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.
Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law
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.
As reported by The Chronicle of Philanthropy, Public.Resource.Org ("PRO") filed a lawsuit seeks to compel the IRS to release Forms 990 in a format that can be read and, thus, searchable by computers. The IRS practice to date is to convert all filed 990s into images, which renders the content therein incapable of being searched. Organizations that provide access to exempt organizations' 990s, like GuideStar and Charity Navigator, must manually enter the data in order to make it accessible to the public. PRO seeks to end the IRS practice that makes such forms effectively useless to organizations wishing to search the filed returns for specific data or information. The IRS argues that current open-records laws do not require it to utilize any particular format in making the information public.
According to The Chronicle, on Wednesday, June 18, 2014, Judge William Orrick (U.S. District Court for Northern District of CA) "tentatively" denied the IRS's motion to dismiss the lawsuit, thus allowing the lawsuit to proceed.
In the ongoing controversy involving the IRS EO division and its past director Lois Lerner, new revelations about lost emails (in the thousands) has reignited the wrath of Congress and the public. As reported in The New York Times, IRS informed Congress in a filing to the Senate Finance Committee last Friday that approximately two years of Lerner's emails (both sent and received) were lost in a 2011 computer crash. The IRS Commissioner is scheduled to be grilled by House committees next week on the lost emails. According to the Daily Tax Report, House Republicans notified the IRS Commissioner via a letter that they intend to question IT employees at the IRS about the lost emails.
As reported by The Minority Report (Blog), U.S. Representative Stockman (TX) has written to National Security Angency Director, Admiral Michael S. Rogers, requesting that the Agency "produce all metadata it has collected on all of Ms. Lerner's email accounts for the period between January 2009 and April 2011." Politico.com opined that since Lerner's crashed hard drive has been recycled, it is unlikely the lost emails will ever be found.
A Dallas Morning News editorial published yesterday calls for the Obama Administration to appoint a special counsel to independently investigate the entire IRS controversy, including the lost emails. Clearly, the IRS and its credibility will be continue to be embattled for the foreseeable future.
Wednesday, June 18, 2014
Donor Disclosure Law. On May 14, 2014, California Governor Jerry Brown signed into law S.B. 27, which requires large donations from nonprofits and other "multi-purpose" (MPOs) organizations to be disclosed beginning July 1. In addition, the California Fair Political Practices Commission is required to post the names of the top 10 contributors on its website. The bill's intended effect is to shed light on “dark money” in political campaigns and referendums by eliminating a now common practice of nonprofit and other organizations contributing significant dollars into such campaigns without disclosure of the original donors. According to the Los Angeles Times, the legislation was advanced after "conservative groups from Arizona poured $15 million into California in 2012 to fight Proposition 30, Gov. Jerry Brown's tax hike, and support an ultimately unsuccessful move to curb unions' political power."
Hospital Executive Pay Ballot Initiative. A ballot initiative to cap the executive compensation of nonprofit hospital executives failed to qualify for the November 2014 ballot. The Charitable Hospital Executive Compensation Act of 2014 would have instituted an annual compensation limit (including bonuses and other benefits) for such execs to the salary and expense account of the President of the United States (currently, $450,000). In addition, the 10 highest-paid executives and 5 largest severance packages would have been required to be publicly disclosed annually. According to the Los Angeles Times, the proposed ballot initiative was dropped by the SEIU-United Healthcare Workers West Union in a deal struck with the California Hospital Association and a majority of California's 430 hospitals.
On June 13, 2014, the IRS Exempt Organizations division released several intermal memoranda addressing the EO application process:
1. Appeals Office Consideration of EO Technical Unit Adverse Determinations. Memorandum TEGE-07-0514-0012 provides that when EO Technical issues a proposed adverse ruling, organizations now have the opportunity to request consideration of the adverse determination by the Appeals Office within 30 days from the date of the letter setting forth such adverse determination. Prior to this guidance, the EO Technical process was different - an organization that received an adverse determination from EO Technical did not have the right to request consideration by the Office of Appeals.
2. Retroactive Reinstatement & Pending Applications. Memorandum TEGE-07-0414-0010 provides that if an organization filed its Form 1023 appliction for exemption prior to the due date of filing its Form 990 or 990-PF, and the IRS later determines that the organization qualifies for tax exemption, the will be granted under usual procedures as long as it has filed a 990 within the past three years. If the organization has not done so and its tax exemption was automatically revoked, the IRS will now treat the application for exemption as a request for reinstatement. Because of IRS backlog in determinations, some organizations suffered a revoked exemption before the IRS could even process its application.
3. EO to Use Six Sigma to Streamline Application Process. Memorandum TEGE-07-0514-0014 provides that EO specialists will be treated on streamline processes evolving from Lean Six Sigma Organization (LSSO) concepts. This streamlining should aid in the IRS's efforts to effect "fair and efficient tax administration."
Tuesday, June 17, 2014
Munson: Fraud on the Faithful? Charitable Intentions of Religious Congregations' Members & Church Property Law
Valerie J. Munson (SIU Carbondale) has posted "Fraud on the Faithful? The Charitable Intentions of Members of Religious Congregations and the Peculiar Body of Law Governing Religious Property in the United States" to SSRN. Here is an abstract:
This article examines American church property law, past and present, and discusses its inconsistencies and ambiguities. It then suggests how state governments could play an important role in clarifying this area of the law and protecting the intentions and expectations of local church donors who may well be unaware that a general church organization (denomination) is the ultimate beneficiary of their donations. The article is unique in that it is written with a perspective that takes into account the real world contexts of church property disputes, in history and today. (The author was aided in this regard by historic Supreme Court documents that became available to scholars just this spring through a recent digitalization project.)
The article begins by placing the reader in the midst of a church property dispute as seen through the eyes of Sandra and John Cook, fictional characters whose experiences accurately reflect those of the author’s former clients. It then proceeds in three parts.
The first part is an overview of church property rights under American law and begins with a short discussion of the religious context in which this country was founded, the legal existence and power given religious organizations in the post-revolutionary period, and early concerns about the need to limit the power of church authorities over non-spiritual matters like possession and control of church property. It then discusses the three very different approaches used to resolve church property disputes by different states, at different times. The first is the “departure from doctrine” rule first announced in the Scottish case, Craigdaillie v. Aikman in 1813. That approach turns on a determination of which faction in a church property dispute most closely follows the religious tenets that existed at the time a local church was founded. The second approach is the “deference” approach which was first articulated by the Supreme Court in 1871 in Watson v. Jones, a case arising out of the civil war. Using that approach, if a court determines that a local church belonged to a general church organization having its own authoritative structure and means of deciding disputes, the court must defer to the decision of the highest judicatory of the general church organization as to which party is entitled to possession and control of church property. The third, and now most prevalent, approach is the “neutral principles” approach endorsed by the Supreme Court in 1979 in the case of Jones v. Wolf. Under that approach, a court may decide a church property dispute if it can do so without deciding any religious issue. That is, it can decide the dispute if it can do so by simply applying neutral principles of state property, contract, and trust law. The first part of the article concludes with a summary of how the state courts have applied the neutral principles approach in recent years, which has continued the ambiguity and inconsistency in this area of the law.
The second part of the article discusses the context in which individuals today decide to donate money to local churches. It looks at what historic case law provides by way of context as well as at current data on church affiliation practices in the United States.
The third, and final, part of the article suggests three ways in which state governments can assume a role in clarifying the area of church property law, a role they have been urged to assume by the Supreme Court for over forty years. The suggested state government actions would also protect the intentions and expectations of potential donors to local churches in a manner consistent with current public policy favoring financial transparency, especially full disclosure in charitable fundraising. One possible action is the amending of state charitable solicitation or church incorporation laws to require specific disclosure of any beneficial interest a general church organization holds in local church property. A second is through vigorous enforcement of existing state anti-fraud laws. A third is through vigorous enforcement of the public policy requirement for continued tax exemption.
The article concludes by bringing the discussion of church property law back to real people, like Sandra and John Cook, who are deeply affected by church property disputes, and suggesting that now is the time for state governments to step up and assume the role envisioned for them by the Supreme Court by acting to protect the intentions and expectations of those who give of their time and money to support local churches.
Luigi Butera (George Mason, Interdiscplinary Center for Economic Science) and Jeffrey Ryan Horn (George Mason, Economics Department) have posted "Good News, Bad News and Social Image: The Market for Charitable Giving" to SSRN. Here is an abstract:
Financial efficiency represents a desirable quality in charitable organizations. Yet, different theories of intrinsic and extrinsic preferences for charitable giving offer opposite predictions about donors’ reaction to this information. On one hand, learning that one’s charity is better than expected directly increases the marginal impact of giving, making donations non-decreasing in the quality of news. This behavior is consistent with warm-glow theory. On the other hand, higher efficiency has an indirect negative effect on giving, since now less money is needed to produce one unit of effective charitable good. Most notably, theories of pure altruism and guilt aversion predict this behavior. A similar tension arises for prestige motivated donors whenever information provides extrinsic incentives to give (e.g. information has a social signaling value). We model this simple framework and test it using a laboratory experiment. We show that when information about efficiency is private, giving is always non-decreasing in the quality of news. However, when the efficiency of donor’ charities is public information, this relationship breaks down: 34% of donors who respond to new information do so by reducing their giving when charities are better-than expected, and increasing it when are worse. We show that this result is driven by image-motivated donors, who treat the size of their gift and the efficiency of their chosen charities as substitutes in terms of social image payoffs.
In its 2014 Report of Recommendations, the IRS Advisory Committee on Tax Exempt and Government Entities specifically recommended:
The IRS Exempt Organizations Division should recommend that Chief Counsel and Treasury open a regulation project so that profits from a substantial commercial activity will not preclude exemption under I.R.C. § 501(c)(3) as long as an organization’s income and its financial resources are used commensurate in scope with its charitable program.
The advisory panel specifically explained:
The IRS should open a regulation project to: (1) formalize the commensurate test articulated in Rev. Rul. 64-182; and (2) to reject application of the commerciality test. Recent court cases and IRS rulings have been applying a "commerciality test" to determine: (1) when certain business activity conducted by a Section 501(c)(3) organization will preclude tax exemption; and (2) what constitutes unrelated business generating taxable income. Neither the tax law nor the implementing regulations provide support for a commerciality test.
The report ultimately concludes that the commerciality doctrine "is not only unsupported by the Internal Code or its implementing regulations, the doctrine is also inconsistent with the common law of charitable trusts," upon which current regulations are based (referring to §1.501(c)(3) -1(c)(1) and -1(e)(1) promulgated in 1959). The advisory panel concludes that the primary purpose test in the Regulations has basically been replaced with a commerciality test in the IRS's determination of an organization's extent of business activity.
The advisory panel also recommended IRS cooperation with the Chief Counsel's office and the Treasury Department to promulgate a comprehensive revenue ruling on various other unrelated business income issues including activities that will be considered related and unrelated; preparatory time spent on activities; and situations evolving from the IRS' college and university compliance project, such as facility rentals and dual-use properties.
Most practitioners would clearly find such guidance helpful as well as definitive IRS guidance reconciling the commensurate test with the regulatory primary purpose test and their interaction with the UBIT rules.
(See also: Daily Tax Report)
This article presents the case for repeal of the façade easement deduction. Proponents of this benefit argue that the deduction encourages historic preservation by reimbursing property owners for relinquishing their right to alter the façade of their property in a way inconsistent with that conservation goal; however, this article shows that there are many reasons to urge its repeal: the revenue loss, the small number of beneficiaries, the financial demographics of that group of beneficiaries; the dubious industries that are supported by the deduction; and the continual marked overvaluation and abuse despite Congressional, court, and administrative review and expense.
After the last major reform effort, the Pension Protection Act of 2006 (PPA), in 2009, only 94 taxpayers claimed the façade easement charitable deduction with an average return deduction of $477,225. While there may be a desire to retain a tax benefit with purported charitable aims, the long history of unbridled abuse even with repeated legislative and administrative response should make it clear that amending the façade easement deduction is an unending proposition. In today’s world, real estate is often subject to regulation that buyers and their neighbors accept in order to retain and increase a community’s property values. The very wealthiest of homeowners who purchase homes in historic districts willingly accept local restrictions on their property’s use. There is no evidence that façade easements significantly alter the behavior of property owners. It provides them with huge tax savings for doing what they would do anyway.
Tuesday, June 10, 2014
What are the many implications for continued tax exemption for the NCAA arising from the current anti-trust and licensing litigation? I don't really know yet but I have on my "to-do" list the task of reading the 157 page complaint. PBS's Frontline has an online source from which readers can learn all there is to know so far regarding the litigation.
I would really have loved to be sitting in the courtroom for however long it takes to listen in on the testimony and arguments. My initial hunches concerning the implications for 501(c)(3) status range from questions regarding whether the NCAA's has a substantial non-exempt purpose to whether paying players for the use of their likenesses implicates the prohibitions on private inurement, excess benefit and/or private benefit. The only problem though with logically thinking about the implications is that tax exemption for the NCAA is so terribly unprincipled in the sense that everyone knows the whole thing is built on a fictional house of cards. That was proven -- if proof was ever really needed anymore -- when the Service dared to suggest that advertising revenue from things such as the "Frito Lay" Fiesta bowl ought to be taxable. And did you know that Nick Saban is now something like the sixth or seventh highest paid head coach in all of televised football, college and pro? He is making about $7 million a year and well worth it he is, considering the largess he helps bring to 'Bama. A lot of other college head coaches make or will make close to the same, I imagine. And yet the University of Alabama and the NCAA keep on running completely tax exempt with nary a batted eyebrow. "Run Forest run!"
Monday, June 9, 2014
The early indicators regarding the effect of the Affordable Care Act on the demand for free health care are mixed, but seem to be trending towards decreasing that demand very quickly. If the trend continues, we should continue seeing a blending of nonprofit and investor owned hospitals. By that, I mean that the two types of hospitals will continue to morph into indistinguishable sides of the same coin. The law already allows for insiders of nonprofit hospitals to be compensated on the same scale applied to investor owned hospitals. And we already know that nonprofit hospitals are allowed -- nay, expected -- to apply the same business practices as investor owned hospitals. Just as direct government subsidy for health care and the influence of managed care policies have already erased the historical distinctions between "alms houses for the poor" and investor owned hospitals, Obamacare will further eliminate whatever distinctions still exist between nonprofit and for profit hospitals. When all is said and done, will the "nondistribution constraint" (which may exist as a hard and fast rule in theory more than reality) be enough to justify continued exemption for customer supported health care? I am not the first to make this observation, I'm sure, but as government continues to grow as the primary arbiter of health care -- I'm not saying whether this is a good thing or not -- in effect requiring all health care providers to serve the poor, tax exemption for health care seems less and less justifiable.
According to this recent NY Times editorial:
Some hospital systems have started tightening the requirements for charity care in efforts to push uninsured people into signing up for subsidized health plans on the insurance exchanges created by the reform law. In St. Louis, for example, Barnes-Jewish Hospital has started charging co-payments to uninsured patients no matter how poor they are. Those at or below the poverty level ($11,670 for an individual) are charged $100 for emergency care and $50 for an office visit. But some medical centers have seen their charity care costs decline. A report late last month in Kaiser Health News and USA Today said that Seattle’s largest “safety net” hospital, run by the University of Washington, saw its proportion of uninsured patients drop from 12 percent last year to a surprisingly low 2 percent this spring, putting the hospital on track to increase its revenue by $20 million this year from annual revenues of about $800 million.
The editorial links to this report by Kaiser, suggesting that the ACA has resulted in a marked decrease in uncompensated health care.
That’s one of the reasons the hospital industry was among the first groups to support President Barack Obama’s health plan,agreeing to Medicare and Medicaid funding cuts exceeding $150 billion over a decade in return for getting more paying patients to reduce their uncompensated care.
Many hospital executives were unnerved, therefore, when the Supreme Court ruled in 2012 that states could not be forced to implement the Medicaid expansion and nearly half of them have refused. As a result, hospitals in non-expansion states are undergoing the funding cuts without a corresponding reduction in uncompensated care.
Big Impact On Patients
In Seattle, Harborview had projected a $10 million gain in revenue this year because it would be able to recoup payments for services provided to the newly insured. Now, with a 10-percentage-point drop in uninsured patients in one year, the hospital system managed by the University of Washington is projecting a $20 million revenue increase on annual revenue of about $800 million, said Associate Administrator Elise Chayet.
Hospital officials say the biggest impact of the change is on patients themselves. Rather than having to rely on emergency rooms, newly insured patients can see primary care doctors and get diagnostic tests and prescription drugs, among other services.
Some safety-net hospitals say they started to see their numbers of uninsured patients dropping almost immediately after the Medicaid expansion took effect in January.
“We have seen a steady decline in our uninsured visits,” said Roxane Townsend, CEO of UAMS. “We did not anticipate this big a drop this quickly.”
About 80 percent of the system’s new Medicaid patients had previously been seen by the hospital as uninsured patients, she said. Their enrollment in coverage means the hospital is paid more for their care and is able to direct them to outpatient services and preventive care.
She said that UAMS has also seen a drop in ER visits by uninsured patients — from 6,000 visits in first three months of 2013 to about 4,000 visits in first three months of this year, calling the decline “significant.”
An even more comprehensive study published in Health Affairs confirms society's growing resolution of charity care and, without saying so, provides more reason to question the continuing tax exemption of nonprofit hospitals, which are no longer the exclusive providers of charity care:
The Affordable Care Act (ACA) is fundamentally reshaping the nation’s health care landscape, particularly in terms of how care is delivered to the low-income uninsured and how that care is financed. Chief among the ACA’s provisions is the expansion of eligibility for Medicaid, in which states can choose to cover people who have incomes of up to 138 percent of the federal poverty level. The ACA also provides subsidies for people with incomes below 400 percent of poverty to purchase health insurance and establishes health insurance exchanges, known as Marketplaces, through which people can obtain coverage. Over the next decade an estimated twenty-five million people will gain health insurance through the ACA.
Ideally, nonprofit ventures thrive and grow to eliminate a market failure problem. They should, perhaps, be subsidized only so long as the problem exists and only to the extent necessary to solve the problem. States, for example, are already in the process of a wholesale reconsideration of the necessity of property tax exemption for health care organizations. I should think too that income tax exemption for hospitals should be reconsidered.
Friday, June 6, 2014
With h/t to Paul Caron at the mother of all blogs, TaxProf Blog:
We investigate the effects of variations in the value of the charitable contribution deduction on nonprofit firm behavior, including exploring for the first time the effects of the tax-price of giving on fundraising and returns to fundraising. We find that a one-percent increase in tax subsidies drives a 1.7-percent increase in fundraising, and decreases average returns to fundraising by two percent. We also find that tax subsidies deliver less than a dollar of value, net of fundraising, for each dollar foregone by the government, and that program-related expenditures are largely unresponsive to subsidies, at least in the short run. We argue that these results may imply that the charitable contribution deduction is less effective than prior research has suggested. For example, we argue our results are consistent with the hypothesis that subsidies trigger a destructive arms’ race for donor funds. The modest elasticity of real charitable output to tax price implies that tax subsidies may simply crowd out other revenue sources, such that the efficacy of the subsidy depends on the relative efficiency of these alternative sources.