Wednesday, July 2, 2014
Bloomberg Businessweek had a fascinating article in May detailing how three billionaires used a complex web of private foundations and limited liability companies to hide not their political activity (they are not the Koch brothers) but instead their charitable giving. Committed to keeping a low profile while supporting their desired causes, the reporter who wrote the story only stumbled across their activities when he noticed two multi-billion dollar charitable funds listed in an IRS database. It then apparently took a year to pull from public documents - IRS annual returns, secretary of state filings, and so on - the overall structure and the individuals ultimately behind it: the three founders of a little known but apparently highly successful hedge fund, TGS Management. Since 2000 the two funds have distributed more than $1.8 billion to various charities (including $700 million to combat Huntington's disease), plus an additional $1 billion that went to the Vanguard Charitable Endowment Program and so the ultimate charitable recipients for that amount are not known.
Bottom line, it is still possible to be a anonymous charitable giver, even on a very large scale, at least for a while.
We previously blogged (here and here) about the lawsuit Princeton, New Jersey residents filed in 2013 against Princeton University, arguing that the University no longer qualified for exemption from property taxes because of its hundreds of millions of dollars in revenues from royalties and commercial ventures. We missed, however, the latest major development in this dispute, which was reported by Bloomberg. In late April of this year, the University announced that it had entered into an agreement with the town to pay more than $24 million, mostly in unrestricted payments, to the town on a voluntary, one-time basis over the next seven years. The amount is a significant increase over the amounts Princeton had been paying the town voluntarily.
The agreements appears designed to undermine the pending lawsuit, and it apparently surprised the residents who brought the claim and their attorney based on comments in the Bloomberg article. I am not familiar enough with the lawsuit, the agreement, or New Jersey law to know if the agreement effecctively moots the lawsuit or otherwise provides grounds for a motion to dismiss by the Unviersity, but I assume that the University's lawyers will eventually argue something along these lines.
Tuesday, July 1, 2014
The IRS today issued rules governing use of the recently proposed Form 1023-EZ. As detailed in the instructions for this form, an organization must answer "No" to all three of the following questions relating to financial size in order to be eligible to use this shortened application form:
1. Do you project that your annual gross receipts will exceed $50,000 in any of the next 3 years?
2. Have your annual gross receipts exceeded $50,000 in any of the past 3 years?
3. Do you have total assets in excess of $250,000?
The instructions also provide 23 other questions relating to the characteristics of the applying organization (such as whether the organization is a church, school, hospital, or supporting organization), that also all have to be answered "No" for the organization to be eligible to use the Form 1023-EZ. More information about the new form is available from the IRS here, including how to obtain a copy of the form.
The IRS also issued final and temporary regulations, with the temporary regulations also serving a proposed regulations, governing which organizations are eligible to use the streamlined application process for recognition of tax-exempt status under section 501(c)(3) provided by Form 1023. Finally, the IRS issued Revenue Procedure 2014-40, which "sets forth procedures for applying for and for issuing determination letters on the exempt status under § 501(c)(3) of the Internal Revenue Code (Code) using Form 1023-EZ, Streamlined Application for Recognition of Exemption under Section 501(c)(3) of the Internal Revenue Code. This revenue procedure is generally available for certain U.S. organizations with assets of $250,000 or less and annual gross receipts of $50,000 or less."
The Washington Post reports that the Corcoran Galley of Art has filed papers in D.C. Superior Court outlining its plan to keep its collection in the DC area through an arrangement with George Washington University ( GWToday announcement) and the National Gallery of Art (National Gallery announcement). As the article details, the plan is apparently driven by the fact the Corcoran has run deficits for 11 of the past 13 years, leading it to conclude that it is not financially possible for the gallery and related college to continue to operate in its current form. The Corcoran is therefore invoking the cy près doctrine to permit changes to how its collection and educational activities are handled in the future.
Under the plan the National Gallery will have first claim on the Corcoran's collection, with any art that the National Gallery chooses not to keep offered first to institutions within the city and then in a growing geographic area outside of the city. The Attorney General for the District of Columbia must approve any transfer of art outside the city, however. The entire process of allocating the artwork may start as early as mid-August. For its part, George Washington University will take over the Corcoran College of Art and Design and also maintain the Corcoran's existing gallery space, as a fail-safe location for the collection taken by the National Gallery. The Corcoran itself will continue to exist, but as a much smaller nonprofit organization devote to the arts.
For more information, see the motion filed by the The Trustee of the Corcoran Gallery of Art (courtesy of the Washington Post).
Hat Tip: Miriam Galston (GWU)
CNN reports that Quadriga Art, a for-profit charity fundraising company, has resolved an investigation by the New York Attorney General's office by agreeing to pay almost $10 million in damages and to forgive another almost $14 million in debt owed to the company. Nick Mirkay previously posted in this space on the still ongoing congressional investigation into this situation.
The CNN report states the focus of the investigation and settlement was the relationship between Quadriga and the Disabled Veterans National Foundation, a charity that Quadriga Art apparently helped set up in 2007 by fronting the charity's initial printing, mailing, and other fundraising costs. The relationship eventually led to the charity raising $116 million, but paying $104 million of that amount to Quadriga and owing Quadriga the debt forgiven in the settlement. As part of the settlement the Foundation also agreed to take a number of steps, including having its founding board members resign, creating a committee to reexamine its business model, and refraining from using Quadriga or a particular direct marketing company for three years.
Saturday, June 28, 2014
Seventeen Seventy Sherman Street, LLC v. Commissioner—Conservation Easement Conveyed for Quid Pro Quo Not Deductible and Negligence Penalty Applied
In Seventeen Seventy Sherman Street, LLC v. Comm’r, T.C. Memo. 2014-124, the Tax Court sustained the IRS’s complete disallowance of the LLC's claimed $7.15 million deduction for the conveyance to Historic Denver of interior and exterior conservation easements restricting the use of the Mosque of the El Jebel Shrine of the Ancient Arabic Order of Nobles of the Mystic Shrine. The shrine, which was built in 1906-1907 and includes many original features (including ornate stenciling, gilded bronze elevator doors, Tiffany glass, and ornate woodworking), is listed on the National Register of Historic Places and as a historic landmark by the City and County of Denver.
Quid Pro Quo
The LLC owned two properties on Sherman Street—the shrine and a parking lot. Prior to granting the easements, the LLC and the City of Denver entered into a development agreement in which, among other things, the LLC agreed to convey the easements to Historic Denver and rehabilitate the shrine in exchange for certain zoning changes to the shrine and the parking lot.
The Tax Court’s opinion nicely details the elements of a quid pro quo analysis in the charitable deduction context.
- A taxpayer's contribution is deductible ‘only if and to the extent it exceeds the market value of the benefit received.’
- ‘[t]he sine qua non of a charitable contribution is a transfer of money or property without adequate consideration.’
- ‘a charitable gift or contribution must be a payment made for detached and disinterested motives. This formulation is designed to ensure that the payor’s primary purpose is to assist the charity and not to secure some benefit personal to the payor.’
- The consideration received by the taxpayer need not be financial. Medical, educational, scientific, religious, or other benefits can be consideration that vitiates charitable intent.
- In ascertaining whether a given payment was made with the expectation of anything in return, courts examine the external features of the transaction. This avoids the need to conduct an imprecise inquiry into the motivations of individual taxpayers.
- The taxpayer claiming a deduction must, at a minimum, demonstrate that “he purposely contributed money or property in excess of the value of any benefit he received in return.”
- Thus, a taxpayer who receives goods or services in exchange for a contribution of property may still be entitled to a charitable deduction if the taxpayer (1) makes a contribution that exceeds the fair market value of the benefits received in exchange and (2) makes the excess payment with the intention of making a gift. Treasury Regulation § 1.170A–1(h)(1). If the taxpayer satisfies these requirements, the taxpayer is entitled to a deduction not to exceed the fair market value of the property the taxpayer transferred less the fair market value of the goods or services received. Id. § 1 .170A–1(h)(2).
The Tax Court explained that a quid pro quo analysis in the conservation easement donation context ordinarily requires two parts—(1) valuation of the contributed conservation easement and then (2) valuation of the consideration received in exchange for the easement. The court explained, however, that when a taxpayer grants a conservation easement as part of a quid pro quo exchange and fails to identify or value all of the consideration received, the taxpayer is not entitled to a deduction because he failed to comply with § 170 and the regulations. In such a case, explained the court, it is unnecessary to determine either the value of the easement or whether the taxpayer made an excess payment with the intention of making a gift. The taxpayer’s failure to identify or value all of the consideration received and, thus, to prove that the value of the easement exceeded the value of the consideration is fatal to the deduction.
In this case, the Tax Court found that the LLC had received two types of consideration in exchange for its conveyance of the interior and exterior easements:
- a zoning change that eliminated authorization to develop residential condominium units within the shrine but also permitted development on the parking lot up to 650 feet, subject to a “view plane” restriction of 155 feet (a view plane restriction limits the height of buildings from a specified view point within Denver's city park and is meant to preserve the view of the Rocky Mountain Skyline from that view point), and
- the Denver Community Planning and Development Agency’s recommendation to the Denver Planning Board to approve a view plane variance (which variance was ultimately approved).
On its 2003 tax return, however, the LLC claimed a $7.15 million charitable deduction for its conveyance of the easements and made no adjustment for the consideration it received in exchange. At trial, the LLC conceded it had received the zoning change in exchange for its conveyance of the easements and argued that its deduction should be reduced by just over $2 million as a result. The LLC also asserted that the Planning and Development Agency’s recommendation to the Planning Board to approve a view plane variance was either not consideration received in exchange for the grant of the easements, or was consideration but had no real value. The Tax Court disagreed, finding that the Agency’s view-plane-variance recommendation was consideration and had substantial value. The court concluded that the LLC’s failure to identify or value all of the consideration received, or to provide any credible evidence to permit the court to accurately value all of the consideration received was fatal to the deduction.
In support of its holding, the Tax Court cited an earlier case, Pollard v. Comm’r, T.C. Memo. 2013-38, in which it sustained the IRS’s complete disallowance of a deduction claimed for the conveyance of a conservation easement because the easement was conveyed in exchange for the receipt of a subdivision exemption and the taxpayer did not establish that the value of the easement exceeded the value of that exemption.
The IRS argued that the LLC was liable for either the 40% gross valuation misstatement penalty or, alternatively, the 20% accuracy-related penalty for negligence or disregard of the rules or regulations.
Gross Valuation Misstatement Penalty
At trial, the IRS’s valuation experts asserted that the interior easement decreased the value of the shrine by only $400,000 and the exterior easement did not have any effect on the value of the shrine because of already existing local historic preservation restrictions. The court found, however, that the exterior easement was more protective of the shrine than local law—i.e., the LLC had decreased flexibility to modify the exterior as a result of the easement and Historic Denver more regularly monitored the property than local authorities. The court also inferred from the City of Denver's insistence that the LLC grant the exterior easement that the exterior easement had value to the City over and above the local landmark designation. Accordingly, the court found that the IRS failed to meet his burden of establishing that the value of the easements claimed on the LLC’s return (i.e., $7.15 million) exceeded 400% of the correct value of the easements.
Accuracy-Related Penalty for Negligence or Disregard of Rules or Regulations
The Tax Court agreed with the IRS that the LLC was liable for the accuracy-related penalty because it acted negligently or in disregard of the requirements of § 170 and the regulations. “Negligence,” said the court, is strongly indicated where a taxpayer fails to make a reasonable attempt to ascertain the correctness of a deduction that would seem to a reasonable and prudent person to be “too good to be true.” And a taxpayer acts with “disregard” when, among other things, he does not exercise reasonable diligence to determine the correctness of a return position.
The LLC conveyed the easements as part of a quid pro quo exchange but reported the conveyance on its 2003 return as a charitable contribution without making any adjustment for the consideration it received in exchange. The court found that the LLC acted negligently or with disregard because it did not make a reasonable attempt to ascertain the correctness of the deduction.
The LLC argued that it was eligible for the reasonable cause and good faith exception to the penalty because it relied on professional advice. The Tax Court disagreed. Although the LLC had consulted with a tax attorney regarding the conveyance, that attorney testified at trial that he had advised the LLC that it had to reduce the value of its deduction by the consideration received in the quid pro quo exchange. The Tax Court noted that it would be unreasonable for the court to believe that at the time of the contribution or at the time of filing the LLC’s return either the LLC or its advisers believed that the contribution of the easements was an unrequited contribution or that the consideration received had no value. Consequently, the LLC's disregard of the attorney’s advice was not reasonable and in good faith, and the LLC could not rely on the professional advice of the attorney to negate the penalty.
Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law
Friday, June 27, 2014
The Chronicle of Philanthropy reports that the American Red Cross (“ARC”) is resisting disclosure of certain information sought by ProPublica. The latter has reportedly filed a public records request with New York State to determine how the charity raised and spent in excess of $300 million following Hurricane Sandy. The ARC is reported to have provided “some information about its Sandy-related activities to New York Attorney General Eric Schneiderman,” but is arguing for redaction of certain reported details on the grounds that they reveal trade secrets. The story on ProPublica’s web page explains that counsel for the ARC maintains that documents filed with the AG contain "internal and proprietary methodology and procedures for fundraising, confidential information about its internal operations, and confidential financial information."
Soliciting and expending funds in connection with major disasters can present some thorny legal issues (as several of us tax and nonprofit law scholars have discussed in our scholarship). In general, analyzing whether these issues pose a problem in any given case does require assessment of the type of information that ProPublica seeks. While privacy laws protecting individuals should certainly be observed, I would think the public interest better served by erring on the side of full disclosure.
Buried in an AP story primarily addressing the lost emails of Lois Lerner, the Washington Post reports that the government has been ordered to pay the National Organization for Marriage $50,000 in connection with its lawsuit alleging that the IRS leaked confidential information concerning the organization’s donors. The key paragraphs:
[A] federal court has ordered the government to pay $50,000 to a conservative group that says confidential information from its tax returns ended up being published by a political opponent.
The National Organization for Marriage, which opposes same-sex marriage, brought a lawsuit last year after private information about its donors appeared in 2012 on the website of the Human Rights Campaign, which supports gay rights. …
The payment was ordered Monday in a consent judgment issued by the U.S. District Court for the Eastern District of Virginia.
Thursday, June 26, 2014
Scheidelman v. Commissioner (Again)—Second Circuit Affirms Tax Court’s Holding that Façade Easement Had No Value
After four years of litigation and two appeals, in Scheidelman v. Comm’r, _ F.3d _ (2d Cir., 2014), the Second Circuit affirmed the Tax Court’s holding that a façade easement donated by Huda Scheidelman to the National Architectural Trust (NAT) had no value. The easement encumbers a townhouse in Brooklyn’s Fort Greene Historic District. It is unlawful to alter, reconstruct, or demolish a building in that district without the prior consent of New York City’s Landmarks Preservation Commission.
In the first case, Scheidelman v. Comm’r, T.C. Memo. 2010-151, Tax Court sustained the IRS’s complete disallowance of deductions totaling $115,000 that Scheidelman had claimed with regard to the easement donation. The court held that the appraisal obtained to substantiate the deductions was not a “qualified appraisal” because it failed to state the method and basis of valuation as required by Treasury Regulation § 1.170A–13(c)(3)(ii)(J) and (K). The appraiser had mechanically applied a diminution percentage to establish the value of the easement and failed to analyze any qualitative factors relating to the subject property.
Scheidelman appealed, and two years later, in Scheidelman v. Comm’r, 682 F.3d 189 (2d Cir. 2012), the Second Circuit vacated and remanded the case, holding that the appraisal was a qualified appraisal because it sufficiently detailed the method and basis of valuation. The Second Circuit explained
[f]or the purpose of gauging compliance with the reporting requirement, it is irrelevant that the IRS believes the method employed was sloppy or inaccurate, or haphazardly applied—it remains a method, and [the appraiser] described it. The regulation requires only that the appraiser identify the valuation method “used”; it does not require that the method adopted be reliable.
The Second Circuit also noted, however, that its conclusion that the appraisal met the minimal qualified appraisal requirements mandated neither that the Tax Court find the appraisal persuasive nor that Scheidelman be entitled to a deduction for the donation.
On remand, in Scheidelman v. Comm’r, T.C. Memo. 2013-18, the Tax Court found the preponderance of the evidence supported the IRS’s position that the easement had no value. The Tax Court determined that the appraisal Scheidelman obtained to substantiate the deductions was not credible for the same reasons it had determined that the appraisal was not a qualified appraisal—i.e., the appraisal involved the mechanical application of a diminution percentage and failed to analyze any qualitative factors relating to the subject property. The court also found that the valuation expert Scheidelman hired for trial was not credible, explaining
Ehrmann ignored studies suggesting a contrary result and adopted those supporting his client’s desired value. Ehrmann’s testimony had all of the earmarks of overzealous advocacy in support of NAT’s marketing program and, indirectly, [Scheidelman’s] tax reporting….
Expert opinions that disregard relevant facts affecting valuation or exaggerate value to incredible levels are rejected. . . . An expert loses usefulness to the Court and loses credibility when giving testimony tainted by overzealous advocacy.
Indefatigable, Scheidelman appealed again, and in Scheidelman IV the Second Circuit affirmed the Tax Court’s holding that the easement had no value. The Second Circuit first explained
‘[O]rdinarily any encumbrance on real property, howsoever slight, would tend to have some negative effect on that property's fair market value.’ But neither the Tax Court nor any Circuit Court of Appeals has held that the grant of a conservation easement effects a per se reduction in the fair market value. To the contrary, the regulations provide that an easement that has no material effect on the obligations of the property owner or the uses to which the property may be put “may have no material effect on the value of the property.” And sometimes an easement “may in fact serve to enhance, rather than reduce, the value of property. In such instances no deduction would be allowable.” (citations omitted)
The Second Circuit agreed with the Tax Court that the appraisal Scheidelman used to substantiate her deductions as well as the testimony of the valuation expert she relied on at trial were entitled no weight. The Second Circuit also noted that, in 2013, the U.S. District Court issued a permanent injunction barring Erhmann and his firm from preparing any further appraisals for tax purposes.
In support of its holding that substantial evidence supported the Tax Court’s conclusion that the easement had no value, the Second Circuit quoted the IRS’s valuation expert, who explained that “in highly desirable, sophisticated home markets like historic brownstone Brooklyn, the imposition of an easement, such as the one granted … does not materially affect the value of the subject property.” The Second Circuit also noted that the Tax Court “drew the fair inference that ‘preservation of historic façades is a benefit, not a detriment, to the value of Fort Greene property’” from the testimony of the Chairman of the Fort Greene Association (a witness for Scheidelman), who explained that the Fort Greene Historic District “actually has created Fort Greene to what it is today…. it's an economic engine for Fort Greene.” Finally, the Second Circuit found persuasive the fact that NAT had assured one of Scheidelman's mortgagors that
[a]s a practical matter, the easement does not add any new restrictions on the use of the property because the historic preservation laws of the City of New York already require a specific historic review of any proposed changes to the exterior of this property.
Scheidelman is but one in a string of cases in which deductions for donations of façade easements to NAT have been disallowed in full or in substantial part. Those cases include:
- Herman v. Comm'r, T.C. Memo. 2009-205
- 1982 East LLC v. Comm'r, T.C. Memo. 2011-84
- Dunlap v. Comm'r, T.C. Memo. 2012-126
- Graev v. Comm'r, 140 T.C. No. 17 (2013)
- Gorra v. Comm'r, T.C. Memo. 2013-254
- 61 York Acquisition, LLC v. Comm'r, T.C. Memo. 2013-266
- Kaufman v. Comm'r, T.C. Memo. 2014-52
- Chandler v. Comm'r, 142 T.C. No. 16 (2014)
NAT also was the subject of a 2011 Department of Justice lawsuit alleging that NAT 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
Tax Notes Today (subscription required) reports that the IRS has provided updated information concerning its progress on clearing the backlog of exemption applications identified in the May 2013 report by the Treasury Inspector General for Tax Administration, which concluded that the IRS had used improper criteria to select social welfare organization exemption applications for additional scrutiny. The IRS reports that as of June 18, 2014, 132 cases in the original backlog (91 percent) have been closed (including 101 cases that received favorable determination letters).
Electronic Citation: 2014 TNT 123-14
The Los Angeles Times reports that Spain's Princess Cristina was indicted Wednesday on charges of tax fraud and money laundering. She and her husband, Iñaki Urdangarin, are said to “have been under investigation for years on allegations of the embezzlement of about $8 million in public money through charitable sports foundations they ran.” The story continues:
On Wednesday, the judge found sufficient evidence to proceed with charges of money laundering and tax fraud against the princess and nine other counts against her husband, and recommended that they go on trial. Fourteen other people, including Urdangarin's former business partner, were also charged.
“There are many indications that Cristina profited from illegal funds on her own behalf, and also helped her husband to do so, through silent cooperation and a 50% stake in his business," Judge Jose Castro wrote in his 167-page indictment.
Wednesday, June 25, 2014
Whitehouse Hotel v. Commissioner (Again)—5th Circuit Affirms Tax Court’s Façade Easement Valuation But Vacates on Penalties
In the fourth in a line of cases, Whitehouse Hotel Limited Partnership v. Comm’r, _ F.3d _ (5th Cir. 2014) (Whitehouse IV), and after six years of litigation, the 5th Circuit upheld the Tax Court’s valuation of a façade easement donated by a partnership in 1997, but vacated the Tax Court’s imposition of a 40% gross valuation misstatement penalty. The easement encumbers the historic Maison Blanche building located on the edge of the French Quarter in New Orleans that is now used as a Ritz Carlton Hotel.
In the first case, Whitehouse Hotel Limited Partnership v. Comm’r, 131 T.C. No. 10 (2008), the Tax Court, in a lengthy and detailed opinion, held that the partnership had overstated the value of the easement by more than 415% and was liable for a gross valuation misstatement penalty. The partnership had claimed the easement had a value of $7.445 million and the Tax Court determined that the value was only $1.792 million.
On appeal, in Whitehouse Hotel Limited Partnership v. Comm’r, 625 F.3d 321 (5th Cir. 2010), the 5th Circuit vacated and remanded on the issue of the easement’s value and, by extension, the penalty. The 5th Circuit held, in part, that the Tax Court had erred in failing to value the entire contiguous property owned by the taxpayer (i.e., the Maison Blanche building, which was encumbered by the easement, and the adjacent Kress building, which was not) as required by Treas. Reg. § 1.170A-14(h)(3)(i). The 5th Circuit found that the Tax Court had erred in declining to consider the highest and best use of the two properties in light of a pending agreement to consolidate the properties into a single ownership, which would preclude the building of sixty additional rooms on top of the Kress building because it would violate the easement encumbering the Maison Blanche building. The 5th Circuit opined that any hypothetical buyer would have assumed consolidation of the buildings and elimination of the right to build the sixty additional rooms, and this should have been taken into account in determining the value of the easement.
On remand, in Whitehouse Hotel Limited Partnership v. Comm’r, 139 T.C. No. 13 (2012), the Tax Court reiterated its original conclusion that the façade easement did not deprive the partnership or a successor owner of the ability to add stories to the Kress Building. Consistent with the 5th Circuit's instructions, however, the Tax Court reconsidered the value of the easement assuming that it precluded the partnership from building atop the Kress building. The Tax Court ultimately concluded that the easement had a value of $1.857 million (or only approximately $65,000 more than the value it had ascribed to the easement in its first opinion). This meant, interestingly, that the partnership’s claimed value for the easement exceeded the actual value by approximately 401%, just barely triggering the gross valuation misstatement penalty (which kicked in at 400%). The court also found that the partnership was not eligible for the reasonable cause and good faith exception, in part because it relied on an appraisal estimating that the Maison Blanche had appreciated in value in less than 3 years by approximately 970% (i.e., from the partnership’s approximate $9 purchase price to an estimated value of $96 million). This dramatic asserted appreciation in value, said the court, must have left the partnership “thunderstruck,” and a reasonably prudent taxpayer attempting to assess its proper tax liability would have further investigated.
The partnership appealed again. This time, in Whitehouse IV, the 5th Circuit upheld the Tax Court’s valuation of the easement. The partnership argued that Judge Halpern’s rehearsal of his analysis that the easement did not preclude building atop the Kress building was evidence of "judicial insubordination" that “infected” the entire remand opinion (Judge Halpern wrote both Tax Court opinions in Whitehouse). The 5th Circuit disagreed. While acknowledging that the Tax Court went out of its way to state its continuing disagreement with parts of the 5th Circuit's analysis, the 5th Circuit found that the Tax Court did not ignore its instructions. Begrudging compliance with our mandate, said the 5th Circuit, is nonetheless compliance.
The 5th Circuit did, however, vacate the Tax Court’s imposition of the gross valuation misstatement penalty. The 5th Circuit noted that it shared Tax Court’s skepticism regarding the taxpayer’s assertion that the Maison Blanche had appreciated in value by approximately 970% in less than 3 years. The 5th Circuit also noted, however, that it was skeptical of the Tax Court's conclusion that following the advice of accountants and tax professionals was insufficient to meet the requirements of the good faith defense, especially with regard to such a complex valuation task that involved so many uncertainties. The 5th Circuit noted that it was particularly persuaded by Whitehouse's argument that the IRS, the IRS’s expert, and the Tax Court all reached different conclusions regarding value. Ultimately, the 5th Circuit concluded that, although reasonable cause must be determined on a case-by-case basis, in this case, obtaining a qualified appraisal, analyzing that appraisal, commissioning another appraisal, and submitting a professionally-prepared tax return was sufficient to show the taxpayer engaged in a good faith investigation as required by law.
The Pension Protection Act of 2006 eliminated the reasonable cause exception for gross valuation misstatements relating to charitable contribution property. The new “strict liability” penalty applies with respect to tax returns involving façade easement donations filed after July 25, 2006. See Chandler v. Commissioner, 142 T.C. No. 16 (2014).
Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law
Chandler v. Commissioner—Façade Easements Had No Value and Strict Liability Penalty Applied for 2006
In Chandler v. Commissioner, 142 T.C. No. 16 (2014), the Tax Court held that façade easements donated to the National Architectural Trust (NAT) with respect to two residences in Boston’s South End Historic District had no value even though they contained some restrictions in addition to those imposed by local historic preservation laws. The court also rejected the taxpayers’ argument that imposition of the new “strict liability” gross valuation misstatement penalty with regard to their 2006 tax return constituted a retroactive application of the new penalty rules enacted as part of the Pension Protection Act of 2006.
The Chandlers claimed charitable contribution deductions with regard to the façade easement donations for taxable years 2004, 2005, and 2006. The IRS disallowed the deductions on the ground that the easements had no value because they did not meaningfully restrict the properties more than local law. The IRS also imposed gross valuation misstatement penalties for each year.
The Tax Court examined the appraisal reports submitted by both parties’ valuation experts and found both wanting.
- The court found the report prepared by the taxpayers’ expert, Mr. Ehrmann, not credible on a number of grounds, including that it contained procedural errors, analyzed properties outside Boston’s unique market, and involved flawed comparable sales analyses. Although not mentioned by the court, Mr. Ehrmann was the subject of a 2013 Department of Justice lawsuit alleging abusive appraisal practices. As part of the agreement settling that suit, he is barred from preparing any kind of appraisal report or otherwise participating in the appraisal process for any property relating to federal taxes.
- The court also found the report prepared by the IRS’s expert to be unpersuasive because it did not isolate the effect of façade easements on the properties examined. The IRS’s expert looked at the sale of nine façade-easement-encumbered properties in Boston and found that the properties had appreciated in value despite of the easements’ restrictions. However, many of the properties had been significantly renovated and the IRS’s expert did not account for the effect of the renovations on value.
Having found both experts’ reports wanting, the Tax Court embarked on its own valuation analysis. It first noted that construction restrictions impair the value of commercial property more tangibly than they impair the value of residential property because commercial property derives its value from its ability to generate cash flows. The court explained that construction restrictions affect residential property values more subtly because personal rather than business reasons usually motivate construction on a home. The court then noted that the difficult task of quantifying the loss of freedom to make changes to the exterior of one’s home becomes even more difficult when local law already imposes restrictions because easements have value only to the extent their unique restrictions diminish the value of the properties they encumber.
The Chandlers identified three differences between local law and the facade easement restrictions.
- The easements restricted construction on the entire exterior of the homes and required the owners to make repairs, while local law restricted construction on only those portions of the properties visible from a public way and did not require repairs.
- NAT inspected each of its properties annually for compliance with applicable standards, while local authorities relied on the public to report violations.
- NAT can enforce easement terms even when doing so would impose substantial economic hardship on the property owner, while, under State law, an owner may obtain an exemption from local restrictions if compliance would cause a substantial economic hardship.
In assessing the impact the additional easement restrictions might have on value, the Tax Court looked to Kaufman v. Commissioner, T.C. Memo. 2014–52, which involved a similar façade easement donated to NAT with respect to a residence in the South End Historic District. The court noted that, in Kaufman, it determined that the easement had no value because buyers do not perceive any difference between the two sets of restrictions. The court saw no reason to break with this result in Chandler and, accordingly, it sustained the IRS’s complete disallowance of the deductions claimed.
Because the Tax Court determined the easements had no value, the Chandlers' misstatements of the value of their easements on their tax returns constituted “gross valuation misstatements,” potentially subjecting them to 40% penalties. The Pension Protection Act of 2006 eliminated the reasonable cause exception for gross valuation misstatements relating to charitable contribution property. This new “strict liability” penalty applies with respect to returns involving façade easement donations filed after July 25, 2006.
Chandler, which involved deductions claimed on the taxpayers’ 2004, 2005, and 2006 returns, raised the novel issue of whether the taxpayers could assert the reasonable cause defense for their valuation misstatement on their 2006 tax return because it was the result of a carryover of deductions from their 2004 return. The taxpayers argued that denying them the right to raise a reasonable cause defense with regard to their 2006 return would amount to retroactive application of the new penalty rules. The Tax Court disagreed, noting that (i) the penalty statute, as revised by the Pension Protection Act, by its plain language applies to all returns filed after a certain date and (ii) when the taxpayers filed their 2006 return they reaffirmed the easement’s grossly misstated value.
The Tax Court did, however, find that the Chandlers were not liable for penalties with regard to the valuation misstatements on their 2004 and 2005 returns because those misstatements were made with reasonable cause and in good faith. The IRS argued that Mr. Chandler should have known the easements were overvalued because he was well educated (he had a JD and an MBA). The Tax Court disagreed, noting that even experienced appraisers find valuing conservation easements difficult and the flaws in the appraisals would not have been evident to the Chandlers. The court also noted that, unlike in Kaufman, where it sustained the imposition of penalties, there was no evidence that the taxpayers in Chandler relied on the appraisals they obtained in bad faith. The court concluded that the Chandlers’ reliance on National Park Service guidance, appraisals obtained from appraisers recommended by NAT, and the advice of an experienced accountant represented a good-faith attempt to determine the easements’ values.
For those tired of following the partisan coverage of the controversy surrounding the IRS’s processing of exemption applications filed in the last election cycle, especially the special scrutiny given applicants with conservative-sounding (like “Tea Party”) names, the following brief, matter-of-fact story appearing in the Los Angeles Times, which addresses lost emails from Lois Lerner, may be helpful. Here are the opening two paragraphs of the story:
A year after the Internal Revenue Service was found to be targeting conservative groups and others seeking tax-exempt status, the scandal has erupted again with disclosures that the agency lost thousands of emails from a former official at the center of the controversy.
IRS Commissioner John Koskinen disclosed June 13 that emails sent by Lois Lerner, the former director of the IRS division that oversaw tax-exempt groups, were lost when her computer hard drive crashed in mid-2011. This week, Koskinen told Congress that eight other hard drives from potential recipients had crashed as well.
The story then poses and answers the following questions:
What’s so important about Lois Lerner’s emails?
What happened to the emails?
So wasn’t there a backup?
Is there anything else the agency can do to recover the emails?
Why are Republicans claiming foul play?
When did the IRS learn about the lost emails?
What has Lerner said about all this?
What’s the White House involvement?
The most recent edition of the National Council of Nonprofits’ Nonprofit Advocacy Matters features several entries that may interest readers, including those addressing the following:
- The status of proposed legislation to permanently extend expired charitable giving incentives
- Passage by the Illinois General Assembly of a bill to align state grant procedures with the federal government’s recently modified guidance promulgated by the Office of Management and Budget
- PILOT initiatives in Massachusetts
- An update on government-nonprofit contracting reforms
- A resolution by the Bethany Beach, Delaware City Council requiring organizations conducting charity fundraising events in public facilities to transfer at least 60% of gross revenue to charity.
This last one is quite intriguing. The story elaborates:
The 60 percent threshold reportedly is based on Charity Watch’s recommended percent of donations nonprofits should spend on mission-advancing programs. Interestingly, Daniel Borochoff, president of Charity Watch, encouraged the town to establish better disclosure requirements rather than regulate the percentage directed to charities, which he correctly observed is constitutionally suspect.
Tuesday, June 24, 2014
As reported in the Boston Globe, Superior Court Judge Jeffrey Locke has sentenced Bostonian brothers Domunique Grice and Branden Mattier to a prison term of three years, “followed by 3 years of probation and 468 hours of community service to people suffering from loss of limbs or brain injury.” According to the story, after the Boston Marathon bombings, the brothers submitted a fraudulent claim to One Fund Boston on behalf of their long-deceased aunt. The two were convicted last week of conspiracy to commit larceny over $250 and attempt to commit larceny over $250; one defendant was also found guilty of identify fraud. What is especially interesting about sentencing is that Judge Locke reportedly gave the defendants a choice between a term of 4 1/2 to 5 years in prison, and the sentence that included lesser jail time and extensive probation and community service. Speaking of the sentence that the defendants accepted, Judge Locke said that it would serve as “a constant reminder for three years of the population you tried to defraud.”
The San Diego Union Tribune reports that the Metro United Methodist Urban Ministry has sued the City of San Diego. The suit alleges that the church is due $43,000 by the San Diego police department, which in 2007 hired the church to mentor children at risk of joining gangs. Additional details follow:
The department used a state grant to pay Metro United $5,000 a month for consulting services until December 2012, when police requested payroll and other records they had not previously sought, the complaint says.
“All of a sudden, the city says we need documentation,” attorney Peter Polischuk said. “We’ve been absolutely pulling our hair out trying to figure out what’s going on.”
Metro United filed suit in July. The city filed a cross-complaint in February, seeking more than $17,000 it claims police wrongly paid to the church, which refuses to return the money.
According to the story, the “police department has had other problems with grant administration,” though city attorneys deny that the case is about the police department’s “accounting practices.”
Monday, June 23, 2014
Today’s edition of Tax Analysts’ Tax Notes Today (subscription required) contains several entries relevant to exempt organization lawyers. One that especially interests me is Private Letter Ruling 201425016, which involves a country club exempt from federal income tax as an organization described in Section 501(c)(7) of the Internal Revenue Code (the “Code”). The country club proposed to sell a conservation easement to a city and use the sales proceeds to improve its golf course, purchase personal property, and renovate and expand its facilities. The Internal Revenue Service ruled that the sale would not jeopardize the organization’s exempt status, and that proceeds reinvested within three years after the closing of the sale of the conservation easement would not generate unrelated business taxable income because of Code section 512(a)(3)(D). Further, the capital improvements contemplated in the ruling request that are made in the year preceding closing will constitute other property purchased and used directly in the performance of an exempt function for purposes of Code section 512(a)(3)(D).
Electronic Citation: 2014 TNT 120-34
As reported in the Boston Globe, India’s Home Ministry has required the Reserve Bank of India to hold all foreign contributions to domestic Indian charities until the ministry says otherwise. A governmental report allegedly asserts that the charities “are costing the country up to 3 percent of its gross domestic product by rallying communities against polluting industries.” The story continues:
The national Investigative Bureau’s report — a copy of which was obtained Thursday by the Associated Press — also accuses the groups including Greenpeace, Amnesty International, and Action Aid of providing reports ‘‘used to build a record against India and serve as tools for the strategic foreign policy interests of Western Governments.’’
The Home Ministry said Thursday it would neither confirm nor deny the existence of the report, which has sparked a firestorm of debate in Indian newspapers and on TV news channels.
The governmental report, says the story, criticizes the charities for stirring protests against nuclear power plants, uranium mines, coal-fired power plants, genetically modified crops, and electronic waste.
Friday, June 20, 2014
The June 2014 edition of the American Bar Association's publication, Business Law Today, contains a "mini-theme" dedicated to nonprofit organizations, with an introduction entitled "Nonprofit Organizations: Changes in Challenging Times." Articles in the edition include:
1. "The Messiest Catch: Fishing for Health-Care Institution Donors in a Changing Sea" by Matthew G. Wright.
2. "Mergers, Acquisitions, and Affiliations Involving Nonprofits: Not Typical M&A Transactions" by William L. Boyd III.
3. "Taking Care of Business: Use of a For-Profit Subsidiary by a Nonprofit Organization" by David A. Levitt and Steven R. Chiodini.
4. "Five Tax Traps for Business Lawyers Advising Nonprofit Clients" by Cynthia R. Rowland and Deborah K. Tellier.
5. "Whither the Parsonage Allowance? Will It Survive the Most Recent Attack?" by Lisa A. Runquist and David T. Ball.
6. "E-mail Voting: A Practical Approach to a Difficult Trap" by Leah Cohen Chatinover.