Nonprofit Law Prof Blog

Lawsuit Challenges Princeton Tax Exemption

One had to figure this was coming sooner or later: a lawsuit challenging state property tax exemption for Princeton University, which a state trial judge has refused to dismiss. The arguments in the case appear familiar: the lawyer for the plaintiffs (property owners in Princeton, N.J.) contends that many of Princeton's buildings are used for commercial purposes, and should be put back on the property tax rolls.  To quote the story:

“In 2011 Princeton University received $118 million in patent royalties and distributed $30 million from the profits to faculty members,” Afran [the lawyer for the plaintiffs] said. “Under the law they are not even entitled to a tax exemption because they are engaged in commercial patent licensing, and the school give out a percentage of profits to faculty. Under the law in New Jersey,  if a nonprofit gives out profits, it is not entitled to an exemption at all.”

The final quote sort of sums it all up:

“In many ways these modern universities have become commercial enterprises.”

JDC

Mike Huckabee: Churches Should Consider Abandoning Exempt Status

The Huffington Post reports that in a speech to a group of Southern Baptist ministers in Houston on Monday, Mike Huckabee said that churches should consider giving up exempt status.  "I think we need to recognize that it may be time to quit worrying so much about the tax code and start thinking more about the truth of the living God, and if it means that we give up tax-exempt status and tax deductions for charitable contributions, I choose freedom more than I choose a deduction that the government gives me permission to say what God wants me to say."  Huckabee confirmed his views in a tweet Tuesday evening.

I don't think I've ever uttered the words "I agree with Mike Huckabee," but there's a first time for everything.  So here goes: I agree with Mike Huckabee.  The primary issue, of course, is the ability of churches to engage in political campaign activity, the same issue at the core of the 501(c)(4) mess.  But in the 501(c)(3) category, we have a nice, bright line: political campaign activity is completely banned.  Nevertheless, that hasn't kept churches and their ministers (on both the right and the left of the political spectrum, by the way) from blatantly violating the law (for examples, see my prior posts here and here).

My view on the relationship of churches to 501(c)(3) has always been the same: if they want 501(c)(3) status, they need to play by the rules.  If they don't want to play by the rules, give up 501(c)(3) status, and engage in politics to their hearts content.  They don't get to break the rules and then whine that the government is picking on them, any more than 501(c)(4)'s should get to blatantly break the rules and whine that the government is picking on them.  So - quit whining, and suck it up.  Make  your choice and live with it.  Be like Mike (Huckabee).

JDC

 

Graev v. Commissioner - Side Letter Kills Deductions for a Façade Easement Donation

In Graev v. Commissioner, 140 T.C. No. 17 (June 24, 2013), the Tax Court sustained the IRS’s disallowance of deductions claimed with regard to the donation to the National Architectural Trust (NAT) in 2004 of both a façade easement valued at $990,000 and an accompanying $99,000 cash endowment. NAT had written a side letter to Mr. Graev, the donor, promising that, if the deduction for the easement is disallowed, NAT would “promptly refund [Mr. Graev’s] entire cash endowment contribution and join with [him] to immediately remove the facade conservation easement from the property’s title.” The Tax Court found that the gifts were conditional and, at the time they were made, the possibility they would be “defeated” was not so remote as to be negligible.

In explaining its holding, the Tax Court noted that IRC § 170 and the corresponding Treasury Regulations provide instructions and limitations that, at least in part, ensure that a donor will be able to deduct only what the donee organization actually receives. Three such limitations effectively provide that no deduction for a charitable contribution will be allowed unless, on the date of the contribution, the possibility that the donee’s interest in the contribution would be defeated is “so remote as to be negligible.” See Treasury Regulation § 1.170A-1(e) (pertaining to conditional gifts); § 1.170A-7 (pertaining to partial interest gifts); § 1.170A-14(g)(3) (pertaining to gifts of conservation easements).

Based on the specific facts in Graev, the court found that, on the date of the contributions, the possibility the IRS would disallow the easement deductions and NAT would return the cash to Mr. Graev and remove the easement (i.e., the gifts would be defeated) was not so remote as to be negligible. The facts the court found persuasive included the IRS’s announced intention to scrutinize deductions for facade easement donations; Mr. Graevs’ insistence that NAT issue the side letter; NAT’s practice of issuing side letters, the very essence of which “implies a non-negligible risk;” and NAT’s incentive to honor its promises in the side letter so as not to undermine its reputation and impair its ability to obtain future contributions.

The Tax Court specifically declined to address the hypothetical circumstance in which a “hyper-cautious” donor conditions his gift on non-disallowance where the possibility of disallowance is so remote as to be negligible. However, the standard for finding that the possibility of defeat of a conditional gift is so remote as to be negligible is very high. The court explained:

In prior cases, we have defined “so remote as to be negligible” as “‘a chance which persons generally would disregard as so highly improbable that it might be ignored with reasonable safety in undertaking a serious business transaction.’”… Stated differently, it is “a chance which every dictate of reason would justify an intelligent person in disregarding as so highly improbable and remote as to be lacking in reason and substance.”

In Graev, the Tax Court noted: “the mere fact that he required the side letter is strong evidence that, at the time of Mr. Graev’s contribution, the risk that his corresponding deductions might be disallowed could not be (and was not) ‘ignored with reasonable safety in undertaking a serious business transaction.’” Obtaining the side letter also indicated that Mr. Graev did not disregard the chance of disallowance "as so highly improbable and remote as to be lacking in reason and substance." Accordingly, the mere fact of obtaining a side letter such as that at issue in Graev might be deemed a tripwire that destroys deductibility.

Graev is the latest in a series of cases in which deductions for façade easement donations to NAT have been disallowed on a variety of grounds. See Herman v. Commissioner, T.C. Memo. 2009-205; 1982 East LLC v. Commissioner, T.C. Memo. 2011-84; Friedberg v. Commissioner, T.C. Memo. 2011-238; Dunlap v. Commissioner, T.C. Memo. 2012-126; Rothman v. Commissioner, T.C. Memo. 2012-218; Scheidelman v. Commissioner, T.C. Memo. 2013-18. See also Kaufman v. Shulman, 687 F.3d. 21 (1st Cir. 2012)(remanding to the Tax Court on the issue of valuation and noting that, because of local historic preservation laws, the Tax Court might well find that the façade easement donated to NAT was worth little or nothing). NAT also was the subject of a 2011 Department of Justice lawsuit alleging that NAT was engaged in abusive practices. The suit settled with NAT denying the allegations but agreeing to a permanent injunction prohibiting it from engaging in the practices.

NAMcL

Belk v. Commissioner - Tax Court Reaffirms its Holding that “Floating” Conservation Easements Are Not Deductible

As previously discussed, in Belk v Comm’r, 140 T.C. No. 1 (Jan. 28, 2013) (Belk I), the Tax Court held that a conservation easement that permits the parties to agree to “substitutions” (i.e., to remove land from the easement in exchange for the addition of some other land), even though subject to certain limitations, was not eligible for a charitable income tax deduction under IRC § 170(h) because it was not a “restriction (granted in perpetuity) on the use which may be made of the real property” as required under § 170(h)(2)(C). 

In Belk v. Comm’r, T.C. Memo 2013-154 (June 19, 2013) (Belk II), the Tax Court denied the taxpayers’ motion for reconsideration, rejecting all three of the taxpayers’ arguments and expanding upon its holding in Belk I.

Tax-Deductible Conservation Easements Must Protect Identifiable, Specific Pieces of Property

  The taxpayers first argued that, as long as the taxpayer agreed not to develop 184.627 acres of land, neither the court nor the IRS should be concerned with what land actually comprises the 184.627 acres. The Tax Court disagreed, holding, as it had in Belk I, that a “floating” easement is not eligible for a deduction under § 170(h), and § 170(h)(2)(C) requires that taxpayers donate an interest in an “identifiable, specific piece of real property.”

This holding is consistent with the legislative history of § 170(h), in which Congress indicated its desire to limit the deduction to “the preservation of unique or otherwise significant land areas” (see Senate Report No. 96-1007, Sept. 30, 1980). It also is consistent with the elaborate threshold conservation purposes and other requirements of § 170(h) and the Treasury Regulations. For example, it would make little sense to require that the donee be given baseline documentation establishing the condition of the specific property encumbered by the easement at the time of the donation only to have the parties remove that property from the easement in exchange for the addition of some other property (which may or may not have similar characteristics and for which there is no requirement of a baseline). Similarly, it would make little sense to require that the taxpayer obtain a subordination agreement from a lender holding an outstanding mortgage on the specific property encumbered by the easement at the time of the donation only to have the parties remove that property from the easement in exchange for the addition of some other property (which may or may not itself be subject to a mortgage and for which there is no requirement of subordination).

The Tax Court in Belk II also noted, citing Treasury Regulation § 1.170A-14(c)(2), that the regulations permit substitutions under limited circumstances, and the easement at issue did not limit substitutions to those circumstances. Treasury Regulation § 1.170A-14(c)(2) provides that, to be eligible for a deduction, the instrument of conveyance must prohibit the donee from transferring the easement except to another eligible donee that agrees to continue to enforce the easement. A limited exception to this rule is provided, however, for extinguishments (i.e., transfers) that appear to have to meet the requirements of Treasury Regulation § 1.170A-14(g)(6)(i) and (ii) (the extinguishment and proceeds regulations), which, among other things, require the payment of proceeds to the holder to be used "in a manner consistent with the conservation purposes of the original contribution." In other words, the regulations appear to permit “substitutions” under the limited circumstances described in the extinguishment and proceeds regulations. (Note: although Treasury Regulation § 1.170A-14(c)(2) cross-references to -14(g)(5)(ii), the proper cross-reference is to -14(g)(6)(ii); the Treasury failed to update the cross-references when it finalized the proposed regulations in 1986.)

Limited Amendment Clause Did Not Nullify Substitution Provision

The taxpayers next argued that the conservation easement did not permit substitutions despite the detailed provisions in the deed expressly authorizing substitutions. They pointed to the amendment provision included in the deed, which provides that the holder cannot agree to amendments that would result in the easement failing to qualify for a deduction under § 170(h). The Tax Court again dismissed this argument, finding, as it had in Belk I, that the amendment and substitution provisions were in conflict, and the parties’ intent to permit substitutions controlled. The court also rejected the taxpayers’ argument that, because they intended to make a deductible contribution under § 170(h), the easement deed should be interpreted not to permit substitutions. The court explained that “matters of taxation must be determined in light of what was actually done rather than the declared purpose of the participants.”

Not an Impossible or Impractical Requirement

 The taxpayers’ final argument was that the court imposed an impossible and impractical requirement on donors and donees because the parties purportedly could change the property subject to the easement under state law and, thus, should not be penalized for including substitution provision in the easement deed. The IRS disagreed, stating that the taxpayers’ interpretation of state law “as giving parties unfettered ability to modify contracts is nonsensical and would make all conservation easements meaningless.” The court held against the taxpayer, noting that “we do not consider whether the parties could have substituted property by mutual agreement without a substitution provision but simply look to the fact that the conservation easement agreement contained such a provision.” Because the easement contained a substitution provision, the court found that the taxpayers “did not agree to restrict their use of the golf course in perpetuity.”

The taxpayers in Belk II also argued, citing to Comm’r v. Simmons, 646 F.3d 6 (D.C. Cir., June 21, 2011), aff’g Simmons v. Comm’r, T.C. Memo. 2009-208 (Sept. 15, 2009), that the Tax Court in Belk I failed to consider “that an element of trust and confidence is placed in a qualified organization that it will continue to carry out its mission to protect and conserve property.” The Tax Court responded that, while the taxpayers were correct that courts trust qualified organizations to fulfill their responsibilities, that trust is based on the requirements imposed on the qualified organization by the conservation easement and local law. The court pointed out that, in Simmons, although the conservation easement deed contained a clause granting the holder the right to consent to changes or abandon its rights under the easement, the Court of Appeals found that both the easement deed and local historic preservation laws prevented the donee from consenting to any changes that were inconsistent with the conservation purposes of the easement. Moreover, if the donee dissolved (thereby abandoning the easement), the easement would be transferred to the District of Columbia to be reassigned to similar organization. Accordingly, “the conservation purpose was protected at all times.” The same was not true in Belk, where the easement granted the parties the right to agree to substitutions and, thus, “there is no restriction on the golf course in perpetuity that we can trust [the holder] to enforce.”

Although not at issue in Belk, charities and government entities that solicit and accept charitable gifts to be used for specific purposes are obligated under state law to administer those gifts consistent with their terms and purposes, and the state attorney general can generally call a holder to account for failing to do so. In Carpenter v. Commissioner, T.C. Memo 2012-1 the Tax Court held, in part, that the tax-deductible conservation easements at issue in that case were restricted charitable gifts, or “contributions conditioned on the use of the gift in accordance with the donor’s precise directions and limitations.” Accordingly, the holder of a tax-deductible perpetual conservation easement, whether a government entity or nonprofit, should be required under state law to administer the easement consistent with its terms and charitable conservation purpose, including the terms included in the deed to satisfy federal tax law requirements.

Finally, the holding in Simmons regarding the grant to the holder of the right to consent to changes to two façade easements should be confined to its facts because it was based, in part, on (i) a regulation applicable only to historic preservation easements (see Treasury Regulation § 1.170A-14(d)(5)(i)), (ii) the presence of “appropriate” federal, state, and local historic preservation laws, and (iii) the provisions of the deeds at issue, which (consistent with the regulation) specifically required that any work done on the properties had to comply with applicable federal, state, and local historic preservation laws, whether the holder consented or not. As the Tax Court in Simmons explained, although the easements grant the holder the right to consent to changes, they also require that any rehabilitative work or new construction on the facades comply with the requirements of all applicable federal, state, and local government laws and regulations, and Treasury Regulation § 1.170A-14(d)(5)(i) specifically allows a donation to satisfy the conservation purposes test even if future development is allowed, as long as that development is subject to appropriate local, state, and federal laws and regulations. The D.C. Circuit in Simmons similarly explained, in part, that “any change in the façade to which [the holder] might consent would have to comply with all applicable laws and regulations, including the District's historic preservation laws” and, thus, “the donated easements will prevent in perpetuity any changes to the properties inconsistent with conservation purposes.” The backstop of “appropriate local, state, or Federal standards” for development is generally not present in the context of conservation easements encumbering land donated for outdoor recreation or education, open space, or habitat protection conservation purposes because such easements typically do not merely duplicate or supplement federal, state, or local zoning or other laws. Moreover, the regulations interpreting the outdoor recreation or education, open space, and habitat conservation purposes do not similarly provide that a deduction will be allowed provided the terms of the easement require that future development conform with appropriate local, state, or federal standards.

NAMcL

IRS Issues (c)(4) Report with Safe Harbor for Expedited Review

The IRS has issued its report on the (c)(4) "targeting" issue, available here.  The report concludes that while there were "significant management and judgment failures," there is no evidence of intentional wrongdoing.  The report indicates that senior IRS staff responsible for the determinations process have been replaced, and that the IRS will take a number of steps to insure similar situations do not recur.

Perhaps the most interesting part of the report is Appendix E, which provides an expedited review process for (c)(4) organizations whose applications for exempt status have been pending for more than 120 days. This process establishes a safe harbor presumption that the organization is engaged "primarily" in promoting social welfare if the organization certifies under penalties of perjury two items:  The Appendix further defines relevant concepts as follows:

1. During each past tax year of the organization, during the current tax year, and during each future tax year in which the organization intends to rely on a determination letter issued under the optional expedited process, the organization has spent and anticipates that it will spend 60% or more of both the organization’s total expenditures and its total time (measured by employee and volunteer hours) on activities that promote the social welfare (within the meaning of Section 501(c)(4) and the regulations thereunder).

2. During each past tax year of the organization, during the current tax year, and during each future tax year in which the organization intends to rely on a determination letter issued under the optional expedited process, the organization has spent and anticipates that it will spend less than 40% of both the organization’s total expenditures and its total time (measured by employee and volunteer hours) on direct or indirect participation or intervention in any political campaign on behalf of (or in opposition to) any candidate for public office (within the meaning of the regulations under Section 501(c)(4)).

The Appendix further defines relevant concepts as follows:

For purposes of these representations, activities that promote the social welfare do not include any expenditure incurred or time spent by the organization on--

• Any activity that benefits select individuals or organizations rather than the community as a whole;
• Direct or indirect participation or intervention in any political campaign on behalf of (or in oppositionto) any candidate for public office;
• Operating a social club for the benefit, pleasure, or recreation of the organization’s members; and
• Carrying on a business with the general public in a manner similar to organizations operated for profit.

For purposes of these representations, direct or indirect participation or intervention in any political campaign on behalf of (or in opposition to) any candidate for public office (“candidate”) includes any expenditure incurred or time spent by the organization on:

• Any written (printed or electronic) or oral statement supporting (or opposing) the election or nomination of a candidate;
• Financial or other support provided to (or the solicitation of such support on behalf of) any candidate, political party, political committee, or Section 527 organization;
• Conducting a voter registration drive that selects potential voters to assist on the basis of their preference for a particular candidate or party;
• Conducting a “get-out-the-vote” drive that selects potential voters to assist on the basis of their preference for a particular candidate or (in the case of general elections) a particular party;
• Distributing material prepared by a candidate, political party, political committee, or Section 527 organization; and
• Preparing and distributing a voter guide that rates favorably or unfavorably one or more candidates.

In addition, solely for purposes of determining an organization’s eligibility under this optional expedited process, direct or indirect participation or intervention in any political campaign on behalf of (or in opposition to) any candidate includes any expenditure incurred or time spent by the organization on:

• Any public communication within 60 days prior to a general election or 30 days prior to a primary election that identifies a candidate in the election. For this purpose, “public communication” means a communication by means of any broadcast, cable, or satellite communication; newspaper, magazine, or other periodical (excluding any periodical distributed only to the organization’s dues paying members); outdoor advertising facility, mass mailing, or telephone bank to the general public; and communications placed for a fee on another person’s Internet website;
• Conducting an event at which only one candidate is, or candidates of only one party are, invited to speak; and
• Any grant to an organization described in Section 501(c) if the recipient of the grant engages in political campaign intervention.

Given my earlier post on the Bright Lines project, I find it particularly interesting that the IRS has defined the relevant standard by reference to BOTH expenditures AND employee/volunteer time. Hmmm . . . .

JDC

(Hat tip to Evelyn Brody)

 

The Bright Lines Project: Good Work, But It Needs Another Bright Line

Although some of the hubbub about 501(c)(4)'s and political activity has settled over the past couple of weeks, we shouldn't overlook the fact that the central fault leading to this mess was (and is) a set of un-administrable (and therefore unenforceable) rules regarding political campaign activity by exempt organizations.

In my back and forth with Rosemary Fei on 501(c)(4)'s, she mentioned that she was part of a group trying to provide better guidance on the line between prohibited political activity and permitted legislative lobbying or issue advocacy activity.  This work is called The Bright Lines Project, and a full draft of their effort as of May, 2013, is available here.

In many ways, the project advances the IRS's own guidance on political activity by 501(c)(3) organizations published in Revenue Ruling 2007-41, but provides additional bright lines (pun unavoidable) on what is permitted and what isn't.  It is a very thoughtful effort, modeled after the regulations on what constitutes lobbying expenditures under Section 4911 and the 501(h) election and fills some nagging holes in the IRS's guidance in Rev. Rul. 2007-41.

But I do think the project makes one mistake and ignores another very deep problem in this area.  The one mistake is a sort of "pulpit speech" exception that is referred to as an exeption for "personal, oral remarks at official meetings."  The project's explanation of this exeption is as follows:

Oral remarks made by anyone (other than a candidate) who is present in person at an official meeting of an organization held in a single room or location, so long as no announcement of the meeting refers to any candidate, party, election, or voting. This exception covers only oral remarks about candidates made by and to persons in attendance, not any other form of communication of those remarks, whether written, electronic, recorded, broadcast, or otherwise transmitted. A prominent disclaimer must be made to those attending, stating that such remarks are the speaker's personal opinion and are not made on behalf of the organization, and that the speaker is not advocating any of the actions set forth in Rule 3 [e.g., expressly calling for the election or defeat of a specific candidate or political party]

In it's examples, the Project notes that this rule would "permit a pastor to express his or her personal views on candidates from the pulpit. It would also allow parents at a PTA meeting, including officers, to express their views on candidates for school board. It would permit speeches, sermons, or discussions at any meeting of any tax-exempt organization to include expressions of opinion on those running for public office in upcoming elections, so long as such views were not made officially or on behalf of the organization."

My own view is that this exception is a huge mistake, because it will be exploited to the hilt by organizations intent on "having their say" about candidates.  Face it - a Catholic priest, giving his "opinions" on candidates at Mass on the Sunday before the election will be viewed as an official church position, regardless how strong the "disclaimer" is that is attached to the remarks.  We actually have a useful bright line on this kind of activity right now under Rev. Rul. 2007-41: you can't do it.  The revenue ruling makes clear that speech such as this at an official function of an organization is prohibited, whether a disclaimer is attached or not.  That seems to me to be an excellent bright line, and we should not replace it with an exploitable exception that is hardly a bright line.

The second major problem with the project is that it says nothing about the core problem that plagues 501(c)(4)'s (and 5's and 6's), which is "how much political activity is too much?"  The project makes no attempt to set a bright line for when political activity becomes a "primary purpose" or otherwise address the "how much" issue.  

This is a critical failing.  The (c)(4) problem is as much (in my opinion, more) about how much political activity is permitted as it is in the dividing line between issue advocacy and campaign activity.  Right now, we have nothing other than the vague notion that a (c)(4)'s "primary purpose" can't be political campaign activity - but there is no standard for judging "primary purpose."

So why not adopt a very clear bright line on this latter issue: the amount of political campaign activity permitted by (c)(4)'s, (5)'s and (6)'s is . . . zero.  None.  Absolute prohibition.  Many of my colleagues believe there should be some "de minimis" amount of campaign activity permitted.  I've heard things like "15%" thrown around, for example.  But here's the problem: 15% OF WHAT?  Of expenditures?  Which expenditures?  Of employee time?  What if volunteers are used?  Is the 15% per year or on a 4-year rolling average that we use elsewhere in 501(c)?  If it's a 4-year average, that means an organization can "save up" for the presidential campaigns that happen every four years.  Providing a de minimis exception is hardly a "bright line" in this area, unless one is going to couple it to a specific mathematical test like that provided in 501(h)/4911 for lobbying by 501(c)(3)'s.  And anyone who's worked with that regime will tell you that it is incredibly complex, particularly when it comes to allocating expenditures (and I'd argue that the test doesn't account for volunteers or the fact that modern communication - e-mail and web sites - cost very little but have major communications impact).  Do we REALLY want to go down that road?  And if so, why? What is gained by such a rule other than complication and confusion?  What part of "NONE" is so hard to understand or hard to comply with that we need an exception of some kind?

So I'll say it again.  If we're really concerned about political campaign activity by (c)(4)'s, (5)'s and (6)'s, prohibit it; any organization that engages in political campaign activity in any amount that wants exemption should be subject to disclosure rules as Lloyd Mayer and others have argued - that is, shuffle them to 527 or some similar regime.

To actually solve the problems that led to the current mess, we need both bright line tests to distinguish between issue advocacy and political activity AND we need a bright line on how much activity is permitted.  In the case of political campaign activity, "NONE" is a nice bright line that is mostly (not completely, I'll admit) incapable of exploitation . . . 

JDC

[This represents a bit of change to my position, by the way - I'm actually OK with a 501(c)(4) category for organizations whose primary purpose is issue advocacy, including lobbying, IF such organization is prohibited from ANY campaign activity.  It's probably a good thing to have such an organization that is also prohibited from receiving deductible contributions under 170 in order to avoid having (c)(3)'s used to end-run the 162(e) limits on the deductibility of lobbying expenses, and I'm also convinced there is a useful public benefit to issue advocacy.]

 

 

 

 

Reporting Program Service Expenses on the 990

Just as a follow up to yesterday's post on the Oregon spendig requirement, I took a quick look again at the Form 990 (go to page 10) and its instructions regarding the allocation of program service expenses (go to pages 41 through 43).   My personal favorite is the instruction on how to allocate indirect costs, which requires the charity to list everything as an administrative cost in column C (that being not a program service expense) and then to add a separate, self-created line under "Other" in which the charity is instructed to place a negative number in column C in order to allocate indirect costs to program service in B or to fundraising expenses in D.   So that's clear as mud -- no chance of error there.  

Also, take a look at the list of administrative expenses to be reported in column C and think about a smallish charity - one that does a full Form 990 but is still relatively small in terms of revenue and expense - for example, a small medical clinic.  The list in the instructions includes the CEO and staff by default (unless directly involved in program service oversight) as well as "costs of board of directors' meetings; committee meetings, and staff meetings (unless they involve specific program services or fundraising activities); general legal services; accounting (including patient accounting and billing); general liability insurance; office management; auditing, human resources, and other centralized services; preparation, publication, and distribution of an annual report; and management of investments."  I wouldn't be surprised if such a charity had issues, or at least is forced into taking a fairly aggressive position on indirect cost allocations.

When we think about fradulent charities, I don't think most of us think of these types of expenses.

Just a thought.  EWW

Oregon Now Requires 30% Program Spending

Thanks to Lloyd Mayer for pointing me to new legislation in Oregon that will disqualify state charitable contributions to organizations that spend less than 30% of their functional expenses on charitable programs.

H.B. 2060 was signed into law by Governor Kitzhaber on June 4, 2013 and goes into effect 91 days after the 2013 regular session of the Oregon Legislative Assembly ends. Specifically, the Oregon Attorney General can disqualify an organization from receiving state income tax deductible contributions if

the organization has failed to expend at least 30 percent of the organization's total annual functional expenses on program services when those expenses are averaged over the most recent three fiscal years for which the Attorney General has reports containing expense information. The calculation of program services expenses and total functional expenses shall be based on the amounts of program services expenses and total functional expenses identified by the organization in the organization's Internal Revenue Service Form 990 return or other Internal Revenue Service return required to be filed as part of the organization's report to the Attorney General.

Oregon H.B. 2060, Section 2(1) (emphasis added).  There is an appeal procedure that would allow the charity to show that payments were made to affiliates, were being accumulated for capital campaigns, or  "such other mitigating circumstances as may be identified by the Attorney General by rule."  Section 2(2)(c).  A disqualified charity is required to notify its donors that donations to it are not deductible.  Interestingly, a disqualification order may not be issued to "an organization that receives less than 50 percent of the organization's total annual revenues from contributions or grants identified in accordance with Internal Revenue Service Form 990 or an equivalent form" (fee for service charities, rejoice!)  Section 2(4)(g).  The legislation can be found here.

There are a number of issues that first came to mind when I read this legislation.  

• The first, of course, is the fallacy that a certain level of  "program service" expenditures  is an appropriate indicator of a charity's effectiveness.  Even if it were an appropriate measure, why set it at 30%?  Why exempt fee-for-service charities?  Why exempt small charities?  (On this topic, see GuideStar, BBB Wise Giving Alliance, and Charity Navigator on the “Overhead Myth”).
• At least in the short term, this legislation punishes the wrong party - a charity's donors - by disallowing the state income tax charitable deduction.   It does appear to also take away the ability of the charity to be tax exempt and, of course, in the long term, the charity's donor base could essentially disappear. 
• Along those same lines, I am concerned that you could have a charity that is disqualified due to a temporary blip in financials and is then required to send a donor notice.  Even if that charity is subsequently rehabilitated, it is permanently damaged.  The state has now devalued one of the charity's most valuable assets: its donor list.   The Oregon Attorney General's press release talks about targetting bogus charities - I'm not convinced initially that its scope will be so limited.
• Finally, as is pointed out in this commentary by Nonprofit Quarterly, the error rate on preparing the Form 990 is ridiculously high.  I am somewhat troubled by the assertion by the Nonprofit Association of Oregon that organizations that make a reasonable attempt to allocate expenses won't get caught in this trap.  In my experience, even sophisticated clients with paid accountants regularly misstate program service expenditures.  (I note that the Nonprofit Association takes the position that only full Form 990 filers (not N or EZ filers) would be affected by the legislation.)

Thoughts, especially from our Oregon friends?  EWW        

 

 

CNN to Showcase "Worst Charities" Investigation

CNN's AC360 will tonight focus on the 50 Worst Charities investigation we blogged about yesterday.  The show airs at 8:00 p.m. and 10:00 p.m. ET.  I'll be watching; I hope you will, too.

VEJ

Judge Orders Company to Pay $3 Million for Sham Fundraising

Yesterday we blogged about the nation's 50 worst charities.  We wondered just what can be done to stop these organizations from taking advantage of an unsuspecting public.  As if in answer to our query, Newsday is reporting that a New York judge has ordered a fundraising company that duped people into giving money to a sham breast cancer charity to pay $3.1 million in restitution. Nearly all of that money will be given to legitimate breast cancer charities through a fund set up by New York State Attorney General, Eric Schneiderman, who brought the action against the Lindenhurst, New York-based Campaign Center, Inc., and its principal, Garrett Morgan of West Islip, New York.

Labelling charitable fundraising scams as "among the lowest of the low," Attorney General Schneiderman praised the decision by New York State Supreme Court Judge Emily Pines.  According to Mr. Schneiderman, "This decision proves that New York fundraisers will be held accountable when they defraud the public and line their own pockets."  He went on to state that the charity played on people's emotions to get them to donate money in the hopes of fighting breast cancer, but little of the money ever went to research or medical services

Judge Pines' decision said that from 2005 to 2011, the Campaign Center raised $4.9 million on behalf of the charity but kept $3.9 million for itself. During those years, the decision continued, fundraisers, including the Campaign Center, raised $10 million for the Coalition Against Breast Cancer, but the charity only spent 4 percent of that on charitable purposes, according to the judge's decision.

Well, someone is doing something!

VEJ

Miller Publishes "Fixing 501(c)(4): Recalibrating the Tax Subsidy for Lobbying and Political Activity"

David S. Miller (Cadwalader, Wickersham & Taft, New York) has published Fixing 501(c)(4): Recalibrating the Tax Subsidy for Lobbying and Political Activity.  The abstract follows:

While the surge in 501(c)(4)s that led to the current IRS scandal is widely attributable to Citizens United, it was a very deliberate IRS action – the decision to exempt donations to 501(c)(4)s from gift tax – that was equally responsible for the unprecedented spending by 501(c)(4)s in the 2012 election.

This paper describes the history of the gift tax as applied to donations to 501(c)(4)s, discusses the policy implications, and then proposes a legislative solution. 

First, under a "disclosure or tax" rule, donations to a tax-exempt organization that engages in any substantial amount of lobbying or campaigning would be exempt from gift tax only if the organization discloses the name of the donor in accordance with the rules in section 527.  

Second, any organization that engages in any substantial amount of lobbying or campaigning would be taxable on all its investment income.  

And finally, appreciated property donated to any organization that engages in a substantial amount of lobbying or campaigning would be treated as sold. 

The effect of these provisions would be an extension of the section 527 rules to organizations that substantially lobby or campaign, except that (i) any organization that substantially lobbies or campaigns would be subject to tax on all of its investment income (and not only the lesser of investment income and the amount spent on campaigning, as is the case today under section 527(f)), and (ii) the organization could keep the name of a donor anonymous if the donor were willing to be subject to gift tax.

VEJ

Michigan Senate Moves to Protect Art Collection at Detroit Institute of Arts

The Michigan Senate has passed a bill intended to protect the Detroit Institute of Arts art collection from sale in the event of a bankruptcy in the City of Detroit.

The Detroit Free Press reports that the Senate voted 24-13 to codify ethical standards adopted by the American Alliance of Museums which bars museums from selling artwork for purposes other than enhancement of the museum’s collection.  The bill now moves to the Michigan House of Representatives.

Detroit’s emergency manager, Kevyn Orr, recently stirred outrage when he said that he has to consider the value of all the city’s jewels when determining how to pull the city out of financial crisis.  Orr went on to say that he was evaluating the DIA’s art collection and preparing in case creditors seek repayment of their debts through asset sales.

VEJ

Tampa Bay Times: America's 50 Worst Charities Rake in More Than $1 Billion For Corporate Fundraisers, Give Little to Charitable Causes

A special report published in the Tampa Bay Times contends that over the past decade, the nation's 50 worst charities paid more than $1 billion to for-profit corporations but gave very little to charitable causes.  The report comes at the conclusion of a yearlong investigation by the Times and The Center for Investigative Reporting.

Using state and federal records, the Times and CIR identified nearly 6,000 charities that have chosen to pay for-profit companies to raise their donations.  The investigators then reviewed records over the past decade to zero in on the 50 worst such charities, based on the money they diverted to boiler room operators and other solicitors during that time period.

According to the Times, these nonprofits adopt popular causes or mimic well-known charity names that fool donors. They then rake in cash, year after year, then pay their solicitors for their services.  Over the past 10 years, these payments have amounted to more than $1 billion.

Among the report's findings are:

• The 50 worst charities in America devote less than 4 percent of donations raised to direct cash aid. Some charities give even less. Over a decade, one diabetes charity raised nearly $14 million and gave about $10,000 to patients. Six spent nothing at all on direct cash aid.

• Even as they plead for financial support, operators at many of the 50 worst charities have lied to donors about where their money goes, taken multiple salaries, secretly paid themselves consulting fees or arranged fundraising contracts with friends. One cancer charity paid a company owned by the president's son nearly $18 million over eight years to solicit funds. A medical charity paid its biggest research grant to its president's own for-profit company.

• Some nonprofits are little more than fronts for fundraising companies, which bankroll their startup costs, lock them into exclusive contracts at exorbitant rates and even drive the charities into debt. Florida-based Project Cure has raised more than $65 million since 1998, but every year has wound up owing its fundraiser more than what was raised. According to its latest financial filing, the nonprofit is $3 million in debt.

• To disguise the meager amount of money that reaches those in need, charities use accounting tricks and inflate the value of donated dollar-store cast-offs — snack cakes and air fresheners — that they give to dying cancer patients and homeless veterans.

The question we must answer is this: what can we do to put an end to this conduct?  Should the federal government act?  The state governments?  I do not know, but I am convinced that the public would benefit greatly if these so-called charities are made to account for every penny they raise.

VEJ   

Mountanos v. Commissioner - Deduction Denied for Failure to Prove Conservation Easement Had Value

In a June 3, 2013, memorandum opinion, Mountanos v. Commissioner, T.C. Memo. 2013-138, the Tax Court sustained the IRS’s disallowance of a $4.6 million deduction claimed for the 2005 donation of a conservation easement encumbering 882 acres of undeveloped land in Lake County, California. The land is almost completely surrounded by federal land and, at the time of the donation, was accessible only through neighboring properties (the Bureau of Land Management had granted the taxpayer limited access to the property for single-family use) and was subject to a Williamson Act contract under California law that limited the land’s use and development. In addition, a permit was required to divert water for private use from the creek flowing through the property.

The IRS disputed the value of the conservation easement and the court found that the taxpayer failed to show that the easement reduced the value of the land.

The Tax Court agreed with the taxpayer’s valuation experts that the highest and best use (HBU) of the land after the easement donation was for recreation. However, the Tax Court found that the taxpayer failed to show that the HBU of the land before the donation was, in part, a vineyard and, in part, either a 22-lot residential development or a subdivision for unspecified uses.

With regard to use as a vineyard, the taxpayer failed to show that there was the necessary legal access or water supply, that there was demand for vineyard-suitable property in the county, or that vineyard use was economically feasible.

With regard to use as a residential development or a subdivision (i) the taxpayer’s valuation experts failed to take into account the restrictions imposed by the Williamson Act, (ii) neither the taxpayer nor the IRS provided the court with the Williamson Act contract relating to the land or a description of the contract’s terms, and (iii) the taxpayer failed to provide any evidence that the Williamson contract was scheduled to terminate for non-renewal or that it could be cancelled. Accordingly, the court looked to the purpose of the Williamson Act, which is to preserve agricultural and open space land and discourage premature urban development, and the general terms of Williamson Act contracts, which limit land to agricultural and compatible uses for ten or more years and automatically renew each year absent notice of non-renewal. The court found that the taxpayer, who had the burden of proof, failed to establish that vineyard use, residential development, or unspecified subdivision were permitted or probable uses of the land at the time of the easement’s donation. Thus, the taxpayer failed to prove that the HBU of the land before and after the easement donation differed, and it followed that the taxpayer failed to show that the easement reduced the value of the land. The court also found that the taxpayer was liable for a gross valuation misstatement penalty.

It is not uncommon for property to be subject to temporary development and use restrictions under state law provisions similar to the Williamson Act at the time of the donation of a conservation easement (numerous states have similar temporary agricultural land protection programs). In situations where property is subject to such temporary restrictions, the estimate of the “before” value of the property for purposes of valuing the easement should take into account the remaining tenure of the restrictions and any penalties or other conditions imposed on termination of the restrictions. The best evidence of such before value would be the sales price of land subject to similar temporary restrictions. In some cases, the before value of the property, even considering the temporary restrictions, may exceed the after value, and the donor would be entitled to a deduction for the difference. In Mountanos, the taxpayer failed to provide any evidence of the Williamson contract terms, the remaining tenure of the restrictions, or the conditions or limitations imposed on termination of those restrictions. Moreover, even if such evidence had been provided, the limited acess and water supply issues may have prohibited or limited vineyard use, a 22-lot residential development, or subdivision in any event. 

NAMcL

Testimony of Washington’s Involvement in 501(c)(4) Scandal

As indicated by some of the stories appearing under titles posted in today’s TaxProf blog, which continues its broad coverage of the IRS scandal(s) (thank you, Paul Caron!), testimony is emerging from the congressional hearings that at least one IRS attorney in Washington was heavily involved in the process of targeting conservative groups applying for recognition of exemption under Internal Revenue Code section 501(c)(4).  One significant story appears here in ABC News.  Here are some of the more poignant excerpts of the coverage:

Gary Muthert, an IRS agent there [in the Cincinnati office], said his local supervisor told him in March 2010 to check the applications for tax-exempt status to see how many were from groups with "tea party" in their names. The supervisor's name was blacked out in the transcript.

"He told me that Washington, D.C., wanted some cases," Muthert said of his supervisor.

Muthert said he came up with fewer than 10 applications. But after checking some of the group's websites, he noticed similar groups with "patriots' or "9-12 project" in their names, so he started looking for applications that mentioned those terms too.

Over a two-month period, Muthert said he found about 40 applications that mentioned tea party, patriots or 9-12 project — the latter being groups which aspire to reinstill a post-9/11 spirit of unity in the country. …

Muthert said his supervisor told him that someone in Washington wanted to see seven of the applications, so Muthert prepared the files. …

Elizabeth Hofacre, also an agent in the Cincinnati office, told investigators she was in charge of processing applications from tea party groups — once they were selected by other agents — from April 2010 to October 2010. Hofacre said her supervisor in Cincinnati, whose name was blacked out in the transcript, told her to handle the applications.

But, she said, an IRS lawyer in Washington, Carter Hull, micromanaged her work and ultimately delayed the processing of applications by tea party groups.

Hull is a lawyer in the division that handles applications for tax-exempt status. But, Hofacre said, his interest in the cases was highly unusual.

"It was demeaning," she said. "One of the criteria is to work independently and do research and make decisions based on your experience and education, whereas on this case, I had no autonomy at all through the process."

This testimony comes from the very people with whom many tax professionals (inside and outside of government) empathize.  The IRS is underfunded.  The exempt organizations division is overburdened.  There are indeed limits on the political activities of section 501(c)(4) entities, and it is not only appropriate but also imperative for agents to engage in the difficult process of determining, in a politically neutral manner, whether entities that plan to engage in them – be they tinted red or blue – will satisfy the admittedly ambiguous criteria for exemption.  The determination agents' jobs are hard enough.  I believe that we would do these agents a real injustice by dismissing their testimony or failing to follow where it leads.

Although much commentary on the controversy has, in my opinion, from the beginning been tainted by partisanship and is becoming even more so (again, in my opinion), we must not ignore the facts.  The facts stand apart from the political and policy implications that we draw from them.  We do not yet know all of the facts, but we should continue to welcome them.  Once we have all of the facts, we can then decide what to make of them.  Opinions, of course, will vary.  Nonetheless, the real facts may cause us all to revise the stories we are telling ourselves about the nature and significance of the whole affair.     

JRB

Developments in Controversy Surrounding American Academy of Arts and Sciences Chief

Following up on two previous posts this week, I see that the Boston Globe reports that Leslie Berlowitz, President of the American Academy of Arts and Sciences, will be taking some time off by her own choosing (whether or not without pay is not publicly known) while the Boston law firm of Choate Hall & Stewart looks into her administration.  The story says that Massachusetts Attorney General Martha Coakley approves of this development:

The announcement was made a day after Massachusetts Attorney General Martha ­Coakley's office contacted the board to find out how it was handling questions about ­Berlowitz's ­resume, compensation, and other issues.

On Monday, the Globe ­reported that Berlowitz earned total compensation of more than $598,000 in fiscal 2012, four times the median salary for the directors of all US nonprofits that size, according to a GuideStar USA survey.

Coakley's office, which oversees charitable organizations in Massachusetts, also planned to ask whether the board fully disclosed Berlowitz's executive perks, such as first-class air travel, on its tax forms.

"We are pleased that the ­executive board has retained ­independent counsel to conduct a full investigation into the questions and concerns that have been raised," said Coakley spokesman Brad Puffer. "Our office will continue to actively monitor this investigation and further action by the board to ensure it carries out its fiduciary responsibility."  

The Globe appears to be using this story to air out more than just the facts raising questions about Berlowitz’s presentation of her credentials and her compensation.  The report also details rather bizarre accounts of how she allegedly has mistreated employees.  Those interested in the specifics can find them in the story.

JRB

Pennsylvania Perspectives on Nonprofits’ Support of Local Governments

The Pittsburgh Post-Gazette features a story that presents a rather friendly spin on PILOTS and other financial contributions made by Pennsylvania nonprofits, ranging from donations derived from a local church’s vacation Bible school fundraiser for a police canine unit, to annual $30,000 PILOTS made by Seton Hill University.  Most of the story reflects a governmental perspective based on positive assessments of the contributions of nonprofits to the community, yet with expectations that nonprofits contribute financially to at least some functions provided by government. 

The article also floats another idea – that state law be modified “to assess a universal fee based on a building's square footage to offset some of a community's costs for fire, police, street repair and snow removal.”  Assessing nonprofits reasonable fees for certain government services, rather than either normal property taxes or case-by-case PILOTS, strikes me as an approach worth considering.     

JRB

Massachusetts AG to Question American Academy of Arts and Sciences

Yesterday, we blogged about a report that Leslie Berlowitz, President of the American Academy of Arts and Sciences, misrepresented that she held a doctoral degree on grant applications filed with the National Endowment for the Humanities, and that she has enjoyed a really generous compensation package.  Today, the Boston Globe reports that Massachusetts Attorney General Martha Coakley plans to contact the Academy’s board to determine how it is dealing with questions about Berlowitz's résumé and salary.  The Globe further reports that the AG intends to investigate whether the Academy fully disclosed Berlowitz's various job-related benefits on returns required to be filed under tax laws.   

JRB

43 Nonprofit Workers Sentenced to Prison in Egypt

The Washington Post reports that an Egyptian court has imposed prison sentences on 43 nonprofit workers, including 16 Americans (one of whom is the son of the United States Secretary of Transportation, Ray LaHood).   Only 11 (all of whom are Egyptian) received suspended sentences; the rest, including the Americans, were ordered to serve real jail time.  None of the American defendants are now in the country, although one stayed until the verdict was issued, according to the story.  The verdict, says the Post, “also ordered the closure of the offices and seizure of the assets in Egypt belonging to the U.S. nonprofit groups and a German organization for which many of the defendants worked.”  These nonprofits include the International Republican Institute, the National Democratic Institute, Freedom House, and Konrad Adenauer Foundation. 

What did these groups do that the Egyptian court found so objectionable?  The Post reports that the nonprofit groups were engaged in democracy training.  They were alleged to have fostered protests in 2011 against the military following Hosni Mubarak’s departure.  Secretary of State John Kerry and several U.S. Senators reportedly have denounced the verdict as politically motivated and inconsistent with Egypt’s movement towards democracy.

Concern over the treatment of nonprofits in Egypt is apparently very high.  The Post explains that President Mohamed Morsi “has proposed a controversial bill regulating NGOs, soon to be debated by the interim, Islamist-dominated parliament,” which “would allow the state to control nonprofits’ activities as well as their domestic and international funding,”  according to Human Rights Watch.  The story continues:

In a joint statement last week, 40 Egyptian rights groups accused Morsi’s Muslim Brotherhood and its political arm of seeking to curb the freedom of rights groups through legal restrictions. They said the proposed law potentially gives Egypt’s security apparatus the power to suppress rights group[s], drawing parallels to Egypt’s recent past under Mubarak’s 29-year rule.

These human rights organizations also are reported to have “expressed fears that foreign nonprofits would be treated with hostility and that vaguely worded legislation would hinder operations or the issuance of work permits.”

 JRB

American Academy of Arts and Sciences Chief under Scrutiny

The Boston Globe reports that Leslie Berlowitz, President of the American Academy of Arts and Sciences, misrepresented that she held a doctoral degree from NYU on at least two grant applications filed with the National Endowment for the Humanities.  The story also asserts that she misstated her work history at the school.  Purported copies of the grant applications were made available here.  The Globe further notes that “[i]ncluding false information in federal grant applications … could potentially violate two separate statutes.” 

In addition, the Globe reports that Berlowitz’s total compensation was almost $598,000 for the fiscal year ending March 2012, and that she “also frequently travels first class, dines on meals prepared by the academy’s caterer, and requires staff to chauffeur her between the office and her apartment building along the Charles River in Cambridge, according to former board members and employees.” Will disclosure of this information prompt a governmental inquiry?  It is too early to tell. The Globe continues:

[Massachusetts] Attorney General Martha Coakley, who is charged with overseeing charities in Massachusetts, declined to say Tuesday whether she planned to examine Berlowitz’s pay, which the Globe found to be higher than the salary of most college presidents.

For a presentation of the facts that is more favorable to Berlowitz’s actions, see this coverage in the New York Times.  The Times reports that Louis W. Cabot, chairman of the Academy’s executive board, describes Berlowitz as having the board’s “unqualified support.”  Further, according to both newspaper accounts, the Academy blames the misstatements on a staff error and states that Berlowitz’s résumé on file with her employer does not contain the inaccurate information. 

JRB