Nonprofit Law Prof Blog

The "Contemporaneous Written Acknowledgment" Trap Costs Taxpayers a $2 Million Charitable Contribution Deduction

In a memorandum opinion issued yesterday, Tax Court Judge David Laro ruled that taxpayers were not entitled to a charitable contribution deduction relating to the donation of a conservation easment because taxpayers failed to comply with IRC 170(f)(8) and Treasury Regulation 1.170A-13(c)(2).  The statute and regulation require "contemporaneous, written acknowledgement" among other things.  It would appear from the opinion that the disallowance of the deduction resulted from a monumental -- $2,000,000 -- tax planning blunder. 

First, it's actually questionable whether there even was a "donation" since the agreement to forego development of the land (the "conservation easement) was made as part of the settlement of litigation between the taxpayer and the county government.  Here is the short version.  Taxpayer sued County over certain warranties associated with the transfer of land.  The parties settle with County agreeing to transfer land, taxpayer agreeing not to develop the land.  According to the settlement agreement, dated August 27, 2004, the "county agreed to provide written acknowledgment, in form and substance acceptable to [Mr.] DiDonato, of a donation to the county of [Mr.]DiDonato’s development rights in the parcel.”  In other words, the parties agreed to settle litigation by calling the taxpayer/plaintiff's part of the agreement a "donation" of a conservation easement and the county agreed to provide acknowledgment suitable to the taxpayer at some later date.  The County would convey land to taxpayer, but retain development rights.  Taxpayer's agreement to forego development rights constituted the grant of a conservation easement.  That the agreement called for acknowlegement is indication that counsel was aware of the contemporaneous written acknowledgement requirement but, according to the court, simply got it wrong.  In any event, assume there was a valid contribution of a charitable conservation easement.  Ok, so taxpayers file their 2004 return in 2005, claiming a $1.8 million charitable contribution deduction and attaching the settlement and an appraisal of the granted easement.  The whole land transfer, though, was subject to a public hearing required by law (because the land involved was conservation land, basically).  The public hearing approving the deal did not occur until December 12, 2005. The court ruled that the settlement agreement could not be a contemporaneous acknowledgement because the deal was subject to a condition subsequent (the public hearing) which had not yet occurred.  Alright then.  According to the opinion, "on or about December 22, 2006, [after taxpayers filed their 2004 return claiming the deduction] the county sent to Mr. DiDonato a letter acknowledging and thanking him for his “donation” of the development rights to the Schaafsma parcel. That letter advised Mr. DiDonato that the county did not independently appraise the donated property and that it was Mr. DiDonato’s responsibility to determine the value of the donated property for “income tax deductibility” purposes." The opinion leaves us to conclude that taxpayer's counsel considered the letter acceptable.  Que the music from Jaws!  Finally, on March 19, 2007, taxpayer's executed a deed of restriction agreeing not to further development the property.   According to the Court, contemporaneous would have been either on December 12, 2005 (the date of the hearing approving the deal) or March 17, 2007 (the date the taxpayer executed the deed restriction).  The County's December 22, 2006 letter does not comply with Treasury Regulation 1.170A-13(c)(2) because it doesn't contain the magic language.  The settlement agreement was not contemporaneous because the transfer could not take place until after the public hearing, according to the court.  Ergo there was no "contemporaneous written acknowledgement" at all! Nor can there ever be one now because "contemporaneous" means on or before the date of the return for the year in which the contribution was made (either 2005 or 2007). The County's letter was on or before the 2007 date, but it did not contain the language required by the statute and regulation.   

What to do?!!!!!  Should taxpayer amend the 2007 return claiming the deduction for tax year 2007?  Its almost 2012, so a proper acknoweldgement now would hardly be contemporaneous, would it?  See, Treas. Reg. 1.170A-13(f)(3).  Boy, this seems a trap for the unwary to me. 

dkj

  

UPDATE: Lady Gaga Denies Japan Fundraising Allegations

Previously I posted that Laday Gaga and various companies with which she is affiliated had been hit with a federal RICO suit alleging improper retention of funds collected through the "Lady Gaga Japan Earthquake Relief Wristband" effort.  She, or rather her publicist, have now responded by denying all of the allegations in "[t]his misguided lawsuit" that "is without merit" according to a Washington Post article.  For additional coverage, see Rolling Stone (which also mentions other pop star charity efforts that run into trouble).

Having reviewed the complaint, I think it is a stretch but not frivolous and probably sufficiently well pleaded to avoid a motion to dismiss.  Assuming that is correct, the key question will then be what will the discovery process reveal.

LHM

NY Attorney General Sues Coalition Against Breast Cancer Alleging Massive Fundraising Fraud

In an absolutely explosive case harkening back to United Cancer Council, the NY Attorney General filed suit against the Coalition Against Breast Cancer, Inc. and several insiders alleging that the exempt organization is "a sham charity that has diverted nearly all of the millions of dollars raised in the name of breast cancer to its officers, directors and fundraisers. Get the full complaint here.  For media reports click LATimes, Reuters, and USA Today.  The complaint's first twelve paragraphs are set out below and, if true, the insiders have a lot more to worry about than just a state law action. 

 

1. CABC is a sham charity that has diverted nearly all of the millions of dollars raised in the name of breast cancer to its officers, directors and fundraisers. Falsely claiming research affiliations with hospitals such as Memorial Sloan-Kettering and using other lies and exaggerations, Defendants deceive donors into believing that their donations will help eradicate breast cancer through research, mammogram screening and other programs. In reality, CABC spends none of its funds on eradicating breast cancer, nor does CABC have any research affiliation whatsoever with Memorial Sloan-Kettering or any other hospital nor does it conduct or fund any research on breast cancer or any other cancer. Nor does CABC perform any mamograms or other breast cancer screening nor is it affiliated with any mammography screening facilities and, as its own records show, CABC spends virtually nothing on breast cancer prevention.

 

2. Instead, in the last five years alone-a period that has witnessed 200,000 women die from breast cancer and millions more fighting to survive it-CABC has squandered and misused virtually all of the $9.1 million it raised in the name of breast cancer. By its own records, during this period, CABC spent less than 4 percent of the donations it received on any purported charitable programs, and almost none of the donations - less than one-half of one percent - went for charitable purposes authorized under its certificate of incorporation. In 2008, a year in which CABC raised over $1.4 million from the public, it spent a mere $374 for mammograms. In the last three years, despite raising over $4 million, CABC funded mammograms for only 11 women.

 

3. In short, Defendants have misused and wasted millions of charitable dollars that could have been used to treat and potentially save an untold number of breast cancer victims across this state and country. 

 

4. Andrew Smith and Garrett Morgan, longtime friends and business associates, launched the CABC fundraising operation in 1995 to exploit the breast cancer nlovement for their personal financial benefit, at a time when both were in need of cash. Smith was emerging from personal bankruptcy and Morgan was being investigated for his role in a fraudulent meals-on-wheels charity, which was later ordered permanently shut down.

 

5. Smith and Morgan launched CABC despite having no connection to the breast cancer cause. From its inception, CABC has served as a cash machine for Morgan, Smith and other insiders. Defendant Snlith best summarized CABC's raison d'etre in a February 2010 email he sent to Morgan following a sharply critical press article that questioned CABC's legitimacy:

 

We are in a bad place. You need the money and so do I.

 

6. The CABC business model is straightforward: pick a sympathetic cause; lie and mislead donors about how donations will be used; provide a veneer of legitimacy by creating a website to exaggerate the organization's mission; spend a token amount on charitable programming; divert nearly all of the funds raised to the founders and other insiders; and ensure that there is no board oversight.

 

7. From CABC's inception, Smith has handpicked the board, appointing his family and friends, including his former wife, Lori Smith, and then later, his girlfriend, Debra Koppelman, and her friend Patricia Scott, none of whom had any experience in the breast cancer cause or non-profit management, much less the capacity to fulfill their fiduciary responsibilities as directors. As a result, CABC has operated without any financial oversight and without any controls preventing self-dealing and conflicts of interests, allowing it to run as a convenient piggy bank for CABC's directors and Morgan.

 

8. Were CABC a bona fide charity and were its board providing even the most basic oversight, it would have been apparent that CABC's mission was not being carried out, given that even after 15 years of operation, virtually none of the money raised in CABC's name went to legitimate charitable purposes. But CABC has no functioning board, with directors serving in nanle only. They perform no oversight, exercise no fiduciary responsibilities, and are simply content to continue the CABC fundraising operation led by Morgan, so long as they are paid their unjustified salaries and benefits.

 

9. Indeed, CABC's directors-Smith, Koppelman and Scott-have completely abdicated their fiduciary oversight responsibilities by ceding control over CABC's fundraising operations and strategy to Morgan and his for-profit telemarketing company, the Campaign Center. With no oversight, Campaign Center has gone unchecked and engaged in fraudulent fundraising tactics on CABC's behalf, including lying or grossly exaggerating the scope of CABC's charitable activities and mailing phony pledge invoices.

 

10. Smith, Koppelman and Scott have failed to exercise any diligence concerning whether the amount paid to Canlpaign Center is reasonable. Year after year, they renew the Campaign Center's contract without ever attempting to negotiate more favorable terms with the Campaign Center, or reaching out to other fundraisers not connected to Morgan to obtain a better deal for CABC. Instead, last year, CABC actually increased Campaign Center's cut from 80% to 85% even though there had been no change or inlprovement in the services provided. They even gave Campaign Center the exclusive right as "broker" to select other fundraisers for CABC.

 

11. Smith, Koppelman and Scott, who are all employed elsewhere, have used the charitable funds raised by Morgan to inlproperly pay themselves salaries, retirement benefits, dental, medical and other benefits-even free BlackBerry phones-despite providing no services' warranting these benefits.

 

12. Smith and Koppelman have also engaged in substantial insider transactions in violation of the Not-for-Profit Corporation Law, including $105,000 in loans to Smith, a $50,000 loan to Koppelman, and a risky stock sale by Smith to CABC.

 

dkj 

Massachusettes Senate Passes Law Requiring State Approval of Nonprofit Officer and Board Member Compensation

Big brother has taken the first step towards taking over the nonprofit sector in Massachusettes.  No kidding!  In a first of its kind law, Massachusettes requires public charities to obtain state approval before compensating nonprofit board members.  The events leading to this incredible result began when the Boston Globe published several articles questioning the compensation paid to nonprofit health care executives.  One such article explained:

The issue of paying nonprofit board members came to the forefront in March after the state’s largest health insurer, Blue Cross Blue Shield of Massachusetts, disclosed that it gave former chief executive Cleve L. Killingsworth an $11 million payout. The Blue Cross board members who approved the package earned annual salaries that ranged from $56,200 to $84,463. Attorney General Martha Coakley’s office said health insurers were not justified in paying directors because they do about the same amount of work as volunteer board members at other nonprofits.  “We’re concerned where board members of any charity are paid, including foundations,’’ said Brad Puffer, a Coakley spokesman.  Following a public uproar over the health insurers’ board compensation, Blue Cross and Fallon Community Health Plan suspended the payments. Harvard Pilgrim Health Care, and Tufts Health Plan — the state’s other two major insurers — said they will continue to pay directors.  Two weeks ago, the state Senate approved a budget amendment that would bar all charitable organizations — not just health insurers — from paying directors without state approval. The Senate amendment has not faced significant opposition, but lawmakers still must reconcile the Senate bill with a House version in coming weeks. It could be modified or cut from the budget.

When the Attorney General got wind of the public outcry, she began an investigation that culminated in a letter to several of the largest nonprofit health care organizations.  The letter, with very dubious authority, rejected all the justifications offered in support of nonprofit board member compensation, stating the following:

The rarity of director compensation within the non-profit industry is entirely consistent with the purpose and structure of non-profit charitable organizations. In the for-profit world, organizations operate for the exclusive benefit of their owners (shareholders) and directors are entirely justified in requiring compensation for serving those private interests.  In contrast,  nonprofit charitable organizations operate for the exclusive benefit of the public and the vast majority of directors view voluntary service as a primary means of giving back to the greater community the value of their skils and experience. Compensating directors is contrary to this spirit and diverts resources otherwise focused on achieving the charitable mission of the organization. Moreover, the authority of directors in the for-profit world to establish and set their compensation is subject to the ultimate authority of the shareholders.  Those who are entitled to the benefits of non-profit charitable organizations (the public) have no such authority.

Although our office is troubled that Harvard Pilgrm and Tufts have continued to compensate board members while health care costs continue to rise, compensation of independent directors is not merely an issue of cost. Compensation has the potential to impair board independence.s For example, the Guide notes that "individuals who have a personal financial interest in the affairs of a charitable organization may not be as likely to question the decisions of those who determine their compensation or fees or to give unbiased consideration to changes in management or program activities." P.23. Likewise, compensation of directors creates an unavoidable conflct of interest inherent in the unchecked ability to self-elect compensation with charitable funds, and is clearly contrary to this volunteer tradition that characterizes our charitable boards.  Moreoever, compensation of independent directors cannot be viewed in isolation from broader concerns about mission drift in certain sectors of our charitable community. Particularly in the health care arena, where non-profits organizations (both providers and insurers) often operate side-by-side with for-profit entities, are subject to the same market dynamics and regulatory requirements, provide similar community benefits and yet are granted far more favorable tax treatment, the traditional justification for granting charitable status is increasingly subject to scrutiny. Compensating independent directors contributes to this trend and further blurs the line between charitable and for-profit entities.

Because compensating independent directors departs from the charitable industry and judicially recognized norm and creates unavoidable conflicts of interest, public charities that undertake this practice should do so only if they have a sound and convincing rationale. 

Thereafter, the Attorney General convinced several legislators to introduce the bill passed by the Senate on June 20, 2011.  The meat of the bill states:

(b) No Massachusetts based public charity required to be registered under section 8E and to file annual reports under section 8F, shall provide compensation to any independent officer, director or trustee for service as such independent officer, director or trustee except with the approval of the Director in accordance with the provisions of this section.

Any such public charity intending to provide compensation to any independent officer, director or trustee shall file an application with the Division, on such forms and with such supporting information and documentation as the Director shall from time to time prescribe, requesting the approval of the Director to provide compensation.

The Director may adopt and promulgate guidelines, rules or regulations to carry out the provisions of this section including, but not limited to, the criteria for granting approval and the time period during which such approval shall be effective. Such criteria shall recognize that service as an independent officer, director or trustee of a public charity is recognized as a voluntary contribution of time and expertise to benefit the community served by the public charity and that any departure from the voluntary nature of such service requires a clear and convincing showing that compensation is necessary to enable the public charity to attract and retain experienced and competent individuals to serve as independent officers, directors or trustees.

If the Director approves an application for compensation, amounts paid as said compensation shall be limited to the amount the Massachusetts based public charity reasonably determines are necessary to accomplish the purposes for which compensation is paid. The Director may rescind the approval for compensation if he finds that any compensation paid under this section is in excess of that reasonably necessary to accomplish the purposes for which compensation is approved and paid.

Subsequent media reports suggests that the real purpose of this law is to altogether prohibit nonprofit board member compensation: 

Senator Mark Montigny, the New Bedford Democrat who sponsored the legislation, said people who serve on nonprofit boards should not collect paychecks. The money would be better spent supporting the organizations’ charitable missions, he said.  “I think the game is over for a lot of these folks,’’ Montigny said. “Unless there is an extraordinary case, we need to look at completely stopping paying volunteer board members.’’

So here is where the editorializing starts.  Nonprofit health care has for too long been allowed to serve as the caricature representative of the entire charitable sector.  Not only that, there have been complaints about compensation practices in the college, university and nonprofit health care industry for years. For the most part, the charitable sector has not heeded those complaints.  The Massachusettes law is a foreseeable result of that failure to heed.  The charitable sector is also referred to as the "Independent Sector" because it is deemed trustworthy enough to engage in responsible self-policing.  The Massachusettes law challenges, in none too subtle ways, that trustworthiness.  Indeed, it sounds a serious warning that should be heeded.  If the charitable sector does not clean up its own act, others will do so for it, typically in ways that are as destructive as the Massachusettes law. 

dkj

Corporate Sponsorship in the NonProfit World: Everybody has a Price!

The blogosphere is abuzz about GLAAD and other tax exempt organizations' sudden, and apparently well coordinated support of a proposed merger between AT&T and T-Mobile.  Anybody with half a brain knows that corporate sponsorships, as defined in IRC 513(i), constitute gross legal fictions.  The fiction is that the tax exempt organization that is being "sponsored" is not engaged in the sale of advertising and thus subject to the unrelated business income tax.  IRC 513(i) perpetuates that fiction so that college football and basketball can make billions of tax free dollars while at the same time absolutely vilifying poor but talented athletes for daring to sell their memorabilia for pizza and beer money.  But I digress.  According to the Boston Globe and other media outlets, GLAAD and several other "liberal" exempt organizations received substantial donations from AT&T, ($50,000 in the case of GLAAD), and sometime thereafter GLAAD sent this letter in support of AT&T's proposed merger with T-Mobile.  Over the weekend, and after the blogosphere began asking what the heck the proposed merger has to do with gay rights, Jarrett Barrios and several GLAAD board members resigned, according to this report. 

Wireless phone service has about as much to do with gay rights as zebras have to do with waterskiing. So gay bloggers were justified in hounding Jarrett Barrios, who until this past weekend was president of the Gay & Lesbian Alliance Against Defamation, after he wrote the federal government on behalf of AT&T, a corporation that had donated $50,000 to Barrios’s watchdog group.

 It should be noted that at least one AT&T executive sits on GLAAD's board of directors.  Corporations, of course, are theoretically incapable of altruism.  The law allows the charitable contribution to corporations but everyone knows that corporations make contributions to polish their image all for the purpose of selling goods or services.  Still, explicit quid pro quo is prohibited, except in the case of college athletics which is different right?  The quid pro quo in this instance -- what might also be referred to as prohibited private benefit which should (but probably doesn't) jeopardize the organizations' tax exemptions -- resulted in eight other GLAAD board members resigning.   For more on the story, see this report in Politico.com.  One of the board members is reported to have severely condemned GLAAD's apparent trading on its name:

But when former GLAAD board co-chairwoman Laurie Perper appeared on Michelangelo Signorile’s Sirius XM radio show earlier this month, she alleged that Barrios had traded favors with Coronado for his support and then backed the AT&T/T-Mobile deal in return.  GLAAD immediately condemned Perper’s comments during the show, calling them “factually inaccurate, uninformed and misleading.”  “We are saddened and shocked that Laurie Perper would distort the truth to this degree

GLAAD shot back with this press release denying any impropriety and suggesting that its interest in media matters arises from its efforts to eradicate gay slurs from public discourse and tying those efforts to its support of the AT&T/T-Mobile merger: 

Finally, GLAAD is accomplishing extraordinary results in its programmatic work. AT&T and Time Warner Cable pulled advertising after GLAAD and the National Hispanic Media Coalition (NHMC) asked advertisers to drop advertisements from Jose Luis Sin Censura, a Spanish-language talk show where the audience frequently chants the word f*ggot and violently assaults LGBT guests. This campaign is continuing. We are now working with the NBA, Major League Baseball and World Wrestling Entertainment to combat homophobia in sports and training announcers, coaches and players to be LGBT inclusive.

Much of GLAAD’s work does not make headlines such as our People of Color Media Institute where 30 LGBT people of color and allies were trained on ways to speak to Americans about LGBT issues and GLAAD’s hard-working and dedicated staff are now getting them national attention. And GLAAD is working with local organizations to amplify powerful stories of LGBT couples and allies in New York, Minnesota, Oregon and many states where our equality is being debated – these are the voices that Americans need to hear from and who are at the heart of GLAAD’s mission.

All of this comes under the dedicated and dynamic leadership of GLAAD President Jarrett Barrios, whom we wholeheartedly support. We are saddened and shocked that Laurie Perper would distort the truth to this degree. She is entitled to her opinion, but she cannot change the facts, including the fact that GLAAD is much healthier today than while she was at the helm.

There is not as much on the internet about other groups who seemed to suddenly pay interest to such mundane matters as corporate mergers but those groups also sent in letters of support after getting hefty donations from AT&T.  Here is the NAACP's letter and statment, the League of United Latin American Citizens (LULAC)'s statment, the Japanese Americans Citizens (JACL)'s letter and even the Sierra Club's letter!  A regular rainbow coalition, I'd say.

Now, I am willing to suspend normal brain functioning just like the next American (especially when it comes to political campaigns, Americans are very good at it then), but this whole mess is a stain on some otherwise reputable tax exempt organizations and ought to be condemned everywhere. I rather doubt much can be done about it though from a legal standpoint.  The problem is, the sale of the organization's support is not quite unrelated business income (since it presumably lacks the regularity necessary to impose UBIT), nor it is it private benefit enough for anybody to do anything about it, since the classic definition of private benefit compares the degree to which the organization has sold its soul with the degree to which it has faithfully pursued its charitable goal.  If the oranization is only an occasional sell-out, its ok, according to the private benefit doctrine.  But make no mistake, these organizations have sold thier proverbial souls and in doing so can no longer claim the indignant high ground against the slimy capitalists of the world!  Shame on all of you!

dkj

Governor's Residence Foundation: There Oughta Be a Law!

I thought it was news but there are at least five tax exempt organizations designed to pay the housing costs of state chief executives, according to Guidestar.  The Los Angeles Times reports in its June 24, 2011 issue that the Governor's Residence Foundation of California exists and is tax exempt for the sole purpose of paying the California governor's rent.  At first, the story seems sensational -- that donors make tax deductible contributions to benefit a specific individual but I suppose it can be explained that the donor's are not exactly doing that.  Instead, they are making donations to assist the state in providing a residence for an executive officer. But apparently these sorts of organizations perpetuate themselves by people who want to support a particular state chief executive.  In other words, after Governor Jerry Brown's term, the organization's insiders will leave (assuming they do not support his successor in office) and will be replaced by insiders who support his successor.  This might all be consistent with 501(c)(3)'s purpose of relieving the burdens of government, but I gotta agree with the article's implicit assertion that it just doesn't smell right!

Gov. Jerry Brown will look to a group of private donors — presently refusing to reveal their identities — to pay his rent at the luxury loft in downtown Sacramento where Brown and his wife live while in town. Donors are contributing to a nonprofit formed specifically to cover the costs of Brown's $3,000-a-month, 1,450-square-foot apartment.  In the past, the practice of having private donors pay for the governor's residence has alarmed ethics watchdogs. Under former Gov. Arnold Schwarzenegger, those who funded his Sacramento hotel penthouse had business before the state. Critics of the practice say the contributions afford those interests undue access and influence.  California is one of only a handful of states that does not provide an official governor's residence.  Brown's office referred questions to George Kieffer, who is president of the nonprofit, known as the Governor's Residence Foundation.  Kieffer said his group would release the names of donors and the amount they have contributed in January 2012. He said the group was raising money to pay Brown's rent, as well as his utility bills.

"We're budgeting some additional money assuming that, from time to time, there'll be entertainment there of legislators and others, as you'd expect in connection with a governor's residence, that are government-related," Kieffer said.  That could push the annual sum raised by the foundation close to $50,000 — all money that Brown would not have to spend.  Kieffer, a lawyer at the law firm Manatt, Phelps & Phillips, was head of the same nonprofit when it paid for Schwarzenegger's stays in the 1,800-square-foot suite at the Hyatt hotel, across the street from the Capitol.  Ethics groups accused Schwarzenegger of using the nonprofits that paid for the residence and other expenses to make an end run around campaign finance laws intended to limit the amount of money corporations and individuals can donate to a candidate. One of Kieffer's fellow foundation directors then was Bob White, who runs a Sacramento consulting firm, California Strategies, that has substantial business before the state. Donors to the fund included Lewis Investment, one of the country's largest private developers; the Western Growers Assn., which represents big farms in California; and developer Tejon Ranch, also a White client.  Kieffer's law firm has a lobbying arm in Sacramento and represents blue-chip clients such as Intel Corp., AT&T Inc., Toyota Motor North America and Xerox Corp.  Kieffer said he saw no conflict raising money for the governor's capital city housing. "Almost every law firm in the state deals at some time with the government," he said.

Kieffer is one of three board members who will govern the residence foundation, he said. The others are John Protopappas, a developer who is president and chief executive of Madison Park Financial Corp. in Oakland, and Zack Wasserman, a lawyer with the firm Wendel, Rosen, Black & Dean, also in Oakland.  All three have long ties to Brown. Kieffer served as general counsel to Brown's 1976 presidential campaign. Protopappas served as treasurer when Brown ran for mayor of Oakland. Wasserman has served as Brown's attorney.

dkj

  

Lady Gaga Japan Relief Efforts Lead to Federal RICO Lawsuit

Lady Gaga (Stefani Germanotta) and various companies have been hit with a federal RICO lawsuit alleging that contrary to public representations they retained a portion of the donations collected through the "Lady Gaga Japan Earthquake Relief Wristband" effort.  The class action suit, filed in the U.S. District Court for the Eastern District of Michigan seeks a range of damages, including punitive and treble damages. No response from Lady Gaga yet, but presumably one will be forthcoming shortly.

Coverage:  International Business Times.

LHM

Brian Galle: Do Charitable Subsidies Decrease Social Welfare?

Brian Galle has posted, "The Distortionary Effects of Subsidies for Charity in a Federal System,"  in which he questions the conventional wisdom that charitable subsidies invariably increases social welfare.  He suggests that the undisciplined application of subsidies might actually decrease social welfare.  Here is the conclusion:

We have shown here that the leading normative justification for subsidized charity inadequately explains that subsidy. The claim in the literature is that subsidies are welfare-increasing. We show that, once interactions with local government are taken into account, in many cases it is ambiguous whether a subsidy would increase social welfare. At best, then, the traditional justification is fully persuasive only in those instances, sketched here, in which the welfare-reducing aspects of the subsidy are mitigated. For example, our analysis implies that the traditional rationale cannot explain subsidies for universities, hospitals, or social-service organizations, all of which can create localized negative externalities and are not fully subject to crowd-out. Accordingly, our analysis can be read to suggest that the subsidy should be available for a dramatically narrower class of organizations than are currently eligible to claim it. Given that the subsidy bears an estimated tax cost of $50 billion annually in the United States, and that eligible recipients account for on the order of one-seventh of U.S. GDP, we think this is a significant result. We note, though, that once nonprofits and local government are considered together as substitutes, new justifications for the subsidy emerge. For example, the threat of nonprofit production of public goods might be desirable when Tiebout sorting is implausible, such as in conditions of high exit costs. In that case, nonprofit production serves the competition function that is usually attributed to federalism. We analyze these possibilities at greater length elsewhere. (Galle 2011).

 

dkj

Federal Grants Discourage Public Fundraising (and the growth of civil society?)

To have a vibrant and active charitable sector, government should not be too generous towards charities.  That seems to be the counter-intuitive lesson in Jeremy Thornton's recently posted "Flypaper Nonprofits:  Federal Grants and Nonprofit Expenditures." Here is the abstract:

The flypaper effect is a common anomaly observed when federal transfers to local governments stimulate local spending more than theoretically expected. The behavioral influence of grants is of particular concern for the nonprofit sector, where governments may wish to stimulate the production of social services. Recent research shows that grants can reduce private sector giving by causing a reduction in private fundraising activity. This study extends the work on federal grants to the charitable sector by examining the influence of incentive versus lump-sum style grants on the subsequent expenditures of recipient nonprofit firms. The paper draws detailed grant data from the Federal Assistance Award Data System (FAADS), which includes structural characteristics of the grant. Empirical results demonstrate that the structure of the grant matters a great deal. Incentive grants appear particularly effective at stimulating both additional fundraising activity and output of the firm.

 

The author tests whether government funding actually reduces or "crowds out" private charitable initiatives.  The research question is a good one to the extent civil society is viewed as a valuable alternative to top-down public action.  The value added by the charitable sector is manifested in the belief that "bottom up" or grassroots public action is distinguishable from top down public action.  The paper supports the assertion that to have a vibrant and active charitable sector, government should not be too generous.  This is a "macro" finding, since an individual charity might maintain its independence and distinction from government even if it receives government funding.  But too much government help might actually impede the growth of a vibrant civil society from a macro standpoint.  This seems a helpful paper for legislative policy makers.

dkj

"Drowning in Debt: Financial Outcomes of Students at For Profit Colleges"

Last week, I blogged on the Cato Institute's report critizing nonprofit higher education's "profligate" spending which, according to the Institute, eats up federal subsidies of higher education and generally results in increased tuition costs as opposed to increased access.  In an effort to give equal time, I note that the U.S. Senate Committee on Health, Education, Labor & Pensions held a hearing (full video, plus witness statements) on student debt at for-profit colleges.  You can get the full text of the witness statements at the Committee's website.  All the witnesses pretty much beat up on for-profit higher education, mostly for encouraging vulnerable populations to borrow too much money to pay for increasingly worthless degrees.  One witness, though, gave a succinct description of the motivations distinguishing for-profit from nonprofit higher education.  I thought the discussion was particularly useful as it relates to the need for the nonprofit form (characterized by the nondistribution constraint) and the advisability of sharing public subsidies amongst both for profit and nonprofit higher education.  Of course, the statement neither addresses nor precludes the assertion that the nonprofit form too often acts very inefficiently.  Here is a large excerpt from that witness (Dr. Sandy Baum):

How is the For-Profit Sector Different from Other Postsecondary Sectors?

The prevalence of high debt levels and high default rates in the for-profit sector justifies a focus on this sector. Individual institutions and categories of students in other sectors who are in similar circumstances also merit particular attention. But it is worth thinking analytically about why so many problems are concentrated in for-profit institutions. Too much of the debate on this issue is tinged with ideology. Are critics of the sector opposed to market forces or to the idea of profits? Are owners, managers and supporters of the sector evil people who cannot see beyond their own pocketbooks?

The reality is that the fundamental purpose and structure of for-profit entities differs from that of public and nonprofit entities. If the outcomes of these structures could not be differentiated, proponents of the free market would not be such strong opponents of a larger role for government in the production of goods and services. The market works very well for our economy and our society in many cases. But it is not difficult to see that all market outcomes are not optimal. We have seen all too well in recent years the dangers of inadequate consumer protection, inadequate information, and inadequate regulation of financial markets. By definition, for-profit enterprises are run with the goal of maximizing profits. Managers have a fiduciary responsibility to make the interests of owners their primary focus.

When the for-profit sector was smaller, it consisted largely of small privately owned institutions. Some owners of for-profit colleges founded their institutions to provide specific opportunities to specific types of students and are deeply committed to the well-being of their students. But the sector is increasingly dominated by large, publicly held companies. Where it exists, good will and social consciousness on the part of the officers of these companies can only go a limited distance in determining how the firms operate. Comparison of compensation levels in the three major sectors of postsecondary education is instructive. Average compensation for the five highest-paid public university chief executives in 2009-10 was $860,000. The five highest-paid Ivy League presidents received an average of $1.3 million in 2008-09. The top five leaders of publicly traded for-profit postsecondary institutions received and average of $10.5 million in 2009.

Economic theory suggests that market forces lead to efficient outcomes if certain stringent conditions are met. These conditions include the absence of significant externalities – the costs and benefits of the product or activity must accrue to the direct participants without significant impact on others - and notably, perfect information. Consumers must have the information necessary to make sound judgments about which products and services will meet their demand. They must understand the characteristics of what they buy, how the products and services produced by different firms compare, and the prices they will pay. The rapid growth in enrollments in the for-profit sector is not just a reflection of increased demand. It’s not that so many students are suddenly making informed decisions about the best way to realize their educational dreams. A combination of aggressive recruiting and the growing funding and space constraints in the public sector have changed the way students perceive their options.

The market for higher education meets few of the requirements for perfect competition. Students can’t buy one, try it, and buy a different brand next time if they are unhappy with the outcome. There is little market incentive for producers to provide thorough and accurate information because they do not rely on repeat customers and once students make a choice, it is likely to take them a long time – and a lot of payments – before they learn the true properties of what they have purchased.

Well-designed consumer protection makes market forces work more effectively. It doesn’t make sense to have students give up large amounts of time, energy, and money to test for themselves whether institutions offer reasonable education and training. Postsecondary education is an investment that typically provides a high rate of return to both the students who participate and to society as a whole. But it can be a risky investment. If we subsidized only students who have a very high probability of succeeding and seeing their investment pay off handsomely, we would fail to provide opportunities to many individuals who cannot afford them on their own. We know some students will fail, either because they aren’t up to the task or because circumstances interfere with their success.

But we shouldn’t subsidize students to play the lottery. Students who enroll in institutions or programs that graduate fewer than 20% (or 15% or 30%) of their students or that succeed in placing only a small percentage of their students in remunerative positions in the fields for which they have been trained are playing the lottery. They are making a significant investment in an undertaking that has a stunningly low probability of success. Our political philosophies might lead us to debate whether or not we should prevent them from playing this lottery. But it is difficult to come up with sound principles of public policy that would support our subsidizing them to play this lottery. And unfortunately, even the best available information is unlikely to discourage the most vulnerable students from playing the lottery with a combination of taxpayer funds and funds they will only have to pay off in a vague and distant future.

Public Subsidies

There is nothing inherently wrong with people making profits from providing education. And no doubt there are some efficiencies in the for-profit sector that could, if applied in other sectors, both improve the learning experiences of students and reduce the cost of providing those experiences. But holding up this sector as an example of market forces at work is simply inaccurate. Many institutions in this sector receive close to 90% of their revenues from federal student aid. That number is actually higher if the federal funds that are excluded under the 90/10 regulations are considered. Very few students are actually paying with their own money to enroll in these institutions. Why is it that only independent students and dependent students from low-income families choose the for-profit sector? Don’t these particularly vulnerable students, who are most likely to be making their educational choices without the advice of college-educated parents or well-trained counselors deserve added consumer protection, rather than maximum opportunity to make decisions with a high probability of damaging their futures?

Surely there should be better regulation of an industry that is so heavily financed by taxpayers and that has such a dramatic influence on the lives of so many Americans – particularly vulnerable Americans.  Advocates of the sector frequently contend that restrictions on their institutions will deprive low-income students of educational opportunities. But if these opportunities lead to heavy debt burdens and questionable credentials, they are not opportunities in any meaningful sense of the word. Is it wrong to regulate payday lenders because it might deprive vulnerable individuals of the right to borrow money at extraordinary interest rates and generate debts they will never be able to repay? Is it wrong to regulate car dealers because we might deprive consumers of purchasing cars that have every likelihood of self-destructing on the road? Institutions in the for-profit sector that are serving their students well should be first in line arguing for protection against their colleagues whose drive for profits is exploiting students and undermining our ability to use market forces to the fullest to further our educational goals.

 dkj

Stanford v. Roche, Bayh-Dole and the Intersection of Patent and Tax Exemption

I hope someone writes an article using the title of this post.  The Wal-Mart case is all over the news these days but Stanford v. Roche,  a case decided last week has gone quietly unnoticed, it seems, by most within the nonprofit sector. I am not quite sure how, but the case seems to unwittingly implicate the prohibition against private inurement.  I am only just now getting to a thorough read, but my first impression is that the Supreme Court appears to state that a researcher at a university may claim personal ownership of intellectual property derived from the researcher's activities on behalf of the university.  This, it seems to me, raises an interesting issue of private benefit, and perhaps private inurement and excess benefit (depending on whether the researcher can be characterized as an insider).  Suppose the researcher applies for and receives a grant in her capactiy as a professor and scholar at a tax exempt university.  The researcher subsequently makes a monumental discovery and, for whatever reasons, retains the IP rights in that discovery.  May the researcher license those rights for her own personal benefit?  Stanford v. Roche seems to answer the question in the affirmative.  But who should own the discovery when the discovery was made at, with the indispensable assistance of, and by virtue of the researcher's affiliation with the tax exempt university? The Court's disposition of the narrow issue, whether the University's rights in the discovery necessarily take precedence over the researcher's rights, seems to miss the important point that the university is a tax exempt public trust.  Only Justice Breyer's dissent seems to give this fact the significance it deserves, though he does not explicitly mention that tax regulations designed to make sure tax exemption leads to public rather than private benefit: 

The Bayh-Dole Act creates a three-tier system for patent rights ownership applicable to federally funded research conducted by nonprofit organizations, such as universities, and small businesses. It sets forth conditions that mean (1) the funded firm; (2) failing that, the United States Government; and (3) failing that, the employee who made the invention, will likely obtain (or retain) any resulting patent rights (normally in that just-listed order).  U. S. C. §§202–203. The statute applies to "subject invention[s]" defined as "any invention of the contractor conceived or first actually reduced to practice in the performance of work under a funding agreement." §201(e)(emphasis added). Since the "contractor" (e.g., a university or small business) is unlikely to "conceiv[e]" of an ideaor "reduc[e]" it "to practice" other than through its employees, the term "invention of the contractor" must refer to the work and ideas of those employees. We all agree that the term covers those employee inventions that the employee properly assigns to the contractor, i.e., his or her employer. But does the term "subject invention" also include inventions that the employee fails to assign properly? . . . Given this basic statutory objective, I cannot so easily accept the majority’s conclusion—that the individual inventor can lawfully assign an invention (produced by public funds) to a third party, thereby taking that invention out from under the Bayh-Dole Act’s restrictions, conditions, and allocation rules. That conclusion, in my view, is inconsistent with the Act’s basic purposes. It may significantly undercut the Act’s ability to achieve its objectives. It allows individual inventors, for whose invention the public has paid, to avoid the Act’s corresponding restrictions and conditions. And it makes the commercialization and marketing of such an invention more difficult: A potential purchaser of rights from the contractor, say a university, will not know if the university itself possesses the patent right in question or whether, as here, the individual, inadvertently or deliberately, has previously assigned the title to a third party.

The majority's rationale and decision might be limited, it seems to me, to a holding that Stanford simply failed to assert the rights necessarily implied by tax exemption.  In other words, many observers suggest that Stanford v. Roche is more about contract law; but Stanford sought to have the contracts at issue interpreted in the context that Justice Breyer seems to understand.  The majority's fault lies in its taking the issue out of the tax exempt, nonprofit context.  Had it paid heed to that context, one which necessarily implies public ownership first and foremost, it might not have held that a researcher may take her invention, made with the indispensible assistance of the tax exempt entity, and commercialize it for her own benefit.

dkj

Burton Weisbrod: Its Fun to Stay at the YMCA!

Burton Weisbrod has posted "The Pitfalls of Profits,"  which explores the increasing commercialization of nonprofits using the YMCA for primary context. The abstract is below the picture: 

  Weisbrod

Since the 19th century, the Young Men's Christian Association (YMCA) has morphed into a health-and-fîtness Goliath. In 2001, this tax-exempt organization had revenues of $4.1 billion, making it the largest nonprofit, in terms of earned income, in the United States. Today, many of the more than 2,400 local Y's in the country boast basketball courts, swimming pools, jogging tracks, and well equipped weight rooms. These familiar neighborhood institutions are under heavy fire, however, for an increasing presence in upscale areas. Private health clubs have sued Y's for unfair competition, claiming that as a tax-exempt charity, the YMCA is able to undercut private operators' prices enough to siphon away a significant amount of profitable business. The Y's expansion into affluent neighborhoods raises the question of whether it has become overly commercialized and whether it deserves its tax-exempt status. The Y's expansion into new markets is just one example of how nonprofits are becoming increasingly commercialized. The social sector is witnessing a wave of commercialization among nonprofits. The trend is partially a response to a leveling off of government grants and contracts as well as the lack of growth in tax-deductible donations to charity- the traditional sources of funding for nonprofits. Mechanisms to encourage donations, by altering tax law, are readily available. Mechanisms to discourage commercial activity, however, are more challenging. Outright prohibition of any activity that generates "sales" would have vast and uncertain consequences, but the use of tax instruments to discourage all commercial activity - not merely unrelated business activity, which is already subject to taxation deserves exploration.

dkj

Worth Reading: Walkathons and Excuses to Give

I like good editorials and sometimes pretend to be a good editorial writer myself.  That's why I still read newspapers, actually.  I can get all the news pretty easily from TV or online, but a good, thought provoking editorial can only be had in an old-fashioned newspaper.  I just hope newspapers are still around when my kids get older.  Anyway, an interesting op-ed in Sunday's NY Times opines that people give when, curiously enough, selflessness coincides with self-interest.  Seems oxymoronic to me.  But if true, maybe the charitable contribution deduction is unnecessary, except or even (I don't know which) for the very wealthy who can give large enough to purchase a quid pro quo from the gift -- a naming opportunity for example, or some advertising in the case of what we wink and call "corporate sponsorships."  But for individuals, who give small gifts, what's the real incentive when most individuals can't take a tax deduction and don't get something named after them?  The op-ed below excerpted below makes sense to me even if it seems ultimately to conclude that people give because they are truly altruistic. 

Not long ago, I stood on a corner near my home and watched as some of the 42,000 men, women and children participating in Boston’s Walk for Hunger strode by. Their 20-mile round-trip trek was a success, raising $3.6 million for food banks. It was as if, by burning calories, they were feeding the hungry.  Still, the logic that united the walkers, the donors and the hungry mystified me. After years of witnessing such events I still wonder why we must be a nation in motion to secure aid for the needy. Why are benefactors moved by the sight of urban hordes headed for the suburbs and back? Why do such exertions trigger the charitable impulse?  What I saw that morning in Boston was a resource diverted from its true purpose. Imagine those 210,000 man-hours (42,000 times a five-hour walk) put into direct service to benefit the poor. Think of the houses that might be built, roofs repaired, gardens planted and harvested, public spaces improved, and meals delivered to shut-ins. (And add in the efforts of the 2,000 volunteers that day and the contributions of 50,000 donors.) Now multiply that by the millions of man-hours that are represented by such events in cities across the nation, from Los Angeles to Louisville, Ky., from Austin, Tex., to Grand Rapids, Mich.  In the charitable ritual that has evolved, two sides expend energy, but only the sponsors’ efforts directly aid the poor. The others’ is pure sweat equity that goes nowhere but down the necks of the participants. Consider, too, the public resources expended: the rescue squads and medics along the way, the police sealing off urban arteries, the snarling of traffic. We tie our cities in knots. Enduring such inconvenience is what each of us gives to the cause. I do not question the sincerity of the participants, but in these mass mobilizations I see many lost opportunity costs. I recognize the value of exercise and companionship, but question why society values these schemes. The easy explanation, of course, is that there would be no giving — or not nearly so much — without the walks. Fund-raisers recognize that the nobility of giving is often stimulated by activities that conjoin the selfless with self-interest. For giving, we often offer value received. Raffles and auctions and naming rights are among the inducements used to win support. But that’s not what’s going on here.

dkj

 

Charitable Giving Increased By Only 2.1 Percent in 2010

A new report prepared by Giving USA Foundation and the Center on Philanthropy at Indiana University found that Americans gave $291 billion to charity in 2010, 4 percent more than they gave in 2009 but more than 6 percent below the all time record set in 2007.  After adjusting for inflation, though, giving increased by only 2.1 percent.  Click here for the report's executive summary, also available for free online:  Download GivingUSA_2011_ExecSummary_Print; the entire report is available for $75.00.  A Reuters report states:

Revised estimates by the study, which started in 1956, showed that during the financial crisis giving fell more than $10 billion in 2008 to $299.8 billion and then dropped more than 6 percent in 2009 to $280.3 billion. Patrick Rooney, executive director of the Center on Philanthropy at Indiana University, said that giving in 2010 grew by 2.1 percent after adjusting for inflation. "But the sobering reality is that many nonprofits are still hurting, and if giving continues to grow at that rate, it will take five to six more years just to return to the level of giving we saw before the Great Recession," he said.  The study estimates the giving by about 75 million households, up to 1.5 million corporations, an estimated 120,000 estates and about 77,000 foundations. That money goes to more than 1.2 million registered charities and some 350,000 American religious congregations. Individual giving rose by 2.7 percent in 2010 to $211.7 billion, charitable bequests soared nearly 19 percent to $22.8 billion, foundation giving remained unchanged at $41 billion and corporate giving rose more than 10 percent to $15 billion.  Edith Falk, chairwoman of the Giving USA Foundation, a philanthropic research group, said that while giving had started to rebound, the gains "suggest philanthropy is likely in for slow growth over the next several years" and changes in donor behavior during the recession are likely here to stay.

dkj

CATO Institute Report: Nonprofit Higher Education is a Pig!

In a report released yesterday, the Cato Institute severely criticizes nonprofit higher education for its "profligate" spending at the expense of students and taxpayers and concludes that government policies should not favor nonprofit over for-profit higher education.  Indeed, the report suggests that the massive government subsidies for higher education stimulate price increases and have the perverse effect of making education less accessible.  Instead of increasing supply, to put it in economic terms, and thereby increasing access, government subsidies are spent on anything but needy students, thereby decreasing access!  As an intuitive matter, I have always tended to agree.  It seems to me, and I have been working in higher education first as an administrator in 1991 and since 1999 as a educator, that there is a correlation between increased financial aid and higher prices, for example, whether in nonprofit or for-profit higher education.  So long as the government subsidizes ability to pay, higher education has no incentive to hold down costs.  Eventually, as seems to be the case today, costs increase at rates exponentially greater than subsidies, with subsidies remaining at least sufficient to lure students into incurring incredible and unsustainable amounts of debt.  The lion's share of the cost increases, contrary to popular notions perhaps, are being horded by private and public nonprofit higher education, according to the report. 

 

Here is an abstract from the report:

Undergraduate education is a highly profitable business for nonprofit colleges and universities. They do not show profits on their books, but instead take their profits in the form of spending on some combination of research, graduate education, low-demand majors, low faculty teaching loads, excess compensation, and featherbedding. The industry's high profits come at the expense of students and taxpayer.

To lower the cost of education, federal government policies should encourage competition. Regulations should not favor nonprofits over for-profits. Further, the accreditation process should be reformed so that any qualified institution can easily enter the industry. The financial-aid process should be redesigned to remove the bargaining advantage that colleges currently hold over prospective students.

The higher-education industry is heavily subsidized by the federal government. These subsidies play a significant role in the high profitability of the industry and represent a massive transfer of wealth from the taxpayer to the industry. This should change. All tax credits and deductions should be eliminated immediately, as should all direct subsidies. The federal loan program should be restructured to eliminate the government subsidy and ensure that any deserving student can graduate from college without excessive debt, and eligibility for Pell grants should be tightened significantly. The net result of these changes would be greater efficiency and annual savings of $50 to $60 billion. To the extent that the federal government continues to play any role in higher education, its goal should be to ensure that all deserving students have access to higher education, not to maintain high industry profits.

Here is an early indictment from the body of the report:

The profligacy of nonprofit colleges is well known. As long-time Harvard president Derek Bok once quipped, "universities share one characteristic with compulsive gamblers and exiled royalty: there is never enough money to satisfy their desires."Why do nonprofit colleges behave this way? Thirty years ago, Howard R. Bowen, an economist and president of three different colleges, proposed what is known in education circles as Bowen’s Law. It can be summarized as "colleges raise all the money they can, and spend all the money they can raise." Bowen’s Law is well-accepted by scholars of higher education economics. But don’t colleges try their best to keep costs low in order to keep tuition down? No! As Bowen points out:  The question of what ought higher education to cost—what is the minimal amount needed to provide services of acceptable quality—does not enter the process except as it is imposed from the outside. The higher educational system itself provides no guidance of a kind that weighs costs and benefits in terms of the public interest. The duty of setting limits thus falls, by default, upon those who provide the money, mostly legislators and students and their families.  This isn’t to say that most college insiders necessarily realize they are spending excessively. Rather, spending for just about anything is justifiable to them in the name of reputation and the pursuit of knowledge. Further, the culture of academia tends to see practical financial concerns as anathema to the scholarly ideal.

What I worry about most, besides how I am going to pay for my own kids college education, is how long the higher education bubble can keep expanding before it blows up in our faces.  Like housing values ten years ago, higher education values are grossly overstated, almost to the point that stakeholders are begining to use words like "fraud."  States are already saying "no more" to higher education spending and our noble nonprofit bubble is no longer persuasive to most people.  We in the acadmey tend to turn up our noses at for-profit higher education but the Cato report suggests we might benefit from some capitalistic discipline, meaning cutting costs and doing without government subsidy.  The counter-argument, of course, is that profit-making and qualitative outcomes are at some point mutually exclusive; at some point, high quality will necessarily be sacrificed for profit.  There is some legitimacy in the argument but right now we have gone in the extreme opposite.  We have completely eschewed low cost and efficiency ostensibly for the sake of high quality, as if the those two things are mutually exclusive.  Instead of first seeing how we can squeeze more quality out of what we already have, we assume that higher quality necessarily requires more money, either in the form of taxpayer subsidy or higher tuition and certainly not for the purposes of increasing the number of students given access to higher education.  What a stupid policy. 

dkj 

GAO issues Report on ACORN

The GAO today released a report on ACORN.  Coincidentally, Project Veritas, the organization that published the surreptitious videos on ACORN, NPR and others recently gained tax exempt status, according to this report in the Chronicle of Philanthropy.  NPR appears to have survived but ACORN is all but dead, leaving behind a sad and cautionary tale.  

      James O'Keefe, Project Veritas

 Here is the GAO Report abstract:

What GAO Found

Seventeen of the 31 agencies identified more than $48 million—$44.6 million in federal grants and at least $3.8 million in subawards (grants and contracts awarded by federal grantees)—to ACORN or potentially related organizations, primarily for housing-related purposes, during fiscal years 2005 through 2009. Agencies were not required to collect data on subawards; consequently, agencies were limited in their ability to identify all funding they provided to ACORN or potentially related organizations through subawards.

Agencies reported that their monitoring of awards to ACORN and potentially related organizations was based primarily on the award amount or available resources and ranged from reviewing progress reports to conducting site visits. We found that agencies’ monitoring of these awards generally did not detect issues identified by inspectors general or internal audits. Audits conducted by inspector general offices or the internal audit unit at six of the agencies supplemented agency monitoring and identified issues regarding the organizations’ use and documentation of funding—such as lack of proper recording and accounting for how funds were spent—that were not detected by the agency, except in one case. The audits were generally more detailed than agency monitoring. Agency officials said they plan to use the findings of the audits to modify their monitoring processes for future grants, for example by revising monitoring guidance.

Of 22 investigations and cases of election and voter registration fraud and wage violations involving ACORN or potentially related organizations from fiscal years 2005 through 2009, most were closed without prosecution. One of the eight cases and investigations identified by the Department of Justice resulted in guilty pleas by eight defendants to voter registration fraud and seven were closed without action due to insufficient, or a lack of, evidence. The Federal Election Commission (FEC) reported five closed matters; for one, the FEC reached a conciliation agreement with a penalty. Another matter was dismissed, and FEC found no reason to believe the violations occurred for three matters. The Department of Labor identified eight wage and hour disputes, plus one delinquent reporting of required documentation, all of which resulted in an organization complying or agreeing to take corrective measures to comply with the applicable requirements.

Twenty-seven of the 31 agencies within the scope of our review were subject to fiscal year 2010 appropriations restrictions on funding to ACORN and certain related organizations, and all took action to comply with the restrictions. Most agencies alerted staff of the restrictions through e-mails, memorandums, or oral communications. Other actions included alerting awardees, and the Department of Housing and Urban Development and National Science Foundation provided guidance on which organizations may fall within the scope of their respective funding restrictions. Eleven agencies reported that they took action to implement the restrictions, at least in part, as a result of our inquiry and subsequent discussions.

Hat Tip: Professor Harvey Dale

 

dkj

GAVI Alliance and GlaxoSmithKline; More on Private Benefit vs. Private Inurement

An article in the Wall Street Journal today provides another opportunity to continue my rant regarding private benefit vs. private inurement.  In my post below regarding Newt's Nonprofits, I argue that the facts raise a private inurement issue because the transactions, though effectuated via a quid pro quo exchange, involved an enrichment of an insider acting on both sides of the transaction.  The WSJ article, on the other hand, involves the relationship between GAVI Alliance, a global vaccine charity, and unrelated private pharmaceutical companies.  Observers criticize the charity, saying that it has too cozy a relationship with certain drug companies and those companies are benefiting from the sale of their pharmaceuticals to GAVI.  It is the absence of an insider on both sides of the transaction, IMHO, that makes this a classic private benefit question.  In Newt's case, the insider on both sides of what is otherwise a fair market value transaction raise the dangers more often associated with insider profit-making at the charity's expense; hence, Newt's case involves private inurement, GAVI involves private benefit.  But enough about me!  Here's an excerpt from the article; I think it makes for an interesting classroom case study:

LONDON—Large donations from the U.K., Norway and the Bill & Melinda Gates Foundation helped a global vaccine charity raise $4.3 billion at a summit Monday, exceeding its targets and allowing it to carry out all its immunization plans through 2015.

GAVI Alliance, the international vaccine agency, raised $600 million more than the $3.7 billion it had been seeking to plug a budget shortfall that threatened the agency's ability to fund its work. GAVI is one of the world's largest buyers of vaccines for poor nations.

Some relief groups such as Doctors Without Borders and Oxfam have criticized GAVI in recent weeks, saying it could make better use of its money by pushing pharmaceutical companies for lower prices. The groups have accused GAVI of having too cozy a relationship with drug companies, two of which sit on GAVI's 27-person board. GAVI has rebuffed this criticism, saying it needs to work closely with drug companies to keep vaccine supplies flowing.

Another online article spells out the concern with greater detail:

Particularly irksome to the relief agencies is a funding scheme, sponsored by GAVI, under which two multinational drug makers, GlaxoSmithKline and Pfizer, have agreed to sell 30 million doses annually for 10 years in exchange for $10.50 per child immunized, plus a subsidy of $225 million to each company.

Drug makers in developing countries have said they could sell similar pneumococcal vaccines at $6 per child, according to Doctors Without Borders, more than 40 percent less than the $10.50 per child currently being paid by GAVI before the subsidy.

Executive Director of the Doctors Without Borders Campaign for Access to Essential Medicines, Dr. Tido von Schoen-Angerer, called  the new funding “great news.”  But, he said,  ”it’s very disappointing that the prices agreed with two big pharma companies will be too high for countries to afford when donor support is not, or is no longer, available.”

GAVI says it needs to cooperate with drug companies to keep vaccine supplies flowing, and the drug companies say their prices are much lower than those charged in Western countries.

At a news conference Monday, Bill Gates said he feels “great about the prices we’ve got” from drug companies, the Journal reported, but he added that he was eager to see new low-cost Indian and Chinese manufacturers accelerate their vaccine output.

If there is not an insider on both sides of the transaction, all we can really do is criticize the charity's business judgment, something we ought not do.  In such cases, its really only a question of whether the private benefit is truly incidental to the charitable goal.  And remember, sombody has to benefit particularly if everyone is going to benefit generally, that is just the nature of the capitalist world in which socialist charities operate.  But wait!  The WSJ article notes that insiders are in fact on both sides of the transaction, since two of the drug company execs sit on the charity's board of directors.  So maybe this is more private inurement than private benefit.  Tax law, of course, is administrable only to the extent we are able to rely on convenient proxies.  For example, the presence of an insider on both sides of the transaction is a useful proxy for the dangers underlying the private inurement/excess benefit transaction.  The problem, one that is likely demonstrated by this case as opposed to Newt's case, is that proxies are not always accurate.  There are indeed insiders on both sides of the transaction in this case but there are also 25 other unrelated directors who do not benefit from the transaction.  In which case, I would argue that the private benefit doctrine is sufficient to police whatever impropriety observers are complaining about.  In the absence of some check on the insider's control over both sides of the transaction, I would favor applying the stricter, private foundation like private inurement prohibition.  That's my tap dance and I am sticking to it. 

dkj

Newt's Nonprofits Under Scrutiny

 

ABC News today is reporting today that Newt Gingrich is operating a nonprofit charity in a way that comes "dangerously close . . . to crossing a bright line that is supposed to separate tax-exempt charitable work from both the political process and [Gingrich's] profit-making enterprises."

The charity, Renewing American Leadership, not only featured Gingrich on its website and in fundraising letters, it also paid $220,000 over two years to one of Gingrich's for-profit companies, Gingrich Communications. It purchased cases of Gingrich's books and bought up copies of DVDs produced by another of the former House speaker's entities, Gingrich Productions. 

ABC News was engaged for weeks in discussions with top Gingrich advisors about money from Gingrich's tax-exempt charity that went to his for-profit businesses -- known as related-party transactions -- which were never disclosed on the charity's tax forms. ABC News found evidence of the payments in a May 2011 audit commissioned by the West Virginia secretary of state's office. Many of ABC News's questions remained unanswered last week when Gingrich's presidential campaign team resigned en masse, citing dismay with the candidate's lackluster approach to his bid. Questions were resent to Gingrich's new team, but they still have not generated a reply.

One of those who quit the campaign, longtime Gingrich spokesman Rick Tyler, told ABC News in a series of email exchanges prior to his resignation that the charity spent no money on political activity and "did nothing to promote anyone's political career." Tyler also revealed that he personally was the beneficiary of the six-figure payments the charity made to Gingrich Communications – money he was paid to run the charity until he began helping prepare Gingrich for a presidential bid.

Boiled to its essence, the report alleges that Gingrich founded and operated charities in a manner that necessarily benefitted his private profit-making entities and, to a lesser extent, his political ambitions.  For example, the charity mentioned in the quoted text above purchased books and DVD's produced by Gingrich's for profit publishing companies and also paid for charter jets used by Gingrich to promote movies his private businesses produced.  The report notes with respect to the books and DVD's (relating to Gingrich's views on a host of social issues) that the exempt organization paid retail price (in other words, "fair market value") for the Gingrich's books and DVD's.  The report suggests that the exempt organization is violating what exempt organization experts call the "private benefit doctrine."  In another context, though, I have suggested that when a charity is operated in such a manner that it necessarily benefits an insider's private businesses, the charity violates the private inurement prohibition even if the charity can be said to receive a quid pro quo from the profit making entity.  I call this sort of relationship "joint venture private inurement."  It is the charity's grant of the franchise to an insider, I think, that makes such cases a private inurement/excess benefit violation as opposed to a private benefit issue.  Why is this distinction important?  Because the latter issue allows too much wiggle room.  In other words, the private benefit issue tolerates a certain degree of private profit.  Charities must benefit someone in order to achieve a charitable purpose.  But when that "someone" is an insider, the benefit seems less coincidental and more purposeful, as is the case when an insider "skims" profit for his own benefit.  Conventional wisdom holds that if the charity "gets what it paid for" no private inurement/excess benefit violation occurs.  The only objection is whether the charity should be engaging in the particular transaction and that requires an illegitimate second guessing of the charity's business judgement, something I don't want to condone.  But when its the insider who is the intended, not just coincidental collateral beneficiary of the charity's pursuit of its charitable goal, the rest of us are justified in questioning even a quid pro quo transaction.  In other words, the presence of the insider in a fair market value transaction makes the transaction more like a skimming than an incidental private benefit.  I don't mean to foist the private foundation rules on public charities lock stock and barrel, but cases like this -- which are also rampant amongst the megachurches where the churches typically grant what amounts to a lucrative, fair market value franchise to an insider's private benefit -- demonstrate that the deference inherent in simply asking whether the transaction was had at fair market value is wholly insufficient. 

 

dkj 

 

Catwoman Creates New Precedent for treating Unreimbursed Expenses as Charitable Contributions

  An interesting Wall Street Journal article on Saturday discussed Van Dussen v. Commissioner, a case involving a cat lover who sheltered homeless cats in her own home on behalf of Fix Our Ferals, a 501(c)(3).  The issue was whether the cat lover, a family law attorney who represented herself before the Tax Court, could deduct the costs she incurred in doing so. This is one of those cases that seem easy in the abstract, but is more difficult in the implementation -- with some observers noting that the case opens the door for the deduction of costs associated with hosting a catered fund raiser in one's home, according to the article.  Those types of admittedly logical extensions are the sort that cause working stiffs to look askance at the charitable contribution deduction.  Anyway, here are the headnotes from the opinion:

P incurred unreimbursed volunteer expenses while caring for foster cats in her private residence. P’s expenses consisted primarily of payments for veterinary services, pet supplies, cleaning supplies, and household utilities. P claimed a $12,068 charitable-contribution deduction for the expenses on her 2004 tax return. R issued a notice of deficiency denying the deduction. R claims that P did not render services to a qualifying charitable organization under sec. 170(c), I.R.C., and that P failed to substantiate her expenses under sec. 170(f)(8), I.R.C., and sec. 1.170A-13, Income Tax Regs. R also asserts that P’s expenses have an indistinguishable personal component.

Held: P’s foster-cat expenses qualify as unreimbursed expenditures incident to the rendition of services to a charitable organization. See sec. 1.170A-1(g), Income Tax Regs. P’s services were directed by a charitable organization. P thus rendered services to a sec. 170(c), I.R.C., organization when she cared for foster cats in her home. Some of P’s expenses are disallowed because they are insufficiently related to foster-cat care or cannot be determined with precision.

Held, further, the recordkeeping requirements of sec. 1.170A-13(a), Income Tax Regs. (for contributions of money), govern unreimbursed volunteer expenses of less than $250.

Held, further, P’s records meet the requirements of sec. 1.170A-13(a), Income Tax Regs., because they are acceptable substitutes for canceled checks under the substantial compliance doctrine. See Bond v. Commissioner, 100 T.C. 32 (1993). P can deduct fostercat expenses of less than $250.

Held, further, P cannot deduct foster-cat expenses of $250 or more. P did not obtain the contemporaneous written acknowledgment from the charitable organization required under sec. 1.170A-13(f)(10), Income Tax Regs.

Held, further, P can deduct a $100 check donation made to a separate charitable organization.

 dkj

National Association of State Charity Officials Submits Comments re IRS Information Sharing

  In comments submitted to the IRS today, the National Association of State Charity Officials expressed disappointment in the manner in which IRC 6104(c) has been implemented to date, as well as proposed regulations issued earlier this year.  Enacted as part of the 2006 Pension Protection Act, IRC 6104(c), allows the Service to notify state officials of certain adverse actions regarding (c)(3) organizations.  NASCO's primary concern relates to the administrative burdens imposed on state officials necessary to receive information from the Service.  In the interest of full disclosure, I should mention that the proposed regulations were drafted primarily by my former University of Pittsburgh Law Student, Casey Lothamer. Of course, he could not comment on NASCO's specific complaints.  NASCO believes that the net effect of the proposed regulations is that information sharing between the Service and the states will actually decrease under the proposed regulations.

NASCO members were hopeful that enactment of the PPA would enhance their ability to exercise their state law responsibilities by working more cooperatively with the IRS to overseetax-exempt entities and ensure the proper administration of charitable assets. It was anticipated that greater ability to work jointly and share information would allow for enhanced enforcement by the IRS and ASOs. As discussed below, however, the limitations placed on both the IRS and the states by the Code have, in fact, significantly reduced those possibilities. . . . There are important synergies among the IRS and state charity officials that can only be fully realized through robust information sharing and coordinated enforcement efforts. At present, however, neither the PPA nor the subject regulations advance that cause in any appreciable way.  It is toward that end that NASCO welcomes the opportunity to meet with staff of the Department of the Treasury, the IRS and members of Congress to discuss further amendments to the disclosure provisions at issue.

The regulation and supervision of charities is, as everyone knows, notoriously lax on both the state and federal level.  Its ironic then, that a statute designed to facilitate the enforcement of both federal and state laws designed to protect the charitable sector would be applied and interpreted to actually decrease enforcement.  We know too that charitable scandals have the most negative effects on legitimate, law-abiding charities, who have to work even harder to avoid the taint left behind by the outliers.  Scandals and legal violations in the charitable sector typically follow the "one bad apple" rule, at least in the minds of the donating public.  So let's hope the feds heed the comments coming from the state officials and, in the words of NASCO come up with a means to facilitate "robust' information sharing for the benefit of the entire sector. 

dkj