Wednesday, February 26, 2014
Though I didn't plan it this way, my series of blog posts this week seem to be taking a look at the commercialization of charities. So this story in the St. Louis Post Dispatch provides one more data point regarding my arguments from Monday: nonprofit hospitals do not have a "primary purpose" that is charitable; instead, their primary purpose is to provide high quality (and in some cases, more efficient) health services for a fee.
Ascension Health is a prototypical example of the hospital that was once a charitable organization and has now morphed into a multi-billion-dollar vertically-integrated health care business. The article details how Ascension, once run by a religious order with a mission to create schools for orphans and hospitals for the poor morphed into the multi-layer, multi-entity health-care giant that last year reported $17 billion in revenue, including over $2 billion in non-operating revenue from investments. To ice the cake, Ascension opened the first phase of a $2 billion "health city" complex in . . . the Cayman Islands, where they hope to better master the efficient delivery of heart surgery.
This, folks, is what passes today for "charity." Ascension notes that it spent about 3% of revenues on a variety of charity care and "community benefit" services. While I have long been skeptical of "community benefit" as the standard for tax exemption for nonprofit hospitals, even if I accept this test, 3% hardly seems to support the notion that Ascension has a primary purpose that is charitable. Providing schools for orphans and hospitals a majority of whose patients are poor would seem to me to be a primary "charitable" mission. But that isn't even close to what Ascension is anymore.
Again, I have no quibble with Ascension or any other health care system doing what they do best: pushing the envelope of high-quality health care; innovating in health care technique and delivery (e.g., the Cayman Island venture). That's a wonderful mission; when I get sick, I want to be treated by such a system. But that's not a charitable mission. It surely is a mission that is important to society; so is Apple Computer's mission to produce cutting-edge electronics devices that revolutionize communications (many of which, by the way, are now used routinely by doctors and other health care providers in providing health services), or Intel's mission to be on the cutting edge of computer processor design (also a key component in modern health care services), or BMW's mission to provide some of the safest cars on the road that also happen to be fun to drive (OK, I can't really link that one to health care; but BMW takes auto safety very seriously and also provides police cars to a lot of Europe; do they have a primary charitable mission of enhancing public safety? Obviously not).
So I'll end my recent troika of posts on the commercialization of charity with the same question I started with on Monday. Why is it so hard for us to accept that the mission of nonprofit hospitals has changed dramatically over the past century or even over the past 50 years? Why is it that when hospitals complained in the late 1960's that the newly-passed Medicare and Medicaid programs would eliminate the need for charity care (talk about hilariously-bad prediction of the future!) and thus make it impossible to meet the IRS's charity standard for exemption, the IRS responded by changing the standard, instead of saying "Well, guys, you know what? If that turns out to be true, then I guess you won't be charities any more!"
Is it really that hard to tie charitable tax-exemption to the way organizations run today, as opposed to how they ran 100 years ago? I guess so.
Tuesday, February 25, 2014
An article in the Nonprofit Quarterly notes that there is a bill in the Kansas legislature that would strip state property tax exemption from local YMCA's (the bill targets exemptions for any service provider that receives more than 40% of its revenues from "the sale of memberships or program services"). Meanwhile, at the same time Kansas is considering another bill to give tax breaks to for-profit gyms. Sigh . . .
The issues here are related to my post yesterday about charities that are essentially commercial businesses. As I noted in this post a couple of years ago, many Y's appear to be more like for-profit gyms than charities. I pointed out in that post that my local Y in Champaign, IL had recently moved into a brand new facility on the far west side of town from an older facility near the center of the city, and about as far as you can get from any minority or disadvantaged population and still be a part of the city of Champaign. The move was accompanied by an ad campaign touting the benefits of the move as "more value and flexibility for our members! For example, you can work out in the 9,000 square foot fitness center and then take your family to the indoor pool and water slide. Or, you can take advantage of some of our two facilities' specialized programs, like water aerobics or recreational gymnastics."
Now, just because charities compete in some way with for-profit enterprises doesn't make them a commercial business. The fact that the Salvation Army runs thrift stores doesn't make its primary mission one of selling used goods. But I noted yesterday that some organizations that might historically have had a charitable mission have essentially morphed into commercial businesses, because their real "primary" mission is no longer charitable. I think that many (not all) Y's have passed this rubicon just as surely as nonprofit hospitals, major college athletics, and the USOC.
The Nonprofit Quarterly article quotes the CEO of Topeka's Y saying that if they have to pay taxes, that will be the end of the Y. I wonder . . . I have a sneaking suspicion that if the Champaign Y lost tax exemption, it would soldier on with maybe a $50/mth membership, instead of $47/mth. Topeka, Kansas might have a different clientele . . . or maybe not.
Monday, February 24, 2014
In a recent column in Forbes, Howard Gleckman asked why the US Olympic Committee is tax-exempt. After all, he notes, "The law says tax exempt status is granted to groups that 'foster national or international amateur sports competition.' But do the hyper-marketed modern games even remotely fit the ideal of amateur sports?" A bit later, he follows with the observation that "By almost any standard, [the USOC] is a commercial enterprise. It exists primarily to help organize a bi-annual made-for-TV entertainment extravaganza. Yes, it provides some support for athletes (though surprisingly little). But its real business is marketing itself and playing its part in a two-week orgy of athletic commercialization."
Welcome, Howard, to the modern world of charitable tax-exemption. Substitute "college sports" in the quotations above and you would have an equally accurate description. And it would hardly be inaccurate to say "By almost any standard, private nonprofit hospitals are commercial enterprises." (And at least some research universities may be heading in that direction). So what might we do about the commercialization of the modern charity?
One thing we could do is take the "primary purpose" rule seriously and apply it with an honest recognition of the way certain organizations operate in the modern world. A charity is supposed to engage in activities that "primarily" futher a charitable purpose. Does anyone really believe that a typical private nonprofit hospital "primarily" pursues a charitable purpose? I certainly don't - private nonprofit hospitals' primary mission is to provide the highest-quality health care they can for a fee. That's an admirable mission, one I heartily support, and one that our nonprofit hospitals mostly excel at; but it is in no way, shape or form "charitable." I could say the same thing about the Olympics or college athletics - these activities, whatever their origins, are hardly about "amateur" athletics any more. The Olympics are a showcase for pros at their sports (men's hockey, anyone?) and big-time college athletics (Division I men's basketball and FBS football) are nothing more than minor leagues for the pros.
I don't know why it is so hard for tax policy to recognize that activities change over time, and things that may once have been charitable might not be today. Nonprofit hospitals were unquestionably charities in the 1800's, when they were essentially homeless shelters staffed by religious volunteers. That model no longer exists. The Olympics were at one time truly about amateur athletics, just as college sports at the enactment of the UBIT in 1950 mostly involved real student-athletes. No longer. Things change, but we refuse as a policy matter to re-examine charitable exemptions in light of changed circumstances. From time to time there have been proposals to require charities to "re-qualify" for exemption every so often (every 5 years, or 7 years or 10 years, for example). But these proposals won't "get it right" if we don't update our views about whether certain activities are charitable or not.
So, Howard, I have an answer to your question: analytical inertia. Our views of charitable activities seem frozen in time. Until we get over it, commercial activities will continue to dominate certain "charities" that are not charities at all.
Sunday, February 16, 2014
Should proposed definition of “candidate-related political activity” apply to 501(c)(3) public charities?
The Evangelical Council for Financial Accountability (ECFA) submitted comments to the U.S. Department of Treasury and to the IRS. Generally, the ECFA’s comments press for “more freedom and greater clarity in the rules governing political activity by tax-exempt organization.”
The comments are in response to the proposed guidance the Treasury and IRS gave last November. While the Treasury and IRS requested “comments from the public” the guidance given by the Treasury and the IRS was meant to help 501(c)(4) tax-exempt social welfare organizations “on political activities related to candidates that will not be considered to promote the social welfare.” The EFCA comments were based on recommendations from the Commission on Accountability and Policy for Religious Organizations.
President of ECFA Dan Busy offered the following four key comments on the proposed guidance:
1) "The Treasury and the IRS should proceed with great caution in applying the proposed 'candidate-related political activity' test to 501(c)(3) organizations."
2) "Replacing the 'facts and circumstances' approach with a clear-cut definition of political activity would benefit charities and the IRS."
3) "The proposed 'candidate-related political activity' test would silence charities from speaking out on issues with political significance."
4) "The Commission's recommendations strike a necessary balance of permitting charities to engage in communications that are relevant to their exempt purposes while ensuring that they expend funds in a manner consistent with their tax-exempt purposes."
If the Kansas legislature passes House Bill 2498 there would no longer be a property tax exemption for “organizations providing humanitarian services with more than 40 percent of revenue derived from membership sales.” The taxation of YMCAs seems to be a hot topic in Kansas because of Senate Bill 72, which would give a “property tax break to the for-profit fitness clubs across Kansas.”
The chief executive of Greater Wichita YMCA, Dennis Schoenebeck, claims leveling the playing field among nonprofit organizations and for-profit companies engaged in fitness programs ignores their diverse missions.
What arguments can me made to support Schoenebcek’s claims? Are YMCA organizations entitled to property tax-exemptions or have they become too much like for-profit corporations? What is troubling, if anything, about private gyms viewing YMCAs as competitors and not charities?
Tuesday, February 11, 2014
A new Nevada law is receiving a lot of praise for the transparency it provides potential donors. The law, Assembly Bill 60, went into effect on January 1 after the Nevada Legislature approved it last year. The new law is a charitable solicitation registration law that requires Nevada nonprofit corporations to register with the secretary of state before soliciting tax-deductible charitable contributions within Nevada.
In addition to the “exact name of the corporation registered with the Internal Revenue Service, the federal tax identification number…[and] the purpose” of the organization, the registry also includes the names and contact numbers of officers and the “name or names under which it intends to solicit charitable contributions.”
At least one fan of the law has said it provides transparency by giving potential donors the information they need to determine whether a nonprofit is a “legitimate nonprofit entity.”
Is this statement true? Do charitable solicitation registration laws like Nevada’s actually provide potential donors all the information they need to make this determination? What else might a potential donor need to know?
Monday, February 10, 2014
A Minneapolis news station received emails from viewers during last week’s Super Bowl asking, “What does it take to be a nonprofit?” The emails came from those viewers curious about the NFL’s nonprofit status.
The station’s response article quotes several people who each shed some insight on the characteristics and justifications of nonprofit organizations.
Jay Kiewdrowski, a nonprofit management teacher, explains “a nonprofit is an organization that exists to accomplish a mission that’s community oriented…They’re not in existence to make money, they’re not owned by shareholders, there are no shareholders.” Michaela Charleston of the Minnesota Council of Nonprofits is quoted stating nonprofits “provide people with services and assistance that are unmet by government and for-profit sectors.”
The article also quotes attorney for the NFL, Jeremy Spector, who explains that the tax-exempt status only applies to the NFL league office, not the “NFL that fans think of every Sunday.”
The NFL league office is funded by fees from all 32 NFL teams and is responsible for writing the rules of the game, scheduling games, negotiating collective bargaining agreements, hiring referees, and more. Spector also explains the NFL league office “does not receive income from game tickets, television contracts and the like.”
The article provides the IRS rule for tax-exempt business leagues like the NFL: “To be exempt, a business league’s activities must be devoted to improving business conditions of one or more lines of business as distinguished from performing particular services for individual persons.”
What justifications or theories of tax-exemption do Kiewdrwoski and Charleston advance? Are these theories consistent with Spector’s explanation of the role of the NFL league office and the IRS rule for tax-exempt business leagues?
Saturday, February 8, 2014
As noted by TaxProf Blog, David Cay Johnston (Syracuse) has written a piece in State Tax Notes that highlights the ability of certain high-income donors living in Arizona to combine Arizona tax credits with the federal charitable contribution deduction to actually make money by giving to charity. This is because each of the state tax credits reduce state income tax liability dollar-for-dollar, thereby allowing the taxes saved through the federal income tax deduction to be all profit. According to Johnston, a married couple in the top federal income tax bracket can make almost $1,300 off charitable contributions of just under $3,300, or almost a 40 percent return.
Brian Galle (Boston College) and David Walker (Boston University) have posted Sunshine, Stakeholders, and Executive Pay: A Regression-Discontinuity Approach on SSRN. Here is the abstract:
We evaluate the effect of highly salient disclosure of private college and university president compensation on subsequent donations using a quasi-experimental research design. Using a differences-in-discontinuities approach to compare institutions that are highlighted in the Chronicle of Higher Education’s annual "top 10" list of most highly-compensated presidents against similar others, we find that appearing on a top 10 list is associated with reduced average donations of approximately 4.5 million dollars in the first full fiscal year following disclosure, despite greater fundraising efforts at "top 10" schools. We also find some evidence that top 10 appearances slow the growth of compensation, while increasing fundraising and enrollment, in subsequent years. We interpret these results as consistent with the hypothesis that donors care about compensation and react negatively to high levels of pay, on average; but (absent highly-salient disclosures) are not fully informed about pay levels. Thus, while donors represent a potential source of monitoring and discipline with respect to executive pay in the nonprofit sector, significant agency problems remain. We discuss the implications of these findings for the regulation of nonprofits and for our broader understanding of the pay-setting process at for-profit as well as nonprofit organizations.
Alicia Plerhoples (Georgetown) has posted Delaware Public Benefit Corporations 90 Days Out: Who's Opting In? on SSRN. Here is the abstract:
The Delaware legislature recently shocked the sustainable business and social enterprise sector. On August 1, 2013, amendments to the Delaware General Corporation Law became effective, allowing entities to incorporate as a public benefit corporation, a new hybrid corporate form that requires managers to balance shareholders’ financial interests with the besat interests of stakeholders materially affected by the corporation’s conduct, and produce a public benefit. For a state that has long ruled U.S. corporate law and whose judiciary has frequently invoked shareholder primacy, the adoption of the public benefit corporation form has been hailed as a victory by sustainable business and social enterprise proponents. And yet, the significance of this victory in Delaware is premature. Information about the number and types of companies opting into the public benefit corporation form has been preliminary and speculative. This article fills that gap. In this article, I present original descriptive research on the 53 public benefit corporations that incorporated or converted in Delaware within the first three months of the amended corporate statute’s effectiveness. Based on publicly available documents and information, I analyze these first public benefit corporations with respect to the following characteristics: (1) year of incorporation as a proxy for corporate age, (2) industry, (3) charitable activities, (4) identified specific public benefit, and (5) adoption of model legislation options not required by the Delaware statute. My analysis returns the following results: 75% of public benefit corporations are likely new corporations in their early stages of operation; 32% of public benefit corporations provide professional services (e.g., consulting, legal, financial, architectural design), the technology, healthcare, and education sectors each represent 11% of public benefit corporations, 10% of public benefit corporations produce consumer retail products; approximately 40% of public benefit corporations could have alternatively incorporated as a charitable nonprofit exempt from federal income taxes. This article discusses these and other findings to assist in understanding the public benefit corporation and how it has been employed within the first three months of its adoption.
Matthew Rossman (Case Western Reserve University) has posted Evaluating Trickle Down Charity – A Solution for Determining When Economic Development Aimed at Revitalizing America's Cities and Regions is Really Charitable on SSNR (Brooklyn Law Review, forthcoming). Here is the abstract:
As our nation's philanthropic sector becomes more entrepreneurial, ambitious and influenced by the private sector, longstanding legal standards on what constitutes "charity" struggle to stay relevant. More and more often, organizations that seek classification by the Internal Revenue Service as a Section 501(c)(3) charity (and the substantial public subsidy that this status unlocks) are not the soup kitchens and homeless shelters of yesteryear, but highly sophisticated ventures which accomplish their missions in ways that are less obviously charitable. In no case is this more true than in the recent widespread emergence of nonprofit organizations whose primary activity is providing direct aid to for-profit businesses.
This Article examines this trend and coins the phrase “trickle down charity” to encapsulate the analytic challenge these organizations (which the article terms REDOs, short for “regional economic development organizations”) pose when they seek classification as a charity. REDOs hope that the privately-owned, profit-seeking ventures they aid will ultimately help those in need in the form of jobs and a flourishing economy. While influential and, in some cases, transformative to cities and regions in economic distress, REDOs turn the traditional charitable services delivery model on its head by advancing private interests first and betting that benefit to a charitable class will follow. By relying on standards designed for more conventional charities, current IRS scrutiny of this new model is outdated, inconsistent and mistimed. The most significant consequence of this imprecision is that the publicly funded subsidy American laws have created to incentivize charitable work may be misused to support organizations that are not really charitable while subtracting from the pool of funds available to those that clearly are.
To solve this problem, I propose that the IRS rely on the law of charity’s often overlooked and sometimes maligned “private benefit doctrine.” Specifically, this doctrine should inform new IRS procedures that (1) require all REDOs to make a more compelling demonstration of the nexus between their activities and the accomplishment of charitable purposes and (2) provide a system of ongoing accountability with respect to those claims. Enlivening, rather than ignoring, the private benefit doctrine in this way will not only address the problem of regulating REDOs but should also serve as a useful template for the IRS in examining other emerging forms of 21st century charity and, thus, in maintaining the overall integrity ofthe philanthropic sector.
The IRS issued proposed regulations relating to how much income 501(c)(9) voluntary employee beneficiary associations, 501(c)(17) supplemental employment benefit trusts, and 501(c)(20) group legal services organizations may set aside as exempt function income that is excluded from unrelated business taxable income and so exempt from the unrelated business income tax. While that exhausts my knowledge of the substance of the proposed regulations, what is striking is that the proposed regulations replace proposed regulations issued in 1986 to implement a 1984 statutory change. Affected groups have not been without guidance for all of this time - temporary regulations were issued in 1986 as well - but the fact that the guidance has yet to be finalized raises the question of what happened. Did the 1986 proposed regulation simply fall off someone's to do list? Did the employee taking the lead on these regulations retire? Of course, today the situation would have been more urgent because under 26 U.S.C. 7805(e), enacted in 1988, temporary regulations expire within three years after their date of issuance - but that provision did not apply retroactively to already issued temporary regulations.
Friday, February 7, 2014
According to TaxProf Blog we are now 274 days into the firestorm that erupted in the wake of Lois Lerner's acknowledgment last May that the IRS had used inappropriate criteria for selecting certain 501(c)(4) applications for additional scrutiny. The resulting controversy not only continues, but it has recently been renewed by another congressional hearing, controversial proposed regulations that are taking hits from both the left and the right, and cryptic legislation that may - or may not - change how and whether the IRS can enforce the existing limits on political activity by tax-exempt organizations.
House Economic Growth, Job Creation and Regulatory Affairs Subcommittee Hearing
Yesterday a subcommittee of the Committee on Oversight & Government Reform held a hearing where the witnesses uniformly blasted the executive branch's handling of the controversy. Their views were not a surprise, given they are all individuals who have been vocal in their criticism of how the Obama administration has handled this situation. The subcommittee also invited DOJ trial attorney Barbara Bosserman, who is leading the DOJ's investigation into this matter, to testify, but she chose not to do so. Despite its one-sided nature, the hearing illustrates that the continuing drumbeat of criticism is not fading away, and is unlikely to do so given . . .
Controversial Proposed Regulations
While I and others have commented that one likely consequences of this mess is that the IRS will be gun shy for some time, particularly when it comes to enforcing the limits on political activity by tax-exempt organizations, the Treasury Department as a whole cannot be criticized for a lack of boldness. The regulations it proposed in late November to redefine what would be considered political activity (or rather "candidate-related political activity") for 501(c)(4) organizations have already generated over 22,000 comments, and the deadline for submitting comments is not until the end of this month. While many comments have been supportive in part, most appear to give mixed reviews.
Some of the most detailed and thoughtful comments to date include the ACLU Comments and the Center for Competitive Politics Comments (which appear on a webpage also gathering some other comments, including ones focused on the paperwork burden imposed by the proposed regulations). Other groups working on commetns that likely will be worth the read are the ABA Tax Section, the Alliance for Justice, Independent Sector, and a coalition that is being spearheaded by Cleta Mitchell (Foley & Lardner) and John Pomeranz (Harmon, Curran, Spielberg & Eisenberg). The Bright Lines Project has also created a model comment that any organization or individual can customize and and then submit. Finally, Rep. Dave Camp has introduced legislation that woudl block finalization of the proposed regulations for a year.
Buried in the recently enacted omnibus spending bill were 68 words that may - or may not - change how and whether the IRS can enforce the current and future limits on political activity by tax-exempt organizations. As reported by Mother Jones, Public Law 113-76 included in the section relating to the Internal Revenue Service the following provisions:
SEC. 107. None of the funds made available under this Act may be used by the Internal Revenue Service to target citizens of the United States for exercising any right guaranteed under the First Amendment to the Constitution of the United States.
SEC. 108. None of the funds made available in this Act may be used by the Internal Revenue Service to target groups for regulatory scrutiny based on their ideological beliefs.
Given that the legislation did not repeal the limits on political activity found in section 501(c)(3) and the relevant charitable contribution provisions, nor did it explicitly address the current interpretation of section 501(c)(4) and other exemption provisions relating to political activity, to say the effect of these two provisions is unclear is to put it mildly. What is not unclear, however, is that these provision will provide an additional arrow for groups that challenge the IRS in court for denying exemption or examining them allegedly because of their political activity, so the courts will almost certainly need to resolve the actual effect of these provisions.
Tax Analysts recently forced the IRS to release thousands of pages of internal training materials for the exempt organizations determiniations unit. Included in the materials was a "Lesson Plan" on section 501(c)(4) organizations.
News outlets, and particularly the Washington Post, continue to publish accounts of how the Koch brothers created and funded a network of primarily tax-exempt organizations to further their political goals in previous election cycles. Recent articles include "Koch-Backed Political Coalition, Designed to Shield Donors, Raised $400 Million in 2012" and "A Rare Look Inside the Koch Brothers Political Empire".
There are a bevy of new leaders with in the Tax-Exempt/Government Entities Division at the IRS, including Sunita Lough (Commissioner, TE/GE), Donna Hansberry (Deputy Commissioner, TE/GE), Tammy Ripperda (Director, Exempt Organizations Division), and Robert Malone (Acting Director, Exempt Organizations Rulings & Agreements). They join continuing EO Division leaders Melaney Partner (Director, Exempt Organizations Customer Education & Outreach) and Nanette Downing (Director, Exempt Organizations Examinations).
Thursday, February 6, 2014
Both the Boston Globe and the Wall Street Journal report that a dispute in Massachusetts over a $172.87 property tax bill could undermine tax exemption for millions of acres held by land trusts nationwide. At immediate stake is the tax status of 120 acres of woodland owned by the New England Forestry Foundation. The bigger issue is whether merely preserving land for public use is sufficiently in the public interest to justify exempting them from property tax under applicable state and local laws, or whether instead some level of actively encouraging public use or otherwise providing public benefit is also required. Both property tax assessors for cash-strapped jurisdictions and nonprofit land trusts are closingly following the case. The Massachusetts Supreme Judicial Court heard arguments last month, and similar cases are working their way through the courts in a number of other states.
Over two years ago we noted that the Pearson Foundation, the charitable arm of major educational publisher Pearson, had allegedly paid for international trips by state education commissioners whose states did business with Pearson. The NY Times recently reported that the Foundation has now had to pay $7.7 million to resolve an inquiry by New York Attorney General Eric Schneiderman into whether the Foundation had been inappropriately aiding its for-profit counterpart. The funds will primarily go to 100Kin10, an effort to train more teachers in high-demand subject areas. The Foundation also agreed to program and governance changes to reduce its ties to Pearson.
According to the AG's press release, the inquiry focused not only on the international trips but also on whether the Foundation had been developing course materials aligned to the Common Core that Pearson then intended to sell commercially. After the inquiry began, the Foundation sold the partially developed courses to Pearson for $15.1 million. For its part, the Foundation's press release states that the Foundation fully cooperated with the investigation and always acted with the best intentions and in compliance with the law, but recognized that "there were times when the governance of the Foundation and its relationship with Pearson could have been clearer and more transparent."
The Economist reports that Britain's mutually owned, not-for-profit banks are increasingly converting to shareholder owned, for-profit institutions or collapsing. These "building societies," which dominated the residential mortgage market in the 1970s, have suffered from a variety of ailments, including poor management, high-risk lending, and a push for demutualization. Interestingly, the Economist appears to regret this development, noting the continuing success of Nationwide Building Society and commenting that "The model is worth preserving. Mutuals have tended to offer better customer service; on average, they generate fewer complaints than other lenders. The fate of British mutuals notwithstanding, studies by the Bundesbank and the IMF suggest that, overall, mutual banks are more stable than their more commercial counterparts."
Wednesday, February 5, 2014
In Private Letter Ruling 201405018 (Jan. 31, 2014), the IRS ruled that the tax-exempt status of an organization formed for the purpose of accepting, holding, and enforcing conservation easements and to convince owners of hunting land to make conservation easement donations should be revoked. The IRS determined that the organization was not operated exclusively for tax-exempt charitable purposes and, instead, operated as a conduit for its President, a CPA, to help his clients obtain sizable charitable deductions on their tax returns.
The IRS noted the following factors, among others, in support of its ruling.
Organization Was Vehicle for Enrichment of President’s Clients. The three transactions the organization had entered into were with entities connected to the President and his accounting practice (i.e., the President prepared the annual tax returns for one or more of the partners of the donating entities). This showed that the President’s intent and goals were not environmental or conservation, but rather that he used the organization as a vehicle for the enrichment of his clients, and this ran counter to the requirements in IRC § 501(c)(3) with regard to private benefit.
President Lacked Appropriate Knowledge, Training, and Experience. The President did not possess the knowledge, training, or experience to make educated decisions about whether a conservation easement serves a conservation purpose under IRC § 170(h)(4)(A). The President did not review one of the conservation easement deeds prior to signing and was unaware of the extensive rights retained by the donor until the IRS agent brought it to his attention (retained rights included the right to have two burrow [sic] pits, not to exceed two acres each, to be used for providing fill material for road repair on the property; the right to engage in not-for-profit and for-profit agricultural, farming, and aquacultural activities; the right to use agrichemicals to accomplish agricultural and residential activities permitted by the easement; and the right to extract minerals, gases, oil, and other hydrocarbons provided that the property is restored back to its natural state). In another transaction, the President failed to secure a conservation easement as intended, and instead received fee title to the land. This demonstrated the President’s lack of experience, knowledge, and willingness to act as a proper fiduciary for the organization. While the President represented that he had read a few articles and conducted some research on how an organization that accepts conservation easements should perform, his lack of knowledge and experience were strong indicators that the organization did not possess the “commitment” required under Treasury Regulation § 1.170A- 14(c) and was not operated for a charitable purpose.
Noncompliant BDRs and Monitoring and Inspection Reports. The President prepared all of the baseline documentation reports (BDRs) and monitoring and inspection reports, to the extent they existed. The President had no specialized training or general training in any area relating to the environment and did not possess “any specialized experience that would qualify him to perform these studies and inspections.”
The one-page BDRs for the three transactions the organization had entered into consisted of the barest of facts and were not substantiated by pictures, analysis, or expert opinion. There was no description of flora or fauna and each report contained a generic statement that referenced the natural characteristic of the land. The President stated that the BDRs were in accordance with Treasury Regulation § 1.170A-14(g)(5) because the regulation uses the word “may” instead of “shall” regarding what should be contained in a BDR. However, the President’s reliance on performing the bare minimum was an indication that the organization does not pursue conservation as a primary goal. The lack of detail in the BDRs also indicated that the organization does not possess the “commitment” required under Treasury Regulation § 1.170A-14(c).
The monitoring and inspection reports were even less descriptive than the BDRs. The inspection reports for one conservation easement contained one or two handwritten sentences that stated that no changes were noted. For another easement, the inspection reports were available but did not indicate what was done by the President in the way of ensuring compliance. For example, one report was extremely brief and stated “Walked by property. OK.” For the other property, there were no inspection or monitoring reports. After several months of inquiring as to the report whereabouts, the President wrote: “there are no written inspection reports. I often go by this property when riding my bicycle, but never made notes about it. The important thing is nothing has been disturbed.” This statement reflects that monitoring for compliance was not and is not a top priority for the President. This lack of vital documentation also demonstrates that the organization does not possess the commitment necessary for accepting, holding, and monitoring conservation easements.
Neither the BDRs nor the inspection reports conformed to the requirements in the Treasury Regulations. The documents did not in any way provide the information the organization would need to enforce the conservation easements. The documents and the lack of substantial information contained therein show that the main concern of the President was not the protection of open space or natural habitats, but the amount of deductions he could claim for his clients. BDRs and annual inspection reports that do not contain more descriptive information as to the type, quality, or full description of the land as well as the boundaries (i) do not meet the requirements of Treasury Regulation § 1.170(A)-14(g)(5) and (ii) are indicators of an organization that is not operating for conservation or environmental purposes.
Organization is Not Run as a § 501(c)(3) Charitable Organization. A number of factors indicated the organization is not run as a § 501(c)(3) charitable organization. There were no financial records beyond what was contained in bank statements. There were no solicitations to the general public for support, and no receipts, expense vouchers, or balance sheets prepared at year end. Considering the fact that the President was a CPA and an expert in this field, this situation was disturbing at best, and at worst demonstrated that the President had not been working in the best interests of the organization.
The fact that the organization had received only two conservation easements and one land transfer in four plus years showed that the commitment to perform as a conservation organization as described in the Treasury Regulations was not present. There were no educational events developed and sponsored by the organization, and the organization did not appear to hold itself out to the public as a charitable conservation organization, except through word-of-mouth and the President’s clients.
The organization was not operated in accordance with it Bylaws. There were no meetings of officers or board members and no elections. There were no internal controls and only the bare minimum with regard to records and recordkeeping. In essence, the President had sole control and was operating his own business under his own terms.
President’ lack of expertise in the area of conservation easements and the lack of detail in the BDRs and inspection reports showed that the organization does not have clear established criteria for accepting easements, nor adequate procedures in place for enforcing the easements. There was no one associated with the organization that had any formal education, training, or expertise in conservation matters and it is not known whether the appraisers that appraised the donated easements had qualifications in valuing conservation easements. The Organization's monitoring activities (such as they were) could not further a charitable purpose because there was no knowledge as to whether the easements the organization accepted served a conservation purpose. Moreover, there was no evidence that the organization possessed sufficient resources to enforce the easement restrictions in instances where a donor were to use an underlying property contrary to a conservation purpose.
Organization Was Not Operated Exclusively for an Exempt Purpose. The organization does not meet the requirements set forth in Treasury Regulation § 1.501(c)(3)-l(c)( 1). More than an insubstantial part of its activities consisted of the acceptance of conservation easements or property transfers for which there was not proper documentation, and the organization failed to establish that acceptance of the easements furthered an exempt purpose. In short, the organization failed to operate for a charitable conservation purpose.
The Organization also failed to meet the requirements set forth in Treasury Regulation § 1.501(c)(3)- l(d)(l)(ii) because it serves the private interests of the President and his clients. The presence of a single substantial non-exempt purpose precludes exemption under IRC § 501(c)(3). The organization exists not to serve the greater good of the general public, but rather to fit the needs of the President’s clients to have sizable deductions on their tax returns.
Organization Failed Public Support Test. The President calculated the public support percentage under IRC §§ 509(a)(1) and 509(a)(2) incorrectly. He failed to take into account that all monies received came from substantial contributors, which by definition are disqualified persons. When properly calculated, public support under both IRC §§ 509(a)(1) and 509(a)(2) was zero. As such, the organization cannot be considered publicly supported and, if revocation of exempt status is not pursued, reclassification to a private foundation should occur.
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A Private Letter Ruling is a written statement issued to a taxpayer that interprets and applies tax laws to the taxpayer's specific set of facts. A PLR may not be relied on as precedent by other taxpayers or IRS personnel. PLRs are generally made public after all information has been removed that could identify the taxpayer to whom it was issued. See Understanding IRS Guidance – A Brief Primer.
Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law
An Illinois Appellate Court recently affirmed the grant of summary judgment in favor of the Attorney General against Maxwell Manor, a charitable nonprofit corporation that operated a nursing home, and several of its directors and officers. The decision, People v. Manor, 2013 IL App. (1st) 113132-U, provides a case study of failure to comply with state law duties, including not only fiduciary duties but also registration and annual report requirements. The heart of the case was the decision by Executive Director JoeAnn McClandon to cause Maxwell Manor and the family partnership that owned the nursing home's building and land to jointly sell the nursing home to a third party for $13,500,000, followed by not only a failure to report the sale to the Attorney General but also a decision by Ms. McClandon to write a check to herself for $2 million, allegedly in repayment of previous personal loans she had made to Maxwell Manor. The court's opinion details the repeated failures under state law, including not reporting the alleged personal loans to Ms. McClandon on the required annual reports, the failure to report the sale or to file the required annual reports for the years after the sale occurred, and the failure to properly account for the $2 million transferred to Ms. McClandon. Not surprisingly, the court affirmed a $2 million judgment against Ms. McClandon, and also the removal of Ms. McClandon and two directors and officers, the dissolution of Maxwell Manor, and the distribution of the organization's remaining assets pursuant to cy pres.
While such situations are fortunately relatively rare, what is rarer still is having such a detailed account of the relevant facts and circumstances and a definitive court ruling laying out both the legal violations and the sanctions imposed. I think I may have found one of my fact patterns for the next time I teach Not-for-Profit Organizations.
NY Trial Court Orders Property Tax Exemption for Drug Policy Alliance HQ Despite Alleged "Advocacy" Focus
A New York court has granted the Drug Policy Alliance's petition for real estate property tax exemption for its New York City headquarters, rejecting the previous denial by the New York City Department of Finance, which had been affirmed by the New York City Tax Commission. In Drug Policy Alliance v. New York City Tax Comm'n, NY Slip Op 33273 (U), the court rejected the city agencies' argument that the Alliance's alleged primary focus on legislative and policy change disqualified it from exemption as an "exclusively" educational organization. The court noted that the Alliance already enjoyed exempt status under federal (501(c)(3)), state, and city authorities, a fact the Commission failed to mention in its decision, and that similar organizations had been granted exemption under a liberal interpretation of the relevant regulation. Given these conclusions, the court declined to reach the Alliance's constitutional claims that the denial was based on the content of the Alliance's public advocacy, which relates to reducing the harms of both drug use and drug prohibition.
While not a surprising result, this dispute indicates the continuing struggle many otherwise tax-exempt organizations face in convincing local authorities that the term "educational" as generally used in both federal and state law is broad enough to encompass public education and advocacy, including with respect to controversial issues. Kudos to the New York Civil Liberties Union Foundation, the Asian American Legal Defense Fund, and the Lawyers Alliance for New York for supporting the Alliance in this case through amicus briefs.
Tuesday, February 4, 2014
In Revenue Procedure 2014-11, the IRS revised the procedures that organizations should use to apply for reinstatement of their tax-exempt status if they have lost that status because of a failure to file required information returns three years in a row. The IRS has also provided a summary of the new procedures, which includes a process by which smaller organizations that were only required to file the Form 990-EZ or Form 990-N and that submit a new application for recognition of exemption within 15 months will not need to have reasonable cause for the failure to file and will also avoid any late filing penalties. Other, more demanding processes are available for groups required to file Form 990 or Form 990-PF and for groups seeking retroative reinstatement more than 15 months after their automatic revocation. As always, groups can instead simply seek prospective reinstatement by filing the required application.