Friday, March 4, 2016
Philip Hackney (LSU) has published Charity Organization Oversight: Rules v. Standards, 13 Pitt. Tax Rev. 83 (2015). Here is the abstract:
Congress has traditionally utilized standards as a means of communicating charitable tax law in the Code. In the past fifteen years, however, Congress has increasingly turned to rules to stop fraud and abuse in the charitable sector. I review the rules versus standards debate to evaluate this trend. Are Congressional rules the best method for regulating the charitable sector? While the complex changing nature of charitable purpose would suggest standards are better, the inadequacy of IRS enforcement and the large number of unsophisticated charitable organizations both augur strongly in favor of rules. Congress, however, is not the ideal institution to implement rules for charitable purpose. The IRS is the better institution generally to institute rules there because of its informational advantage over Congress. Additionally, the IRS can implement rules in a more flexible rule format than can Congress. Still, Congress as a rulemaker makes sense in a few scenarios: (1) where it implements transparent procedural requirements; (2) where it regulates discrete behavior of charitable organization acts; and, (3) where it intends to remove a set of organizations from charitable status through simple rules.
Kristine Knaplund (Pepperdine) has published Becoming Charitable: Predicting and Encouraging Charitable Bequests of Wills, 77 Pitt. L. Rev. 1 (2015). Here is the abstract from the SSRN posting of the article:
What causes people to leave their property to charity in their wills? Many scholars have explored the effects of tax laws on charitable bequests, but now that more than 99% of Americans’ estates are exempt from federal taxes, what non-tax factors predict charitable giving? This Article explores charitable bequests before the federal estate tax and a deduction for charitable bequests were enacted by Congress. By examining two years of probate files in Los Angeles and St. Louis, in which 16.6% of St. Louis testators, but only 8.3% in Los Angeles, made charitable bequests, we can begin to discern why testators in St. Louis were far more inclined to give to charity. The surprising results may help policy makers encourage those in the United States and in developing countries to give beyond their family and friends.
This Article is unique in that it is the first to examine not just whether a will included a charitable bequest, but whether the charity received it. This crucial information adds key insights to who gives to charity. In fact, if we compare the two cities by looking at charitable bequests which were actually received, St. Louis testators are even farther ahead of their Los Angeles counterparts, with 15% of St. Louis testators giving to charity compared to 6% in LA.
By examining hundreds of wills executed before the federal estate tax was enacted, we can see patterns for the vast majority of people who die with estates far too small to be impacted by the estate tax. Five clear steps emerge to ensure that testators will give to charity.
Michael McConnell (Stanford) and Luke Goodrich (Becket Fund for Religious Liberty; Utah) have posted on SSRN On Resolving Church Property Disputes, Arizona Law Review (forthcoming). Here is the abstract:
In recent decades, major religious denominations have experienced some of the largest schisms in our nation’s history, resulting in a flood of church property disputes. Unfortunately, the law governing these disputes is in disarray. Some states treat church property disputes just like disputes within other voluntary associations — applying ordinary principles of trust and property law to the deeds and other written legal instruments. Other states resolve church property disputes by deferring to religious documents such as church constitutions — even when those documents would have no legal effect under ordinary principles of trust or property law.
We argue that both courts and churches are better served by relying on ordinary principles of trust and property law, and that only this approach is fully consistent with the church autonomy principles of the First Amendment. Only this approach preserves the right of churches to adopt any form of governance they wish, keeps courts from becoming entangled in religious questions, and promotes clear property rights. By contrast, deferring to internal religious documents unconstitutionally pressures churches toward more hierarchical governance, invites courts to resolve disputes over internal church rules and practices, and creates costly uncertainty.
Joel Newman (Wake Forest) has posted on SSRN What is a Church? A Look at Tax Exemptions for the Original Kleptonian Neo-American Church and the First Church of Cannabis, Lexis Federal Tax J.Q. (Dec. 2015). Here is the abstract:
The tax definition of "church," as well as the definition of "religion," have evolved. For years, the IRS defined churches with a fourteen factor test. More recent cases and rulings, however, have used an "associational" test.
This article applies these two definitions to two "marijuana churches" -- the Original Kleptonian Neo-American Church, founded in the 1960's, and the First Church of Cannabis, founded in 2015. I conclude that both churches either would already pass muster under either definition, or could easily do so with a bit of tweaking and some lawyerly advice. Therefore, it would not be too difficult to game the system, and to create a religious organization and a church for tax purposes, even when that status is not legitimate.
However, in light of First Amendment concerns, there are no alternative definitions that would do the job any better. The risk that an occasional illegitimate organization might derive the tax benefits of being a religious organization or church is an acceptable price to pay for a robust First Amendment.
Joseph Yockey (Iowa) has published Using Form to Counter Corruption: The Promise of the Public Benefit Corporation, 49 U.C. Davis L. Rev. 623 (2015). Here is the abstract from the paper's SSRN posting:
Many observers argue that part of the blame for foreign corrupt practices should be placed on legal form. Their claim is that traditional corporate norms of shareholder wealth maximization help explain why corporate corruption is so prevalent. This essay shifts that argument to examine whether there are characteristics among corporate forms that can boost the efficacy of internal compliance strategies. In doing so, the paper’s primary recommendation is for founders to focus greater attention on an emerging new corporate association — the public benefit corporation — as a promising option for blueprinting sustainable anti-corruption compliance.
: The Development of an Informal Support Network to Increase Access to ServicesLeadership in an Asian American Community in the South
, , and The Local Embedding of Community-Based Organizations
, , , and Episodic Volunteering and Retention: An Integrated Theoretical Approach
, , and Nonprofit Organizations Becoming Business-Like: A Systematic Review
, , and Workplace Giving in Universities: A U.S. Case Study at Indiana University
, , , , and Motivations to Volunteer and Their Associations With Volunteers’ Well-Being
, , , and Nonprofit Financing to the Rescue? The Slightly Twisted Case of Local Educational Foundations and Public Education in New Jersey
and Kristina T. Lambright, Program Performance and Multiple Constituency Theory
and Sharyn Rundle-Thiele, Supporter Loyalty: Conceptualization, Measurement, and Outcomes
: A Field ExperimentRecognition and Cross-Cultural Communications as Motivators for Charitable Giving
Book Review: Creating Value in Nonprofit-Business Collaborations: New Thinking and Practice by J. E. Austin and M. M. Seitanidi
Tobias Bürger, Book Review: Social Purpose Enterprises: Case Studies for Social Change by J. Quarter, S. Ryan and A. Chan (Eds.)
Amy Blackford, Book Review: Catalysts for Change by M. Martinez-Cosio and M. Rabinowitz Bussell
IRS Scandal Update: Crossroad GPS Approval, Class Certification in One Case, Settlement of Another, and 501(c)(4) Notices
The biggest development coming out of the IRS scandal in recent months was the public revelation that in November 2015 the IRS approved the application by Crossroads GPS for recognition of exemption under Internal Revenue Code section 501(c)(4). This approval means the entire application file is available to the public, and Robert Maguire has very helpfully made all the documents available at OpenSecrets.org at the end of his analysis of them. Based on a quick review of these hundreds of pages of documents, here are several take-aways:
- Part V of the Protest (and Part VI of the Revised Protest) highlights the most constitutionally problematic aspect of the existing limit on political activity by section 501(c)(4) organizations (and also of the prohibition on such activity by section 501(c)(3) organizations) - the vagueness of the facts and circumstances approach for determining whether a given communication or other activity is actually political campaign intervention.
- Regardless of your views on the merits of the application and the final IRS decision regarding it, the legal writing and submissions by the attorneys representing Crossroads GPS provide a good example of professional but strong (and ultimately effective) advocacy based on an extensive factual record. This advocacy both focused on small but critical details - such as whether particular communications were in fact political campaign intervention - and larger legal issues such as the constitutional issue mentioned above.
- The application materials provide many examples of communications and other activities that may - or may not - cross the line into political campaign intervention. In addition, most and possibly all of the communications are helpfully summarized in charts submitted by Crossroads GPS that include the geographic area of distribution, whether the organization asserted that the communication was part of an ongoing series, and other facts that the IRS has identified as relevant.
- Taken as a whole, the documents provide a comprehensive illustration of the application for recognition of exemption process, including the initial application, IRS questions and detailed responses, proposed denial, protest, communications with IRS Appeals regarding the protest, and then finally the favorable determination letter. It also reveals several apparent procedural missteps on the part of the IRS that Crossroads GPS then used to strengthen its case for granting the application.
Media coverage: Politico; ProPublica; Washington Post. Not surprisingly, the IRS decision has generated both scathing criticism (see this NY Times editorial), as well as defenders (see this commentary by exempt organizations and constitutional law attorney Barnaby Zall).
In other news, the IRS lost a motion in one case related to the scandal but managed to settle another case. The loss came in NorCal Tea Party Patriots v. IRS, where a U.S. District Court certified a class consisting of various groups that allege they were subject to an improper level of scrutiny by the IRS during the exemption application process because of their political views. For an analysis of the decision, see this Forbes column by Peter J. Reilly. More positively for the IRS, Law360 reports that the IRS agreed with the Republican National Committee to dismiss a federal suit by the RNC against the Service involving a request for documents relating to the Service's treatment of exemption applications under section 501(c)(4). As part of the settlement, the IRS agreed to pay more than $20,000 in attorney's fees.
Finally, the IRS announced in Notice 2016-09 that the new notice required from certain section 501(c)(4) organizations based on a statutory change Congress made this past December will not be due until at least 60 days after Treasury and the IRS issue temporary regulations under new section 506. The Notice also clarifies that an organization seeking recognition from the IRS of its exemption under section 501(c)(4) will still need to apply for such recognition and, until further guidance is issued, organizations seeking such recognition should continue to use Form 1024. Such an application remains optional, however.
Social Enterprise Update: A New Model of Philanthropy and a Newspaper's Creative Use of a Public Benefit Corporation
The Christian Science Monitor recently published an article titled "Should Saving the World Be Profitable?" It highlights the different approach that many of today's philanthropists - Mark Zuckerberg, Bill Gates, Warren Buffett, for example - take to doing good as compared to past major philanthropists. The following quote in the article highlights this difference:
“Older practitioners of philanthropy were far more responsive to the needs and desires of the public, supporting projects that were controlled largely by local communities or even government,” writes Garry Jenkins, a professor at The Ohio State University Moritz College of Law who focuses on philanthropy and corporate governance, in an e-mail. “Today’s philanthrocapitalists are much more controlling, more directive, more confident that they have all the answers to the social problems.”
And just a month earlier The Washington Post reported that the owner of a major newspaper operation was transferring its ownership to a nonprofit. That operation included the Philadelphia Inquirer, which the article identifies as the third-oldest newspaper in the United States and the winner of 20 Pulitzer Prizes, and its related website. What made the transfer particularly interesting is that it used a public benefit corporation, which actually owns the newspaper operations (and remains a taxable entity) but now is owned by the tax-exempt nonprofit Institute for Journalism in New Media, which in turn is operated under the auspices of the Philadelphia Foundation. Additional coverage: NY Times.
Last month the Boston Globe reported that the chairman of both the Senate Finance Committee and the House Ways and Means Committee sent joint letters to 56 colleges and universities with endowments of $1 billion or more. The letter asked 13 sets of questions covering topics ranging from categories of assets to management costs to spending policies. While it is now a common practice for the congressional tax writing committees to investigate various types of tax-exempt organizations - see the recent Senate Finance scrutiny of private museums opened by individual collectors and the 2008 Senate Finance letter to colleges and universities about their financial practices - it is interesting and perhaps significant that this latest inquiry is a joint one by committee chairmen in both chambers (including also the chairman of the House Ways and Means Subcommittee on Oversight). The current set of inquiries come in the wake of endowments (mostly) recovering from the Great Recession, a Congressional Research Service report focusing on college and university endowments, and prominent calls for wealthy educational institutions to provide more need-based financial aid (for example, see the recent NY Times Op-Ed by Victor Fleischer (San Diego)).
Thursday, March 3, 2016
IRS Changes to Advisory Committee, EO Audits, Form 990-N Filing, and Supporting Org Regs (latter only proposed)
Since the beginning of the year the IRS has proposed several minor but still significant changes to its practices relating to tax-exempt organizations:
- In January the IRS announced that because of structural changes within the TE/GE Division the Advisory Committee on Tax Exempt and Government Entities (ACT) will now focus on tax administration issues encountered across that Division and have, as of June 2016, a smaller membership of 15 as opposed to the current 21. ACT's new charter, effective as of last May, also changed the terms of members to a flat three years as opposed to the previous two years plus the option of a one-year extension.
- Bloomberg BNA Daily Tax Report reported (subscription required) yesterday that the IRS has issued an internal memorandum (TEGE-04-0216-0003) stating that the IRS will no longer modify an organization's exemption category when the organization is found to no longer qualify for exemption under its original exemption category. So, for example, if an organization originally recognized as exempt under section 501(c)(4) is found to no longer qualify for that status but could qualify for recognition of exemption under section 501(c)(7), the IRS will no longer modify its status to exemption under section 501(c)(7) but will instead simply revoke (or treat as revoked for declaratory judgment purposes) its status under section 501(c)(4). Such an organization may, however, apply or reapply for recognition of exemption under a new exemption category. The memorandum states this change is necessary because Congress has now made a declaratory judgment process available for all revoked exempt organizations, not just revoked 501(c)(3)s, and so all revocations must be treated the same. While not completely clear, this change appears to driven by a need to ensure all organizations that lose their recognition of exemption under a particular category have the option to seek declaratory judgment because modifying an organization's status to place it under a different category would, or at least could, prevent it from exercising its declaratory judgment rights.
- Effective as of the end of last month, the e-filing system for Form 990-N has moved to the IRS website. Filers will need to complete a one-time registration form when they first file on the IRS website. Previously the Urban Institute hosted the e-filing webpage for this form, but that webpage now sends readers to the new IRS webpage.
- Last month the IRS issued a set of proposed regulations for Type I and Type III Supporting Organizations. The preamble to the proposed regulations states "[t]hese proposed regulations focus primarily on the relationship test for Type III supporting organizations." Comments on the proposed regulations are due by May 19, 2016.
The IRS Statistics of Income Division has published Nonprofit Charitable Organizations and Donor-Advised Funds, 2012, reporting on selected data for Internal Revenue Code section 501(c)(3) organizations and donor-advised funds. Highlights from the tax year 2012 Form 990 and Form 990-EZ filings include the following:
- 279,405 501(c)(3)s reported an estimated $3.3 trillion in assets, $1.3 trillion in liabilities, $1.7 trillion in revenues, and $1.6 trillion in expenses, representing modest increases in all of these categories over amounts reported for tax year 2011
- 501(c)(3) with $10 million or more in assets represented only 8% of returns but reported 92% of total assets and 86% of total revenues
- donor-advised funds, which less than 1% of 501(c)(3)s sponsor (2,121 total), had a value of nearly $53 billion
- only 4% of 501(c)(3)s had donor-advised fund holdings over $100 million, but these organizations held over 80% of the total value of such funds and Fidelity Investments Charitable Gift Fund held $24 billion in such funds alone
Wednesday, March 2, 2016
Georgetown University recently invoked Internal Revenue Code section 501(c)(3) as the basis for its policy prohibiting students from engaging in any political campaign activity on campus (see this The Hoya article for more details). Today the House Ways and Means Oversight Subcommittee held a hearing focusing on that policy and its alleged basis in the federal tax laws. Among others, Professor Frances Hill (University of Miami) provided testimony on the issue of whether such activities by students would be attributed to the University under section 501(c)(3) and so cause the University to violate that section's prohibition on political campaign intervention. As she details, the IRS has a long-standing, public position that generally the the political activity of students is not attributed to their schools, indicating that Georgetown University is incorrect in its assertion that federal tax law compels its current policy. That said, as a private institution the University is free to limit or even prohibit political activity on its property as long as it does so in a manner that does not favor a particular candidate or political party.
Hat tip: EO Tax Journal.
HuffPost Politics reports that a number of significant donations to the charitable foundations associated with Hillary Clinton and Donald Trump may not have been true gifts to the foundations from the original payors but instead payments for services to the now candidates, followed by gifts by Clinton and Trump to the foundations. Quoting three of this blog's contributing editors (Alice Thomas, Roger Colinvaux, and Nick Mirkay), the article questions whether contributions made in exchange for speeches (Clinton), a Comedy Central appearance (Trump), and other appearances and meetings (Trump) should have instead been treated as income to Clinton and Trump and subsequent contributions by them, not the original payors, to the respective foundations. The author of the article is careful to note that "[n]one of this necessarily means that Trump or Clinton has bilked taxpayers out of revenue" but also says "[m]ore information from both candidates' camps would be helpful." This is particularly true given that the two foundations at issue - the Bill, Hillary and Chelsea Clinton Foundation and the Donald J. Trump Foundation - each have a close relationship with their respective namesakes and have benefitted them in various ways (although all of those benefits may be perfectly legal).
(Photo from original story (Clinton: Mark Makela/Getty Images; Trump: John Gurzinski/AFP/Getty Images).)
UPDATE: The first sentence of this post has been revised to clarify the tax issue raised by the payments.
Monday, February 29, 2016
This Friday, March 4, I will be participating in the University of Detroit Mercy School of Law Centennial Conference on the past, present, and future of the City of Detroit. The lineup looks really great, including among others Andrea Boyack from Washburn University School of Law. I will be participating in a panel on the Detroit bankruptcy and the "grand bargain" surrounding the Detroit Institute of Arts collection. It's a little daunting, not only because I am not a bankruptcy law scholar, but also because my co-panelists are The Honorable Gerald E. Rosen, Former Chief Judge of the US District Court for Eastern District of Michigan, and the architect of the "grand bargain," and Eugene A. Gargaro, Chair of the Board of Directors of the Detroit Institute of Arts.
Making matters worse, while I am personally very pleased by the outcome and the preservation of the DIA collection, I expect to be somewhat critical of the bankruptcy court's opinion, which held (without explanation or authority) that Detroit probably could not have sold the DIA collection. According to the bankruptcy court, the collection was protected by both the "public trust" doctrine and specific transfer restrictions. However, neither of those conclusions are supported by the evidence. Few (if any) of the works in the collection were protected by specific transfer restrictions. And the "public trust" doctrine simply doesn't apply to art museums, in the absence of state laws specifically imposing restrictions on the sale of artworks by charitable museums.
That museums are public trusts is a truism in academic discourse and industry discussion. What various commentators mean when they speak about museums as public trusts, however, is less clear. This Article untangles and analyzes the various meanings of “public trust” and how these meanings translate into regulatory systems. I propose that two predominant meanings - the public resource and trust law meanings - jointly constitute the definition of a public trust, and that each meaning has a consequent regulatory framework. These definitional and regulatory frameworks coexist without conflict in most contexts. In the context of deaccessioning, however, they collide.
Deaccessioning - the practice of a museum selling art from its collection - is highly contested because it is perceived to be a significant violation of the public trust, in all meanings of the term. Nonetheless, public resource and trust law rules treat deaccessioning quite differently. Public resource rules, exemplified by industry standards and state statutes, strictly prohibit the use of deaccessioning funds for any purposes other than to purchase new art. Trust law rules, on the other hand, work primarily to ensure that the terms of organizational charters, trust instruments, and gift agreements are met. One goal of this Article is to identify and describe the public resource and trust law frameworks. A second goal is to leverage the debate surrounding deaccessioning as a means for discussing how the two frameworks compete and why the trust law framework, enhanced by the addition of corporate governance principles and grounded in “publicity” values, is preferable.
I would go further. The "public trust" doctrine simply shouldn't apply to museums. By way of explanation, the Association of Art Museum Directors (AAMD) and the American Alliance of Museums (AAM), the primary professional organizations governing art museums, have adopted rules governing the sale or "deaccessioning" of works owned by museums. Essentially, those rules provide that works can be sold in order to purchase new works, but cannot be sold for any other purpose, including to cover operational costs. The supposed rationale for this rule is that the works are held in the "public trust" by the museum. But as Donn Zaretsky has observed over and over, this is nonsense on stilts. Normally, if property is held in the "public trust," it cannot be sold for any reason. But somehow, the museum version of the "public trust" doctrine provides that artworks protected by the public trust cannot be sold unless it is convenient. It is telling that the legal scholars who have considered this argument have been ... unsympathetic. And that proponent of the "public trust" argument tend to respond to criticism by raising their voices.
However, public choice theory provides a plausible explanation for the museum version of the "public trust" doctrine. Art museums typically obtain the overwhelming majority of their works via gift or bequest. Under the current deaccessioning rules promulgated by the AAMD and the AAM, once a work is donated to an art museum, it is off the market forever, unless it sold to purchase another work. Moreover, most of the works owned by art museums simply sit in storage. For example, the Metropolitan Museum of Art currently owns more than 2 million objects, but exhibits only about 20,000. In other words, the deaccessioning rules effectively promote scarcity and increase the price of works not owned by museums. So, the deaccessioning rules effectively ensure that private owners of artworks get to claim any capital gains, rather than museums. While I doubt than many (any?) museums or museum directors have considered the issue on those terms, I suspect a version of "agency capture" encourages them to rationalize self-imposed rules that make no sense. And occasionally lead to the dissolution of museums that own many valuable works, but cannot monetize them to cover operational costs.
For one thing, the AAMD & AAM rules conflict with the duty of a charitable organization to increase public welfare. It makes no sense for an art museum to close, rather than sell one artwork. Especially when the (implicit) purpose of preventing the sale of artworks is to increase the value of works owned by private parties. One wonders how the AAMD and AAM would fare in an antitrust action.
Brian L. Frye
Saturday, February 27, 2016
Like December for children, or June for SCOTUS watchers, February is a time of wonder and excitement for legal scholars, as SSRN reveals new treasures by the hundred.
To that end, Matthew Bruckner (Howard) has posted "Bankrupting Higher Education" to SSRN. This piece (which might hit a little too close to home for some academics) compares bankruptcy options across organizational types (for-profit, nonprofit, and government). Here's the abstract:
Many colleges and universities are in financial distress but lack an essential tool for responding to financial distress used by for-profit businesses: bankruptcy reorganization. This Article makes two primary contributions to the nascent literature on college bankruptcies by, first, unpacking the differences among the three primary governance structures of institutions of higher education, and, second, by considering the implications of those differences for determining whether and under what circumstances institutions of higher education should be allowed to reorganize in bankruptcy. This Article concludes that bankruptcy reorganization is the most necessary for for-profit colleges and least necessary for public colleges, but ultimately concludes that all colleges be allowed to reorganize in chapter 11.
Tuesday, February 23, 2016
This weekend, Ohio joined the group of states that have “defunded” Planned Parenthood. Ohio’s bill follows the model used by other states, and bans certain funding to go to any organization or affiliate that performs or promotes elective abortions. (Before the bill, there was no government funding of elective abortions.) “Affiliate” means any organization that shares common ownership or control, has a franchise agreement, or shares a trademark or brand name. Under this bill, an independently incorporated organization that, for example, licenses the Planned Parenthood logo would be precluded from participating in funding, even if it does not perform or promote elective abortions. Ohio’s restrictions apply to several specific programs, including the Violence Against Women Act and the Breast and Cervical Cancer Mortality Prevention Act.
Against my better judgment, I’m wading into these treacherous waters because these bills pose interesting legal and theoretical issues about the ability of government condition the receipt of funding to nonprofits based on disagreement with the organizations’ ideology.
Monday, February 22, 2016
If you've ever been involved in helping a charity comply with the various state solicitation registration requirements, then somewhere between swearing and tearing your hair out I'm sure you thought, "There has to be a better way!" Shake your fist at the sky in despair no more! It is with unbounded joy that I share part of a note I received from Bob Carlson of the Missouri Attorney's General Office, who has been actively involved for some time with NAAG and NASCO's efforts to develop a simplified filing process. And lo...
The Multistate Registration Filing Portal, Inc. has released our Request for Information (RFI) regarding a Single Internet Registration Portal. ... The RFI has been posted at http://mrfpinc.org/rfi/. We welcome all comments and look forward to robust response to the RFI. We also invite you to share it with anyone you believe may be interested.
The MRFP will host a conference call on March 15, 2016 from 3:00 p.m. – 4:30 p.m. EST to provide additional background information and answer questions from the public about the registration process. Dial-in: (800) 232-9745; PIN: 3232959. Charities, their registration services providers, and any other interested parties are welcome to participate. ...
The RFI will remain open until April 1, 2016.... Our one-page project summary is still available at http://mrfpinc.org/project-overview/
Seriously awesome work, Bob and everyone involved with this process. I am sure I speak for lots of folks when I say that we can't wait to see this become a reality!
The Association for Research on Nonprofit Organizations and Voluntary Action (ARNOVA) and the Nonprofit Policy Forum have just published a special issue on nonprofit organizations and public policy. Here is the content:
Friday, February 19, 2016
The San Antonio City Council plans to privatize its Convention & Visitors Bureau by creating a new nonprofit to house the operations currently conducted by a governmental agency. The plan is that this restructuring will allow the CVB to increase its budget by leveraging additional funding sources from the private sector (including “corporate sponsors, memberships, partnerships and advertising dollars”), which would allow it to be more competitive in its spending relative to other Texas cities.
According to press reports, the Council has not yet finalized the structure of the governing board. Options include having representatives of the council and the mayor’s office sit on the board alongside representatives from the tourism and business community, and/or having board members voted upon by the city council. Although having publicly-appointed and publicly–affiliated board members running a nominal nonprofit is hardly unique to San Antonio, these public-private nonprofit hybrids don’t fit neatly into either public or nonprofit legal regimes. As a result, it is often unclear whether quasi-governmental organizations must comply with state public record laws, which vary from state to state. (See, for example, the Texas Supreme Court’s 2015 decision regarding the Greater Houston Partnership.)
Moreover, what are the specific fiduciary obligations of board members who are city council members, or who are appointed (and, in many cases, removable by) city councils or mayors? One easy answer might be that all nonprofit directors share identical fiduciary duties to the organization; however, expecting city councilmembers and their representatives to abandon their political perspectives may not be realistic, and arguably would run counter to the very purpose of structuring the board to include city councilmembers. One solution would be for the City to clarify these rules through the process of creating the organization.
PS I’m new to the blog, and thrilled to be joining such a great line-up. I’m in my second year of academia as an Assistant Professor at Cleveland State University, where I have the fortune of holding a joint appointment with the Cleveland-Marshall College of Law and with the nonprofit management and public administration programs at the Maxine Goodman Levin College of Urban Affairs. My research interests include legal issues of volunteering, questions of board governance, and Constitutional rights of nonprofits, with a particular attention to how legal rules change behavior of nonprofit actors. I also continue to practice law from time to time, advising nonprofits and litigating matters pro bono. I’m happy to be on the team.
Monday, February 15, 2016
In Palmer Ranch v. Comm’r, _ F.3d _ (11th Cir. 2016), the 11th Circuit held that the Tax Court’s valuation of a conservation easement in Palmer Ranch v. Comm'r, T.C. Memo 2014-79, was appropriate in some respects and inappropriate in others. Accordingly, the 11th Circuit affirmed the Tax Court’s decision in part and reversed and remanded in part. The opinion is entertaining, having been written with a certain flair by Judge Goldberg of the U.S. Court of International Trade, sitting by designation on a panel with two 11th Circuit judges.
As background, the 11th Circuit explained that:
- the value of a conservation easement for deduction purposes is generally equal to the difference between the fair market value of the subject property before the easement donation (the before-value) and the fair market value of the subject property after the easement donation (the after-value);
- a parcel’s before-value is based on the parcel’s highest and best use (HBU) before the easement’s conveyance, which is the “reasonable and probable use that supports the highest present value” or “the highest and most profitable use for which the property is adaptable and needed or likely to be needed in the reasonably near future”; and
- one method of valuing a parcel once its before-easement HBU is determined is through the use of the "comparable-sales method," which entails considering sales of similarly situated parcels.
In 2006, Palmer Ranch Holdings (a partnership) donated to Sarasota County, Florida, a conservation easement with regard to an 82.19-acre parcel of land located in the county (the B-10 parcel). Palmer Ranch made this “altruistic” donation after having failed in its attempt to rezone the B-10 parcel and the adjacent B-9 parcel for multifamily residential development. Palmer Ranch claimed a federal charitable income deduction of $23.9 million for the donation under IRC § 170(h) and the IRS objected, claiming that the easement had a value of only $6.9 million.
In Palmer Ranch v. Comm'r, T.C. Memo 2014-79, the Tax Court held that Palmer Ranch was entitled to a deduction of $19.9 million for the easement donation. While the Tax Court agreed with Palmer Ranch that the HBU of the B–10 parcel before the donation was a 360-mutlifamily unit development configured to protect the eagle’s nest and other environmentally sensitive areas on the parcel, it determined that the before-value of the B-10 parcel was just over $21 million, not just over $25 million as had been posited by Palmer Ranch.
Unhappy with the Tax Court’s reduction of its claimed deduction by almost $4 million, Palmer Ranch appealed to the 11th Circuit.
IRS’s Arguments on Appeal
On appeal, the IRS argued that the Tax Court had erred because (i) contrary to the Tax Court's finding, rezoning of the B-10 parcel to permit the hypothesized 360-unit development was not “reasonably probable,” (ii) the Tax Court failed to address whether the 360-unit development was “needed or likely to be needed in the reasonably near future,” and (ii) the Tax Court failed to consider that a willing buyer of the B-10 parcel would discount the price because of the failed rezoning history. The 11th Circuit disagreed.
(i) “Reasonably Probable” Rezoning
The 11th Circuit agreed with the Tax Court that, despite two failed rezoning attempts in the past, rezoning of the B-10 parcel to permit the hypothesized 360-unit development was “reasonably probable.” The 11th Circuit explained that, because the 360-unit development was configured to address the Board of County Commissioner’s previously expressed environmental concerns, the rezoning history suggested that the rezoning would be approved.
(ii) Development “Needed or Likely to be Needed in the Reasonably Near Future”
While the 11th Circuit agreed that the Tax Court had failed to address whether the hypothetical 360–unit development was “needed or likely to be needed in the reasonably near future,” it found that failure to be a harmless error under the circumstances.
The 11th Circuit first explained that the Tax Court had inappropriately confined its HBU analysis to consideration of whether the Board of County Commissioners would approve the rezoning; the Tax Court should have gone a step further and considered whether, assuming rezoning, a developer would perceive enough demand for the proposed 360 housing units to actually break ground. The 11th Circuit pointed to Esgar Corp. v. Comm’r, 744 F.3d 648 (10th Cir. 2014), in which the 10th Circuit held that, just because the properties at issue could be rezoned for gravel mining did not mean that gravel mining was the properties’ HBU. Determining a properties’ HBU also necessitates a look at market demand, and, at the time of the easement donations in Esgar, there was no demand for gravel from the properties and no evidence that this was likely to change in the reasonably foreseeable future.
The 11th Circuit then determined that the Tax Court’s failure to undertake a “market-demand inquiry” in Palmer Ranch was harmless because, at the time of the easement’s donation, the market for development of the type proposed for the B-10 parcel was “bullish.”
(iii) Discounting for the Costs, Time, and Risks Associated with Rezoning
The IRS argued that hypothetical buyers of the B-10 parcel would glean from the failed rezoning history a risk that the parcel could not be developed as proposed and would discount the purchase price accordingly. The 11th Circuit rejected this argument, explaining that “the test for highest and best use already bakes in some adjustment for development risk” and “from the vantage of 2006, there was substantially no risk that B–10 would not be developed [as proposed] in the near future.” “No risk,” said the court, “means no reason for a risk-based discount.”
The 11th Circuit's analysis of this point was incomplete. As explained in my forthcoming article, Conservation Easements and the Valuation Conundrum, even if it is determined that rezoning of a property is “reasonably probable,” appraisal sources indicate that under no circumstances should the property be valued as if it were already rezoned. The risk of being denied rezoning, or that an exaction or other condition may be placed on the rezoning, always exists and must be taken into account. In addition, the time delay and costs associated with the rezoning process must also be considered. Rezoning of the B-10 parcel would have involved a multi-step process: (i) a preapplication meeting with County staff, (ii) a neighborhood workshop, (iii) submitting of applications to the County for staff review, (iv) public hearings by the planning commission, (v) a public hearing by the Board of County Commissioners, and (vi) possible judicial review. Accordingly, even though the 11th Circuit concluded that the risk of being denied rezoning of the B-10 parcel was negligible (that such risk was “baked into” the test for HBU), the possibility that an exaction or other condition might have been placed on the rezoning, as well as the time delay and costs associated with the rezoning process should also have been considered. A willing buyer considering purchase of the B-10 parcel in its not-yet-rezoned state would have taken those factors into account and likely discounted the purchase price of the B-10 parcel as a result.
In addition, appraisal sources further instruct that finding true comparable sales in the reasonable-probability-of-rezoning context is difficult. Developers interested in purchasing property for development typically condition their purchases on procurement of the necessary rezoning approvals. If the approvals are not obtained, the sales generally do not take place. Accordingly, sales of properties that have sold for development generally do not represent the price at which the property would have sold if the purchaser had to procure rezoning after the date of closing. Instead, such sales represent the price of a property with the rezoning approval already in place. Although appraisers must often resort to using such sales as comparables, it is essential that they make appropriate adjustments to account for the risks, time delays, and costs inherent in the rezoning procurement process. That neither the Tax Court nor the 11th Circuit discussed this issue with regard to the comparables gives the reader less confidence in their conclusions regarding the before-value of the not-yet-rezoned B-10 parcel.
Palmer Ranch’s Arguments on Appeal
On appeal, Palmer Ranch argued that the Tax Court erred in reducing the B-10 parcel’s before-value from just over $25 million to just over $21 million. In particular, Palmer Ranch argued that (i) once the Tax Court had rejected the “lowball” HBU asserted by the IRS’s valuation expert in his appraisal, the court was bound to adopt Palmer Ranch’s expert’s valuation without entertaining any reduction, (ii) the Tax Court erred by “concoct[ing] sua sponte” a valuation method that was advanced by neither party and contrary to established comparable-sales appraisal principles, (iii) the Tax Court impermissibly ventured beyond the evidentiary record in its discussion of monthly appreciation rates, and (iv) the Tax Court erred “in finding that there was no appreciation throughout 2006” and, in any case, incorrectly calculated the amount of pre-2006 appreciation.
The 11th Circuit rejected Palmer Ranch’s first contention—that the Tax Court was bound to adopt Palmer Ranch's expert’s valuation once it had rejected the IRS expert’s lowball HBU. The 11th Circuit explained that, in deduction cases, the Tax Court is not bound to accept the taxpayer’s valuation in full merely because the IRS’s valuation is unsatisfactory. Rather, the Tax Court may determine its own valuation based on the whole of the evidentiary record and it is free to treat the work of the taxpayer’s expert as a starting point. The 11th Circuit further explained in a footnote:
To be as clear as the Sarasota sky, we do not hold that the tax court is obligated to use the comparable-sales method to value B–10 ... we recognize the tax court’s expertise in adjudicating tax disputes, and therefore will not lay down a hardline rule confining the tax court to the parties’ preferred appraisal method(s) in every case. The tax court has discretion to adopt a valuation method befitting the matter before it—even if the parties have not proposed that method.
The 11th Circuit, however, agreed with Palmer Ranch’s other contentions regarding errors made by the Tax Court. First, the 11th Circuit explained that the Tax Court’s $21 million before-value for the B-10 parcel
was premised on an old appraisal as modified by monthly appreciation rates, instead of on comparable sales.… Because the parties’ appraisers both used the comparable-sales method, and because the tax court neither voiced disapproval nor acknowledged (much less explained) its departure from the method, that departure was error. The tax court must at minimum explain why it departed from the comparable-sales method in valuing B–10.
The 11th Circuit then explained that, even if the Tax Court’s unexplained departure from the comparable-sales method was proper, the Tax Court still erred by relying on evidence outside the record to value B–10. In particular, in choosing a monthly appreciation rate the Tax Court relied upon an old appraisal report that was not in the evidentiary record. The 11th Circuit explained that a “trial judge may not ... undertake an independent mission of finding facts ‘outside the record of a bench trial over which he [presides].’” Lastly, the 11th Circuit found that the Tax Court seems to have erred in how it applied its chosen monthly appreciation rate (it may have made a mathematical error).
The 11th Circuit ultimately concluded that,
[o]n remand, …the tax court must either stick with the comparable-sales analysis or explain its departure. Whatever the tax court chooses to do, the court must keep its sights set strictly on the evidentiary record for purposes of selecting an appreciation rate, and ensure that it crunches the numbers correctly.
Contrary to some of the commentary on the case, the 11th Circuit did not find that Palmer Ranch’s asserted $25 million before-value for the B-10 parcel was correct. Rather, the court specifically noted that “[o]ur holding in no way precludes the tax court from valuing B-10 below” that amount, provided the valuation is based on the evidence.
A Final Issue—Enhancement
In addition to not addressing all of the factors that might have impacted the before-value of the B-10 parcel, another troubling aspect of Palmer Ranch is the seeming lack of analysis regarding whether the easement donation increased the value of Palmer Ranch’s other property. At the time of the donation of the easement, Palmer Ranch reportedly owned a 39-acre parcel “immediately to the north of” the B-10 parcel (the B-9 parcel). If the B-9 parcel was contiguous to the B-10 parcel, the deduction should have been equal to the difference between the fair market value of the entire contiguous parcel (B-9 and B-10) before and after the donation of the easement. See Treas. Reg. § 1.170A-14((h)(3)(i). If the B-9 parcel was not contiguous to the B-10 parcel, the deduction should have been reduced by the amount (if any) by which the donation of the easement increased the value of the B-9 parcel. See id. It is impossible to tell from the court opinions whether donating the easement on the B-10 parcel increased the value of the B-9 parcel. It certainly might have, since people are often willing to pay more to live adjacent to or near permanently protected open space. And if it did, the deduction should have been reduced accordingly.
In a February 22, 2016, Daily Business Review article discussing the case, the reporter notes that Hugh Culverhouse, Jr., who owns Palmer Ranch, is "finalizing a deal to sell the adjoining 38-acre parcel. Coming soon: 36 single-family homes with a view." This suggests that donating the easement on the B-10 parcel may indeed have increased the value of the B-9 parcel.
Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law