Thursday, November 21, 2013
Maria Di Miceli has recently published Drive Your Own PILOT: Federal and State Constitutional Challenges to the Imposition of Payments in Lieu of Taxes on Tax-Exempt Entities, in the Tax Lawyer. Here is the abstract:
With the recession raging on, state and local governments continue to look for innovative ways to save money and slash state and local government programs. Despite providing a public good to states and municipalities, the nonprofit, tax-exempt sector is no exception to state and local government's purview. One of the methods used by governments is to levy ad hoc, coerced payments in lieu of taxes ("PILOTs") on tax-exempt organizations. Major cities such as Boston, Philadelphia, and Madison have taken a myriad of approaches and, thus far, nonprofits have generally been on the weak side of the bargaining table. But what state, local, and federal constitutional challenges might a nonprofit make against the imposition of a PILOT? And what is a PILOT anyway: a tax, fee, contract, penalty, or some combination? This Article will explore those and other areas in an attempt to help entities effectively drive their own PILOT.
Hat Tip: TaxProf Blog
According to The Jewish Week, the Brooklyn-based Aleh Foundation is the defendant in a $5 million lawsuit filed by Masha and Shaul Yakobzon, an Israeli couple who moved to New York City about ten years ago to obtain better medical care for their young daughter, Ayalah. Aleh Foundation allegedly used a photograph of Ayalah to solicit funds, ostensibly to support her family’s efforts to serve her needs. Says the story:
The only problem is that the Aleh Foundation, which purports to be the American fundraising arm of ALEH, a well-known Israeli charity that provides residential facilities for the disabled, never gave a dime for Ayalah’s care, and it used her likeness fraudulently, according to a $5 million lawsuit filed this fall in Brooklyn Supreme Court. [The suit claims] … that representatives of the Aleh Foundation never indicated that their daughter’s likeness “might be widely published, disseminated, or otherwise exploited for a fundraising campaign.” And, the parents claim, “No funds, additional special services, products, or monetary assistance of any kind, has been provided” to the family for Ayalah’s care.
And that’s not all. The story also reports that officials of ALEH, described as “a well-known Israeli charity that provides residential facilities for the disabled,” have been attempting to distance their charity from the Brooklyn entity. The story continues:
For officials at ALEH, who have for three years been trying quietly to get the Aleh Foundation and its longtime head, the politically connected Borough Park rabbi, Shlomo Braun, to stop passing himself off as a representative of the charity, the Yakobzons’ lawsuit is the last straw. And it has pushed what had been a private dispute into public view.
Talking to the media for the first time, in extensive interviews with The Jewish Week, ALEH officials are mounting an offensive against Rabbi Braun in an effort to prevent confusion in the minds of donors about the relationship between the two groups. They allege that Rabbi Braun has funneled only a fraction of the money he has raised on ALEH’s behalf to the organization in Israel. And they claim that he has not provided requested documentation about his fundraising expenses.
The story contains additional details of the history of the two entities and the specific concerns of the representatives of the Israeli charity regarding what they believe to be fundraising irregularities surrounding the Brooklyn entity. It is also noteworthy that Charity Navigator, which rates the efficiency of nonprofits, has issued a “donor advisory” with respect to the Brooklyn entity because of the lawsuit.
Wednesday, November 20, 2013
The NonProfit Times reports that two United States Senators and Senate Finance Committee Members, John Thune (R-S.D.) and Ron Wyden (D-Ore.), have drafted a letter to their leadership to urge maintaining the charitable contributions deduction. The letter, timed to coincide with “Protect Giving Day,” garnered support from some 200 representatives of 140 nonprofit organizations. The gist of the letter appears in the following excerpts, reported in the Times:
We write to you to underscore the importance of protecting the full value and scope of the charitable deduction during a comprehensive rewrite of the tax code …. Analysis has repeatedly shown that proposals to cut, cap, or limit the charitable deduction could cause charitable donations to decline by billions of dollars annually. Worse yet, weakening the charitable deduction would most hurt the adults and children who receive vital charitable services from organizations like soup kitchens, after-school programs, and medical research projects, just to name a few.
The Times further reports that, at a congressional staff lunch attended by nonprofit leaders and tax policy experts, new research was presented concerning “the recession’s impact on charitable giving and the potential impact of limits to the charitable deduction.” According to Dr. Arthur Brooks, President of the American Enterprise Institute, charitable giving is now at pre-recession levels, and the administration’s perennial proposal to limit the benefit of the charitable contributions deduction by treating donors as though their maximum marginal income tax rate were 28 percent (for purposes of calculating the deduction) “could cause giving to decline by nearly $10 billion in the first year.”
Illinois Law Professor and fellow blogger John D. Colombo has recently posted the following papers on SSRN, listed by title and accompanying abstract.
Here is the first:
The IRS University Compliance Project Report on UBIT Issues: Roadmap for Enforcement ...Reform...or Repeal?
The recent completion of the IRS College and University Compliance Project again raises questions about the rationale for and purpose of the Unrelated Business Income Tax (UBIT). This paper addresses these questions in three main parts. Part I reviews existing UBIT law, particularly as it applies to colleges and universities. The second part is a short summary of the IRS findings on UBIT compliance. The final part then examines whether the UBIT should be reformed or even repealed. The paper concludes that while expansion of the UBIT to an all-inclusive commerciality tax (a proposal I have made in previous papers) is still my preferred solution, absent such reform, Congress should consider simply repealing the UBIT and relying on disclosure and non-tax incentives to control commercial activity by charities.
And the second:
Private Benefit: What Is It -- And What Do We Want It to Be?
Beginning with the landmark decision American Campaign Academy v. Commissioner in 1989, the Internal Revenue Service has used the “private benefit” doctrine as a primary tool to police the activities of charitable organizations exempt under Code Section 501(c)(3). Unfortunately, the doctrine literally has no doctrinal content. Unlike its sibling, the private inurement doctrine, the private benefit doctrine has no statutory basis in 501(c)(3). Though the IRS claims the doctrine flows from the 1959 Treasury Regulations, it is a claim that is questionable given the language used, and in any event, this interpretation of the regulations appears not to have been “discovered” until some at least a decade after the regulations were promulgated. This paper reviews the history and application of the private benefit doctrine, and suggests a specific normative test for application of the doctrine to situations involving a “failure to conserve” charitable assets.
And the third:
The Role of Redistribution to the Poor in Federal Tax Exemption for Charities
Over the past several years, many commentators have suggested that federal tax exemption for charities should be limited to organizations that help the poor – that is, organizations with a redistributive mission. This paper reviews and comments on three areas of existing federal exemption law where the redistribution view either already controls tax benefits or is being pushed by policy makers as a change to existing law: the push for a charity care standard for exempting nonprofit hospitals, the current university endowment debate, and a hodge-podge of rulings relating to what I will call “middle class charity” in which the IRS has denied exemption to nonprofit organizations providing services to the middle class (as opposed to the poor). Part I provides a brief introduction to the history of the redistribution concept in federal exemption under 501(c)(3) prior to the current regulations introduced in 1959. Part II then provides a summary of current law and proposals in the three areas described above (nonprofit hospitals, programs aimed at the middle class, and university endowments). Part III then turns to some analysis and observations. The main observations are (1) that the redistributive push in the areas identified by this paper is almost certainly bad policy and inconsistent with the IRS’s supposed adoption of the broad common-law view of charity in the 1959 regulations; (2) that the redistributive paradigm seems to pop up most in areas where the organizations in question carry on activities that look very similar to commercial enterprises – in other words, what we may be seeing is the use of the redistribution paradigm to help distinguish charitable services from ordinary for-profit business; (3) limiting the definition of charitable for tax exemption purposes to relief of the poor is inconsistent with the historical definition of charity; and (4) the effort to limit the scope of tax exemption/deductibility to redistribution to the poor is inconsistent with virtually all the theories proposed to explain tax exemption and essentially adopts one particular view of distributive justice that may not be appropriate in formulating tax benefits for charities. Until tax policy chooses an underlying rationale for charitable tax exemption, however, the inconsistencies in applying exemption are likely to continue.
61 York Acquisition, LLC v. Commissioner – $10.7m Facade Easement Deduction Denied For Failure to Restrict Entire Exterior
On December 18, 2006, 61 York Acquisition, LLC (the Partnership) granted a façade easement with respect to a certified historic structure located in the Historic Michigan Boulevard District of Chicago to the National Architectural Trust, or NAT (now known as the Trust for Architectural Easements). Consistent with IRC § 170(h)(4)(B), as amended by the Pension Protection Act of 2006, the easement requires the grantor to obtain prior written consent from NAT before making any change to the “Protected Facades,” which include “the existing facades on the front, sides and rear of the Building and the measured height of the Building.” The Partnership claimed a $10.7 million charitable income tax deduction for the donation on its 2006 partnership tax return. The IRS disallowed the deduction in full and, in 61 York Acquisition, LLC v. Commissioner, T.C. Memo. 2013-266, the Tax Court granted the IRS’s motion for summary judgment sustaining the disallowance.
At the time of the donation of the facade easement, ownership of the structure subject to the easement was divided into two parts: the Partnership owned the first 14 floors (the Office Property), and a third party owned the top 6 floors (the Residential Property). In addition, the two owners had entered into an agreement (the Agreement) pursuant to which:
- the Partnership owned the “Façade,” defined as including only portions of two sides of the building,
- the Partnership reserved the right to grant an easement with respect to the Façade,
- the Partnership was responsible for maintenance of the Façade as well as maintenance of other portions of the facade of the structure, and
- any owner who wished to make an addition, improvement, or alteration that materially altered the Façade had to obtain prior written consent of the other owner.
The IRS disallowed the Partnership’s claimed deduction on the grounds that the Partnership could not have granted a valid easement restricting the entire exterior of the structure (front, sides, rear, and height) because the Partnership did not own the entire exterior of the building. The taxpayer argued that the terms of the easement and the Agreement collectively imposed enforceable restrictions on the entire exterior of the property, and that, under Illinois law, ownership of the entire exterior is not required to grant an easement that imposes enforceable restrictions on the entire exterior.
The Tax Court sided with the IRS. The court first reiterated the well-established rule that, while “[s]tate law determines the nature of property rights, … Federal law determines the appropriate tax treatment of those rights.” Accordingly, to determine whether the easement complied with the federal requirement that a façade easement restrict the entire exterior of a structure, the court looked to state law to determine the effect of the easement.
The court determined that, under Illinois law, “a person can grant only a right which he himself possesses,” Accordingly, the Partnership did not grant an easement in the entire exterior of the structure, as required under federal law, because the Partnership had rights only to the Façade, which was defined to include only portions of two sides of the structure.
The court rejected the taxpayer’s argument that the Partnership had an assignable right in the entire exterior because the Partnership had an obligation under the Agreement to maintain the entire exterior. The court explained that it declined to “find a right [to restrict] in an obligation [to maintain],” and noted that the taxpayer cited no Illinois case law in support of its proposition.
The court also rejected the taxpayer’s argument that the Agreement, which disallowed certain alterations to the property without the prior written consent of the other property owner, gave the Partnership an assignable right to restrict with respect to the entire exterior of the property. The court explained that the Agreement required the altering owner to obtain prior written consent from the other owner only if the alteration would materially alter the Façade. The Partnership thus did not have the right to restrict alterations to the two sides of the structure not covered by the definition of Façade, or to the excluded portions of the other two sides. The Partnership, said the court, could not contribute rights it did not possess.
Even if the Agreement had granted the Partnership rights to restrict alterations with respect to the entire exterior of the structure, it is not clear that the donation of those rights would satisfy the perpetuity or other requirements under § 170(h), or what the value of those rights would be for purposes of § 170(h). Cf. Schwab v. Commissioner, T.C. Memo 1994-232 (the parties stipulated that donation of rights to restrict land the taxpayer did not own was a qualified conservation contribution).
61 York Acquisitions, LLC, is yet another in a string of cases involving challenges to deductions claimed with respect to façade easements donated to NAT. See Herman v. Commissioner, T.C. Memo. 2009-205; 1982 East LLC v. Commissioner, T.C. Memo. 2011-84; Dunlap v. Commissioner, T.C. Memo. 2012-126; Rothman v. Commissioner, T.C. Memo. 2012-218; Graev v. Commissioner, 140 T.C. No. 17 (2013); Friedberg v. Commissioner, T.C. Memo. 2013-224; and Gorra v. Commissioner, T.C. Memo. 2013-254. See also Kaufman v. Shulman, 687 F.3d. 21 (1st Cir. 2012) (remanding to the Tax Court on the issue of valuation and noting that, because of local historic preservation laws, the Tax Court might well find that the façade easement donated to NAT was worth little or nothing). NAT also was the subject of a 2011 Department of Justice lawsuit (discussed here) alleging that NAT was engaged in abusive practices. The suit settled with NAT denying the allegations but agreeing to a permanent injunction prohibiting it from engaging in the practices.
Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law
Tuesday, November 19, 2013
Tax Analysts’ State Tax Today (subscription required) reports an interesting decision of the Ohio Board of Tax Appeals. In Talbert Services, Inc. v. Testa, an outpatient clinic provided assessment, treatment, case management, and referral services for clients suffering from substance abuse and mental health disorders on property that included an apartment. When the clinic bought the property in 2008, an individual lived in the apartment, and he continued to do so for several years. The Tax Commissioner denied property tax exemption for the apartment on the grounds that it was not used for charitable purposes because it was leased to an individual. Reversing this determination, the Ohio Board of Tax Appeals found that the apartment was used by for charitable purposes. It accepted testimony that, although the tenant was not an official client of the clinic, a director “provided one-on-one informal counseling and referral services to the tenant, just as [the clinic] … provided to its other clients.” Further, the clinic did not lease the apartment with a view to profit, but merely used the rent to cover its expenses.
The electronic citation of this decision is 2013 STT 223-22.
Monday, November 18, 2013
On November 15, the IRS issued a consumer alert about possible scams taking place following Typhoon Haiyan, which hit the Philippines on November 8 and brought widespread devastation. Says the alert:
Following major disasters, it is common for scam artists to impersonate charities to get money or private information from well-intentioned taxpayers. Such fraudulent schemes may involve contact by telephone, social media, email or in-person solicitations.
The IRS cautions people wishing to make disaster-related charitable donations to avoid scam artists by following these tips …
The specific pointers offered by the IRS are available here.
As reported in the Los Angeles Times, a leaked affidavit of an FBI agent asserts that California State Senator Ronald S. Calderon has offered political favors in connection with facilitating contributions to a charitable nonprofit established by his brother, Tom Calderon, with less than entirely charitable goals in mind. Key excerpts of the story follow:
Calderon … allegedly accepted $60,000 from an undercover FBI agent posing as a studio executive in exchange for pursuing legislation to expand tax breaks for film companies, according to a sealed FBI affidavit made public by a cable network.
The agent agreed to pay $25,000 of the money to a nonprofit set up by the senator's brother, former Assemblyman Tom Calderon, says the affidavit ….
"We have this nonprofit. It is called Californians for Diversity," Calderon told the agent, according to a transcript of a recording included in the document.
The group, Calderon said, was set up to advocate positions on issues being debated in California.
"Then Tom and I down the road, we build that up, we can pay ourselves," the senator allegedly told the agent. "Just kind of make, you know, part of [a] living."
The nonprofit, formed in 2008, also received $25,000 from "Yes We Can," a political committee of the California Legislative Latino Caucus, which made the donation in January.
The FBI affidavit alleges the "Yes We Can" donation was arranged by Sen. Kevin de Leon …"in exchange for Ronald Calderon agreeing not to challenge Senator [Ricardo] Lara to become the Chairman of the Latino Caucus."
"They are doing exactly what contribution limits are there to guard against," said [Loyola Law Professor Jessica] Levinson, a member of the Los Angeles Ethics Commission.
According to the story, Calderon and De Leon have denied any wrongdoing, and nobody named in the affidavit has yet been charged with a crime.
The Times reports on connections between other California lawmakers and various nonprofit entities, but pinpoints nothing of such import as the facts surrounding Senator Calderon.
Thursday, November 14, 2013
In Gorra v. Commissioner, T.C. Memo. 2013-254, the Tax Court held that the taxpayers were entitled to a charitable income tax deduction under IRC § 170(h) for the donation of a façade easement on a residential townhouse located in the Carnegie Hill Historic District of New York City to the National Architectural Trust, or NAT (now the Trust for Architectural Easements, or TAE). The court also held, however, that easement caused only a 2% reduction in the value of the subject property and the taxpayers were liable for a 40% gross valuation misstatement penalty. These and the other holdings in the lengthy opinion are discussed below.
Qualified Real Property Interest
The Tax Court found that the façade easement was a “qualified real property interest” for purposes of IRC § 170(h)(2)(C)--“a restriction (granted in perpetuity) on the use which may be made of the real property.” Unlike the nondeductible golf course easement at issue in Belk v. Commissioner, 140 T.C. No. 1 (2013), reconsideration denied and opinion supplemented in T.C. Memo 2013-154, which permitted the parties to remove portions of the golf course from the easement and replace them with property currently not subject to the easement (i.e., to engage in “substitutions” or “swaps”), the court found that the façade easement in Gorra “clearly defines the property donated under the easement and restricts the easement to that property” and does not authorize substitutions.
Valid Conservation Purpose
The IRS argued that the façade easement was not donated for a valid conservation purpose because the easement did not preserve the property beyond what is already required under New York’s Landmarks Preservation Law, which is enforced by the Landmarks Preservation Commission (LPC). The Tax Court disagreed, finding the easement in Gorra to be more restrictive than the Landmarks Law in a number of respects, including that it protects the front, side, rear, and measured height of the property as required by IRC § 170(h)(4) as revised by the Pension Protection Act of 2006. The court also found that (i) TAE actively monitors its easements, while LPC is passive and relies heavily on complaints to uncover violations, (ii) TAE performed annual inspections of the subject property and kept records, including photographs, while it was unclear whether LPC ever inspected the property, and (iii) the taxpayers’ arguments regarding TAE’s ability to enforce the restrictions more effectively than LPC were convincing. In its finding of facts, the court noted that TAE employs three people to monitor 550 properties (which translates to 183.3 properties per employee), while LPC is responsible for the preservation of 26,000 structures and has a staff of four employees responsible for inspection (which translates to 6,500 properties per employee).
The court also noted that, although the easement allows TAE to consent to changes to the property, the deed requires that any change must comply with all applicable federal, state, and local government laws and regulations, and Treasury Regulation § 1.170A-14(d)(5) specifically allows a facade easement donation to satisfy the conservation purposes test even if future development is allowed, provided that development is subject to applicable federal, state, and local government laws and regulations.
Conservation Purpose Protected In Perpetuity
The Tax Court found that the conservation purpose of the façade easement was protected in perpetuity as required by IRC § 170(h)(5)(A). The court noted that, while the taxpayers had requested that the easement be terminated because they were having a difficult time selling the property, TAE denied that request. “Under the terms of the deed,” said the court, “the easement is granted in perpetuity and may not be terminated at any time.” The court also found that the façade easement is distinguishable from the nondeductible easements at issue in Carpenter v. Commissioner, T.C. Memo. 2012-1, reconsideration denied and opinion supplemented in T.C. Memo. 2013-172, because the façade easement does not include a provision authorizing extinguishment of the easement by mutual agreement of the parties and, instead, allows the easement to be extinguished by judicial decree consistent with the requirements of Treasury Regulation § 1.170A-14(g)(6).
NAT delivered the easement to the recorder’s office on December 28, 2006, paid the recording fees and taxes, and obtained a receipt for the delivery. Due to a cover sheet error, however, the easement was not recorded until January 18, 2007. The IRS argued that the deed was not recorded until 2007. The Tax Court disagreed, holding that, under New York law, delivery of the deed to the recorder’s office, with receipt acknowledged, constituted recordation, even though there was a delay in the actual recording until the following year because of the cover sheet error. The court cited N.Y. Real Prop. Law § 317, which provides that every instrument entitled to be recorded is considered recorded from the time of delivery to the recording officer.
The Tax Court found that the taxpayer’s appraisal constituted a “qualified appraisal” as defined in Treasury Regulation § 1.170A-13(c)(3). Although the appraiser used the phrase “market value” in the appraisal, the court found that the appraiser’s definition of that term was synonymous with the definition of “fair market value” used in the Treasury Regulations. The court also found that the appraisal, which employed the before and after method, a paired sales analysis, and a percentage diminution, included the “method of valuation used” and reported the “specific basis for valuation” as required by the Treasury Regulations. The court noted that, as in Scheidelman v. Commissioner, 682 F.3d 189, 198 (2d Cir. 2012), while the IRS might deem the appraiser’s analysis unconvincing, “it is incontestably there.”
Generally Accepted Appraisal Standards
IRC § 170(f)(11)(E) as amended by the Pension Protection Act of 2006 specifies that a “qualified appraisal” must be conducted by a qualified appraiser in accordance with generally accepted appraisal standards, and IRS Notice 2006-96 provides that an appraisal will meet the specifications of § 170(f)(11)(E) if, for example, “the appraisal is consistent with the substance and principles of the Uniform Standards of Professional Appraisal Practice (‘USPAP’).” The Tax Court summarily dismissed the IRS’s argument that the taxpayer’s appraisal had serious defects and was inconsistent with USPAP, noting that “[a]ppraising is not an exact science and has a subjective nature.”
After a careful review of the valuation experts’ reports, the Tax Court concluded that the facade easement caused only a 2% (or $104,000) reduction in the value of the subject property, and the reduction stemmed from the heightened financial burdens of an eased façade, enforcement actions of TAE, and the scope of the easement. The court found that the taxpayers did not meet their burden of proving that the easement resulted in a 9% (or $465,000) reduction in the value of the property. The court also rejected the IRS expert’s assertion that the easement had no value, noting that the easement was more restrictive than local historic preservation laws and “[o]rdinarily, any encumbrance on real property, however slight, would tend to have some negative effect on the property’s fair market value.”
The Pension Protection Act of 2006 lowered the threshold for imposition of the 40% penalty for gross valuation misstatements under IRC § 6662(h) and eliminated the reasonable cause exception for gross valuation misstatements with respect to charitable deduction property (i.e., the penalty in a case such as this is a strict liability penalty). The taxpayers in Gorra were liable for this penalty because their original asserted value for the easement ($605,000) was more than 200% of the amount determined by the court to be the correct value ($104,000). The court rejected the taxpayers’ argument that the penalty was an “excessive fine” under the Eigth Amendment to the United States Constitution, noting that such penalties are remedial in nature, not “punishments,” and are an important tool because they enhance voluntary compliance with tax laws.
Gorra is the most recent in a string of cases involving challenges to deductions for façade easements donated to NAT. See Herman v. Commissioner, T.C. Memo. 2009-205; 1982 East LLC v. Commissioner, T.C. Memo. 2011-84; Dunlap v. Commissioner, T.C. Memo. 2012-126; Rothman v. Commissioner, T.C. Memo. 2012-218; Graev v. Commissioner, 140 T.C. No. 17 (2013); Friedberg v. Commissioner, T.C. Memo. 2013-224. See also Kaufman v. Shulman, 687 F.3d. 21 (1st Cir. 2012) (remanding to the Tax Court on the issue of valuation and noting that, because of local historic preservation laws, the Tax Court might well find that the façade easement donated to NAT was worth little or nothing). NAT also was the subject of a 2011 Department of Justice lawsuit (discussed here) alleging that NAT was engaged in abusive practices. The suit settled with NAT denying the allegations but agreeing to a permanent injunction prohibiting it from engaging in the practices.
Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law
Wednesday, November 13, 2013
At least this one will pay property taxes, although construction will be financed by tax-exempt bonds because the owner is a 501(c)(3) exempt private foundation (looked 'em up on Guidestar). So we'll all still subsidize the complex, just more indirectly via tax-exempt bonds. I guess it's no worse than subsidizing professional sports stadiums with government bond financing . . . Sigh.
Tuesday, November 12, 2013
The last of a three-part series by NPR and the Center for Responsive Politics examining "dark money" in politics and the role of 501(c)(4)'s and (c)(6)'s in the process of "laundering" campaign money is now available. The full series is a must-read for those interested in these issues, but if you want a quick overview, visit Forbes.
Howard Gleckman is absolutely correct - this is the real scandal, and it has nothing to do with the IRS's handling of Tea Party exemption applications. He is also correct that the Congressional witch-hunt over the IRS handling of such applications makes it more likely that these groups will receive no meaninful scrutiny from the IRS going forward.
This is the real mess Congress should be investigating, but I'm not holding my breath waiting for them to do anything constructive about it.
In the ongoing property exemption battle between Pittsburgh and UPMC, UPMC has moved again for dismissal of the case, noting that it has no employees and therefore cannot be liable for payroll taxes.
While probably technically correct, the more interesting fact from my perspective is that UPMC is a holding company shell at the top of a business enterprise consisting of 44 subsidiaries.
Think about that for a second. We have a supposedly charitable enterprise that has 44 separate business entities (not all of them tax-exempt). This kind of structure is not unusual for large healthcare enterprises, and is even becoming more common for large universities.
Somehow, I don't think this is exactly what the English Parliament had in mind when it passed the Elizabethan Statute of Charitable Uses in 1601.
Monday, November 11, 2013
A story yesterday in the St. Louis Post-Dispatch highlights a tax-exemption area that may well become the next battleground (after nonprofit hospitals) for state property tax exemption: senior retirement living complexes.
The story highlights the issues. Senior living complexes typically claim charitable status on the grounds of providing services to the aging. Indeed, some complexes do have on-staff health care professionals, and some have sections of the complex designed to provide residents who need on-site health services and some level of daily living help (assisted living). But as the story notes, many of these complexes are thinly-disguised luxury apartments for seniors - and it ought to be obvious that providing luxury apartments to seniors is not a charitable activity.
So why do we have this mess? Largely because of a lack of clear standards for what constitutes "charity" and a lack of understanding (or perhaps a lack of will) on the part of local property tax officials (and frankly, the IRS) to try to distinguish different kinds of senior living arrangements.
At the federal level, tax exemption for senior living complexes was based on a "relief of the poor" standard of charity prior to the 1970's. Before Revenue Ruling 72-124, the IRS position with senior living complexes substantially mirrored its pre-1969 position with respect to nonprofit hospitals: charitable tax exemption depended on providing free services to the poor - in this case, the poor elderly who could not financially afford to take care of themselves. Then in 1972, the IRS adopted more of a "community benefit" approach to senior living complexes, recognizing that "the relief of the distress of old age as a charitable purpose was not based on financial considerations alone. Instead, the ruling recognizes that the elderly as a class face forms of distress other than financial, such as need for suitable housing, physical and mental health care, civic, cultural, and recreational activities and an overall environment conducive to dignity and independence." (That quote and the ones to follow are from a 2004 IRS CPE text on elderly housing). In the ruling, the IRS considered a church-sponsored senior living complex that provided "housing, limited nursing care, and other services and facilities needed to enable its elderly residents to live safe, useful, and independent lives." The organization was self-supporting: "operating funds were derived principally from fees charged for residence in the home. An entrance fee was charged upon admission, with monthly fees charged thereafter for the life of each resident. Fees varied according to the size of the accommodations furnished." A key aspect of the ruling, however, was that "the organization was committed by established policy to maintaining them as residents, even if they subsequently became unable to pay the monthly charges." The IRS found that the arrangement fulfilled the housing, health care and financial security needs of the elderly, and granted exemption.
One aspect of the ruling that seems all but forgotten today was the IRS's position that "The organization operates so as to provide its services to the aged at the lowest feasible cost, taking into consideration such expenses as the payment of indebtedness, maintenance of adequate reserves sufficient to insure the life care of each resident, and reserves for physical expansion commensurate with the needs of the community and the existing resources of the organization." In addition, high-end retirement facilities have all but erased the problem of maintaining residents who become unable to pay the charges by simply requiring large up-front "entry fees" that are designed to cover the actuarial risk of a resident outliving their assets. Some clearly do, of course, but some, to put it bluntly, die early. It doesn't take a genius to figure out how much to charge as an entry fee to minimize back-end risk; it just takes a good actuary.
Rev. Rul. 72-124 is what opened the doors to high-end retirement homes getting tax exemption at the federal level under Section 501(c)(3), and in turn the federal exemption may have influenced similar standards for state property tax exemption. State standards regarding what constitutes a "charity" for property tax purposes are independent of federal standards under 501(c)(3), but particularly in areas where there is little state precedent, when an organization comes to a local assessor's office waving a federal exemption letter, that letter can be influential. And that is doubly true when the organization waving the letter also happens to be a church.
Frankly, most retirement homes have no more claim to exempt status than many profit-obsessed nonprofit hospitals, and it is high time we re-examine exemption for these organizations. Perhaps Senator Coburn would like to look into this issue alongside his NFL exemption crusade. In my view, charitable tax-exemption for high-end retirement complexes is far more of a scandal than trade-association status for the NFL league office, which probably wouldn't pay any taxes anyway.
Wednesday, November 6, 2013
According to the Nonprofit Quarterly, the Washington Post's recent investigative piece, "Inside the hidden world of thefts, scams and phantom purchases at the nation's nonprofits," has captured the attention of Senator Charles Grassley (R-IA), the ranking member of the Senate Judiciary Committee and a long-time overseer of tax-exempt organizations. The Post's article focused on the American Legacy Foundation and its less than full disclosure of what eventually amounted to a $3.4 million loss and a delayed call to investigators. The Post found that over a four year period more than 1,000 nonprofit organizations reported on their annual Forms 990 that they had discoverd a "significant diversion" of assets arising from "theft, investment fraud, embezzlement and other unauthorized uses of funds." As part of its investigative reporting, The Post, with the assistance of GuideStar, created a searchable database of nonprofits that have reported diversions. The Post article lists numerous other nonprofit organizations, comprising public charities, trade associations, veterans' associations, and other tax-exempts, that have had discovered diversions and misappropriations of funds totalling in the millions; a truly disturbing revelation.
As Nonprofit Quarterly reported, much more exploration on this topic is needed including, but not limited to, internal financial control difficulties, challenges for smaller organizations, the frontline capabilities of state attorneys general, and the effectiveness of actions taken by affected organizations. As NQ also concluded, Congress's review should include not only the source of these problems but also a focus on solutions.
As reported by the Daily Tax Report and Nonprofit Quarterly, the Citizens fpr Responsibility and Ethics in Washington (CREW) has requested that the IRS take notice of the use of 501(c)(6)s as the new tax-exempt vehicle for political campaign activity. CREW specifically targeted Freedom Partners, a nonprofit organization linked to the Koch brothers that fundraised and distributed between $235 and $250 million in the 2012 election cycle, asking the IRS to review the organization's use of its tax-exempt status to funnel anonymous donations to other organizations conveying a predominantly conservative political message. Organizations that are tax-exempt under section 501(c)(6) are typically business leagues or trade associations associated with a particular line of business or industry. According to its website, Freedom Partners states that it is a "501(c)(6) chamber of commerce that promotes the benefits of free markets and a free society." Both the Nonprofit Quarterly and CREW similarly opine that Freedom Partners seems to lack a "common business interest" other than ideological. CREW acknowledged the "vague" rules governing 501(c)(6) organizations, requesting that the IRS provide clarification on required and restricted activities.
David S. Miller (Cadwalader) has posted "Reforming the Taxation of Exempt Organizations and Their Patrons" to SSRN. The abstract provides:
The paper contemplates a radical reformation of our entire system for taxing exempt organizations and their patrons. First, all non-charitable exempt organizations that compete with taxable commercial businesses (such as fraternal benefit societies that provide insurance (section 501(c)(8)) and credit unions (501(c)(4))) would become taxable. Also, business leagues, chambers of commerce, and the Professional Golf Association and National Football League would be taxable but could operate as partnerships. Thus, section 501(c)(6) would be repealed.
Most other tax-exempt organizations would be reassigned into one of five categories, corresponding roughly to current section 501(c)(1) (U.S. governmental organizations), section 501(c)(3) (charitable), section 501(c)(4) (social welfare), section 501(c)(7) (social clubs, but stated more generally as mutual benefit organizations), and retirement plans.
The paper leaves section 501(c)(1) entirely intact, and largely leaves section 501(c)(3) alone, except that it proposes that certain very large public charities with “excessive endowments” be taxable on their investment income to the extent the income is not used directly for charitable purposes.
This paper also generally leaves section 501(c)(4) alone, except that any 501(c)(4) (or other tax-exempt organization) that engages in a significant amount of lobbying or campaigning would be taxable on all of its investment income.
The fourth catchall category – corresponding roughly to the tax treatment of social clubs ‒ would cover virtually all other tax-exempt organizations (other than retirement plans). Very generally, these organizations would not be subject to tax on donations or per capita membership dues, but would be taxable on investment income, fees charged to non-members, and fees charged to members disproportionately.
The paper proposes two significant changes to the treatment of donors. First, section 84 would be expanded to treat any donation of appreciated property to a tax-exempt organization as a sale of that property. Second, any donation to a tax-exempt organization that engages in significant lobbying or campaigning and does not disclose the name of the donor would be treated as a taxable gift by the donor (subject to the annual exclusion and lifetime exemption).
Finally, the paper proposes two measures of relief for tax-exempt organizations. First, the unrelated debt-financed income rules would be repealed. Second, limited amounts of political statements by the management of 501(c)(3) organizations (like election-time sermons) would not jeopardize the tax-exempt status of the organization.
Matthew J. Lindsay (Baltimore) has posted "Federalism and Phantom Economic Rights in NFIB v. Sebelius" to SSRN. The abstract provides:
Few predicted that the constitutional fate of the Patient Protection and Affordable Care Act would turn on Congress’ power to lay taxes. Yet in NFIB v. Sebelius, the Supreme Court upheld the centerpiece of the Act — the minimum coverage provision (MCP), commonly known as the “individual mandate” — as a tax. The surprising constitutional basis of the Court’s holding has deflected attention from what may prove to be the decision’s more constitutionally meaningful feature: that a majority of the Court agreed that Congress lacked authority under the Commerce Clause to penalize individuals who decline to purchase health insurance. Chief Justice Roberts and the four joint dissenters endorsed the novel limiting principle advanced by the Act’s challengers, distinguishing between economic “activity,” which Congress can regulate, and “inactivity,” which it cannot. Because the commerce power extends only to “existing commercial activity,” and because the uninsured were “inactive” in the market for health care, they reasoned, Congress lacked authority under the Commerce Clause to enact the MCP. Critically, supporters of the activity/inactivity distinction insisted that it was an intrinsic constraint on congressional authority anchored in the text of Article I and the structural principle of federalism, rather than an “affirmative” prohibition rooted in a constitutional liberty interest.
This Article argues that the neat dichotomy drawn by the Chief Justice and joint dissenters’ between intrinsic and rights-based constraints on legislative authority is false, and that it obscures both the underlying logic and broader implications of the activity/inactivity distinction as a constraint on congressional authority. In fact, that distinction is animated less by the constitutional enumeration of powers or federalism than a concern about individual liberty. Even in the absence of a formal constitutional “right” to serve as a doctrinal vehicle, the justices’ defense of economic liberty operates analogously to the substantive due process right to “liberty of contract” during the Lochner era — as a trigger for heightened scrutiny of legislative means and ends — through which the justices constricted the scope of the commerce power.
Current scholarship addressing the role of individual liberty in NFIB v. Sebelius tends to deploy Lochner as a convenient rhetorical touchstone, to lend an air of illicitness or subterfuge to the majority’s Commerce Clause analysis. I argue that the Lochner-era substantive due process cases are both more nuanced and more instructive than judges and many scholars have realized. They illustrate, in particular, that constraints on legislative authority that are rooted in individual liberty and constraints on legislative authority that are rooted in enumerated powers and federalism can and do operate in dynamic relationship to one another. Reading NFIB v. Sebelius through this historical lens better equips us to interrogate the role that economic liberty plays in the majority’s Commerce Clause analysis, and provides an important alternative analytical framework to the structure/rights dichotomy advanced by the Chief Justice and joint dissenters. The activity/inactivity distinction not only portends a constitutionally dim future for federal purchase mandates, but may also herald more far-reaching restrictions on congressional interference with individual liberty, in which individual sovereignty assumes a place alongside state sovereignty in the Court’s federalism.
Daniel C. Willingham (Husch Blackwell, St. Louis) has published "'Are You Ready for Some (Political) Football?' How Section 501(c)(3) Organizations Get Their Playing Time During Campaign Seasons," in 28 Akron Tax J. 83 (2013). The introduction to the article provides the following:
The purpose of this Article is to analyze the ways in which Section 501(c)(3) organizations take part in lobbying activities while still maintaining their tax-exempt status. This topic is crucial as we revisit these same issues at all levels of government every election season.
This Article examines the Tax Code, treasury regulations, revenue rulings, case law, and scholarly research. Its purpose is to provide a detailed analysis of the current law and how exempt organizations can apply it in practice. To achieve this goal, this Article is broken down into seven parts. Section II provides the statutory framework under which Section 501(c)(3) organizations operate. Sections III and IV examine the "substantial part" test and the Section 501(h) expenditure election, respectively. If an organization routinely fails both the "substantial part" test and the Section 501(h) test, then it should establish an affiliated Section 501(c)(4) organization, which is covered in Section V. Section VI attempts to tie all the rules together for the "substantial part" test, the Section 501(h) election, and the use of a Section 501(c)(4) affiliate. Section VI then provides a proposal on how Section 501(c)(3) charitable organizations advance their tax-exempt purposes through lobbying while still protecting their tax-exempt status during campaign seasons. Section VII offers some final thoughts on why the study of this area of the law is so important.
Tuesday, October 22, 2013
According to the Detroit Free Press, Michigan Governor Rick Snyder is closing his NERD (that's New Energy to Reinvent and Diversify Fund) Fund. The NERD Fund was formed to raise funds to defray the cost of Detroit's emergency manager, Kevyn Orr. The Fund reportedly also paid the salary of a Snyder aide, Richard Baird.
The NERD Fund apparently qualified as a Section 501(c)(4) organization, and as a result, does not have to disclose its donors. Synder has gotten some heat from watchdog groups and the press, who accused him of using the NERD Fund as a way back door way for special interests to give to Snyder. Query whether it could have been formed as a Section 501(c)(3) for the purpose of lessening the burdens of government?
Sadly, this arises at the same time that The Chronicle of Philanthropy (Sub required) raises the question "Can Philanthropy Save Detroit?" It sort of boggles the mind that the closing of the NERD Fund is in the same issue of The Chronicle.
And, most importantly, who the heck thought that The NERD Fund was a good name? Someone FOIA that, stat.
With a hat tip to the TaxProf Blog, I simply must post regarding the most recent compelling and ground-breaking work done by the readers of Freakonomics. (Should H&R Block Hire Models to Increase Charitable Giving?) Freakonomics updated its readers on its fundraising campaign for Freakonomics Radio, as follows.
Your comments and e-mails were also a great window into a better understanding of what makes someone want to donate to a given cause or not. You pointed out incentives we overlooked, or overvalued, or undervalued. ... Here, for instance, is one my favorite comments, from a reader named Eric Kennedy:
[Y]ou forgot a primary reason why people donate to charity: to impress their attractive tax preparers. I’m not kidding. I’m very attractive and worked as a tax preparer for two years. I’ve seen this first-hand. I now find myself considering the impression I will make on my attractive tax preparer. The most effective way to boost nation-wide charitable giving, would be to staff H&R Block with models and encourage them to make comments about the size of people’s annual donation amounts.
I must agree with Mr. Kennedy's assessment, although I will neither confirm nor deny whether I have participated in the preparation of tax returns that contain significant charitable deductions...and that fact would, of course, have no bearing on my scholarly assessment of Mr. Kennedy’s observations in this regard.