation giving has increased by an annualized average of 7.6 percent over the past five years. Religious organizations continue to receive the largest proportion (31 percent) of giving among types of charities. These numbers mask at least two interesting trends, however. One is the well-known growth in donor-advised funds (see, e.g., this Atlantic article and this ThinkAdvisor article, both gathering data about such growth). The other is a decline in the number of donors, even as the total amount of donations has increased, as documented in data collected by the Indiana University's Lilly School of Philanthropy showing that from 2000 to 2014 the share of Americans donating dropped from 66.2 percent to 55.5 percent. See Chronicle of Philanthropy article.
The Giving USA report almost certainly does not reflect much impact from the recent federal tax legislation, given its passage in December 2017, but the AEI report fills that gap by trying to predict how the legislation as enacted will affect charitable giving. It concludes that the tax law changes will reduce charitable giving by 4.0 percent or $17.2 billion in 2018 under a static model and by $16.3 billion if the changes also provide a modest boost to growth. Four-fifths of this effect is driven by the increased number of taxpayers who will claim the enhanced standard deduction and so will no longer benefit from the itemized charitable contribution deduction.
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
States Continue to Chip Away at Donor Anonymity for Politically Active Nonprofits (Missouri and Washington)
With the nonprofit created by now former Governor Eric Greitens very much in the news, the Missouri Ethics Commission (MEC) issued an advisory opinion clarifying that nonprofits are considered "committees" and so subject to registration and public reporting of donor requirements under Missouri law if they receive more than a nominal amount for the primary or incidental purpose of influencing or attempting to influence voters with respect to an election to public office or a ballot measure. Perhaps as importantly, the MEC's opinion also notes that the use of a nonprofit to attempt to conceal the actual source of a contribution to a candidate committee or other (political) committee is prohibited. See also St. Louis Post-Dispatch.
In Washington, the legislature passed and the governor signed the DISCLOSE Act of 2018. The legislation, which will not be effective until January 1, 2019, creates a new category of entities required to register and publicly report their significant donors known as "incidental committees." Such committees are any nonprofit organization that is not a political committee but that makes political contributions or expenditures above a $25,000 annual threshold directly or indirectly through a political committee. The donor disclosure provision only applies to the top ten donors in a calendar year who give, in the aggregate $10,000 or more.
For example, Nebraska's Attorney General just released a detailed report and filed a consent judgment against Goodwill Industries, Inc. and Goodwill Speciality Services, Inc. in Omaha. The report explains how the AG's investigation, triggered by a series of newspaper articles, found that the two organizations had shifted away from their nonprofit mission toward retail sales, paid excessive executive compensation, and had boards that failed to provide appropriate oversight (while also concluding that transactions with board member affiliated companies were fair to the nonprofits). The consent judgment commits the nonprofits, now under new leadership, to a variety of remedial actions including adopting new governance policies relating to conflicts of interest and nepotism, ending certain business relationships and practices, and making a variety of other governance changes. For additional information, see Press Release; Omaha World-Herald.
Taking a broader look at charity oversight, Seven Days in Vermont reports that while that state only has a single assistant attorney general to oversee the more than 6,000 tax-exempt nonprofits in that state, neighboring New Hampshire has a staff of eight to oversee its 10,000 nonprofits. The report also contrasts the differing filing and governance requirements of the two states, with New Hampshire requiring registration, annual financial reports, and the adoption of a conflict of interest policy, while Vermont does not impose any of these requirements. The report suggests that delays in investigating reported problems with certain charities in Vermont may be attributable to this lack of requirements and staff. Hat tip: Nonprofit Quarterly.
Finally and probably not surprisingly, New York has been particularly active in recent months. I will get to the Donald J. Trump Foundation in a separate post, but even setting aside that high-profile case there has been a lot of activity. This includes a settlement with a trustee of the Richenthal Foundation that included $550,000 in restitution and a permanent bar on serving in any fiduciary position with a nonprofit operating in New York, a settlement with the Wounded Warriors Foundation of Orange County relating to fake raffles that required the charity to immediately dissolve and pay $4,200 in restitution, and a lawsuit against the accounting firm that audited a sham cancer charity that was shut down a year ago.
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
I previously blogged about the lawsuit by the Pearson Family Members Foundation and Thomas L. Pearson against the University of Chicago relating the University's alleged failure to abide by the terms of a grant agreement for the creation and funding of The Pearson Institute for the Study and Resolution of Global Conflicts and The Pearson Global Forum. The United District Court for the Northern District of Oklahoma has now ruled on the University's motion to dismiss. Applying New York law, as required by the agreement, the court granted the motion with respect to a fiduciary duty claim because a fiduciary relationship did not exist between the grantor and the grantee and with respect to a fraudulent concealment claim because it was superseded by a breach of contract claim. The court did, however, allow not only the breach of contract claim but also a breach of duty of good faith and fair dealing claim and an anticipatory retaliation claim to proceed. Stay tuned for further developments.
The United States District Court for the Eastern District of Louisiana recently held in Rowe v. United States that the special rules applicable to church tax inquiries and examinations under Internal Revenue Code 7611 do not apply when the IRS seeks church financial records relating to an investigation into the tax liability not of the church but its pastors. The taxpayers in the case, Dr. Herbert H. Rowe and his wife Dr. Carol G. Rowe, are pastors at the Upperroom Bible Church in New Orleans. According to the court, the Rowes had not filed a federal income tax return from 1996 to 2011 (the last year being the one under investigation for them), although they filed a tax return for 2011 after the investigation began. As part of its investigation, the IRS issued broad summonses for records relating to church bank accounts at two banks. The court concluded that the plain language of section 7611 meant that section did not apply to investigations relating to the tax liability of parties other than the church itself, and cited a number of decisions reaching that conclusion with respect to summons directed at church financial records. The court then concluded that the normal rules for such summonses supported their issuance, and therefore denied the Rowes' petition to quash the summonses and granted the government's motion to dismiss that petition.
- 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.)
Sunday, July 1, 2018
The article begins by explaining that it’s a myth that 501(c)(3) organizations cannot make a profit. Nonprofits can make a profit, whether its taxed or not depends on whether the profit comes from activities related to the organizations purpose. If a nonprofit’s income comes from activities that are related to its tax-exempt purpose that income is not taxable income. Nonprofits can use this income to pay operating expenses, but they cannot dispense the income to their officers or directors. When nonprofits make money from things that are unrelated to their purpose, that income is called unrelated business income and that income is subject to federal taxation unless that unrelated business income is less than $1000. If the unrelated business income results in too big of an excess the IRS can revoke a nonprofit’s tax-exempt status. To read the full article, click here: https://www.nolo.com/legal-encyclopedia/taxes-nonprofit-corporation-earnings-30284.html
Friday, June 29, 2018
Part 2 of this article discusses how the operations of nonprofit organizations and how the new jobs act will impact them. The first impact it discusses is how UBIT is calculated. Before if a nonprofit ran two different unrelated business activities the nonprofit could offset the losses from one activity against the gains of the other one. This is not permitted anymore. Now, any losses from one activity can be carried over indefinitely, but can only offset the same activity. Next, the article explores the limitations on entertainment related deductions. Organizations may no longer take deductions for any activity considered entertainment, amusement, or recreation (even if it is directly related to the organizations purpose); any facility used for entertainment, amusement, or recreation; or any transportation fringe benefit. To learn more about how the operations of nonprofits are impacted by the new jobs act, click here: https://www.nonprofitlawblog.com/new-tax-law-impact-nonprofits-part-2/<https://na01.safelinks.protection.outlook.com/?url=https%3A%2F%2Fwww.nonprofitlawblog.com%2Fnew-tax-law-impact-nonprofits-part-2%2F&data=02%7C01%7Cdavid.brennen%40uky.edu%7Cc00f9732b33746c00b1c08d5dc4760b5%7C2b30530b69b64457b818481cb53d42ae%7C0%7C1%7C636657121479442930&sdata=1qKUrHGBcwQB%2FZYuV%2BVenhDDauhK6hyrY73VhGgnADM%3D&reserved=0>