Nonprofit Law Prof Blog

Wachter v. Commissioner—North Dakota Conservation Easements are Not Deductible

In Wachter v. Commissioner, 142 T.C. No. 7 (March 11, 2014), the Tax Court held that North Dakota law, which limits the duration of easements created after July 1, 1977, to a maximum of 99 years, precludes conservation easement donors in the state from qualifying for a federal charitable income tax deduction under IRC § 170(h) because easements in North Dakota cannot be granted “in perpetuity.”

The Tax Court in Wachter reiterated the fundamental principle that, while state law determines the nature of property rights, it is federal law that determines the federal tax treatment of those rights. Wachter confirms that a state can render all conservation easement donations in the state ineligible for the various federal tax incentives offered to conservation easement donors by enacting laws that prevent conservation easements from complying with federal requirements.

In Wachter, the IRS argued that North Dakota’s law limiting the term of all real property easements to 99 years prevents conservation easements in the state from satisfying both:

(i) IRC § 170(h)(2)(C)’s requirement that a tax-deductible easement be “a restriction (granted in perpetuity) on the use which may be made of the real property” and

(ii) IRC § 170(h)(5)(A)’s requirement that the conservation purpose of a tax-deductible easement be protected in perpetuity.

The Tax Court noted that these are two separate and distinct perpetuity requirements, and the failure to satisfy either of them will prevent an easement from being deductible under IRC § 170(h). The court held that North Dakota law precludes conservation easements in the state from qualifying as granted “in perpetuity” under both of these subsections.

The taxpayers in Wachter argued that North Dakota’s 99-year limitation should be considered the equivalent of a remote future event that does not prevent an easement from being considered perpetual. They cited Treasury Regulation § 1.170A–14(g)(3), which provides, in part, that

A deduction shall not be disallowed … merely because the interest which passes to, or is vested in, the donee organization may be defeated by the performance of some act or the happening of some event, if on the date of the gift it appears that the possibility that such act or event will occur is so remote as to be negligible.

This regulation merely restates a rule that applies to all charitable gifts (see Treasury Regulation § 1.170A-1(e)). The rule is intended to ensure that taxpayers are permitted to claim deductions for charitable gifts only if the donee (whether a government entity or charity) will actually receive and retain the gift for the benefit of the public. Thus, no deduction is allowed unless, on the date of the gift, the possibility that the donee’s interest would be “defeated” (i.e., that the property would be returned to the taxpayer and thereby removed from the charitable sector) is so remote as to be negligible.

The Tax Court in Wachter noted that the courts have construed the so-remote-as-to-be-negligible standard to mean:

'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' or '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.'

The Tax Court explained that the term “remote” refers to the likelihood of the event that could defeat the donee’s interest in the gift. It then explained that the likelihood of the event in Wachter that could defeat the donee’s interest in the charitable gifts of the conservation easements – expiration of the easements after 99 years - was not “remote.” On the date of the donation of the easements, the court explained, it was not only possible, it was inevitable that the donee would be divested of its interests in the easements by operation of North Dakota law. Accordingly, the easements were not restrictions granted “in perpetuity” and, thus, were not deductible under IRC § 170(h).

The courts have held that the so-remote-as-to-be-negligible standard cannot be invoked to cure a taxpayer’s failure to comply with specific requirements in the Treasury Regulations interpreting IRC § 170(h), including the mortgage subordination requirement (§ 1.170A-14(g)(2)), the judicial proceeding to extinguish requirement (§ 1.170A-14(g)(6)(i)), and the division of proceeds upon extinguishment requirement (§ 1.170A-14(g)(6)(ii)). See, e.g., Mitchell v. Commissioner, T.C. Memo 2013-204. This makes sense. The specific requirements in IRC § 170(h) and the regulations establish bright-line rules that promote efficient and equitable administration of the federal tax incentive program. If individual taxpayers could fail to comply with those requirements and claim that their donations are nonetheless deductible because the possibility of defeat of the gift is so remote as to be negligible, the IRS and the courts would be required to engage in an almost endless series of probability assessments with regard to each individual conservation easement donation. By including specific requirements in IRC § 170(h) and the regulations, Congress and the Treasury Department presumably intended to avoid just such inquiries.

Accordingly, it appears that taxpayers can invoke the so-remote-as-to-be-negligible standard with regard to an event that could defeat a gift of a conservation easement only if the event is not the subject of a specific requirement in IRC § 170(h) and the Treasury Regulations. One such event, provided as an example in Treasury Regulation § 1.170A-14(g)(3), is forfeiture of a conservation easement as a result of the donee’s failure to rerecord the easement under the applicable state’s marketable title act. The Treasury presumably assumed that the prospect of such forfeitures was so remote as to be negligible given that donees have a fiduciary obligation to protect the charitable assets they hold on behalf of the public and not transfer such assets to private parties. Another such event might be a tax lien foreclosure that could terminate a conservation easement. If the probability of such a foreclosure is so remote as to be negligible at the time of a conservation easement's donation, it should not render the easement nonperpetual.

Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law

Born This Way Foundation is most recent celebrity charity under heat

Together pop star Lady Gaga and her mother Cynthia Germanotta co-founded and lead the Born This Way Foundation, a 501(c)(3) whose mission is “to foster a more accepting society, where differences are embraced and individuality is celebrated.” This week the organization has been scrutinized as its 2012 form 990 surfaced on the internet showing $2.66 million in revenue with $1.85 million of that amount going to operational expenses. Critics question how the Born This Way Foundation can really serve its mission if it has been spending the organization’s money in the following manner:

• $406,552 on legal expenses;
• $348,000 on event productions;
• $150,000 on philanthropic consulting;
• $77,923 on travel; and
• A single $5,000 grant.

In the organization’s defense, Lady Gaga’s mother explained, “First and foremost, we are an organization that conducts our charitable activity directly, and we fund our own work. We are not a grant-maker that funds the work of other charities, and were never intended to be.” Germanotta also explained that Lady Gaga used her own money to cover the organization’s start-up costs, and that Gaga “uses her celebrity to constantly advocate on behalf of tolerance, individualism, and kindness.”

Are Germanotta’s arguments persuasive? What else might you need to know, if anything, about the organization, it’s mission, and it’s spending?

http://nypost.com/2014/03/12/lady-gagas-charity-short-on-actual-charity-tax-records/

http://www.foxnews.com/entertainment/2014/03/12/lady-gaga-giving-grievances-in-2012-stars-charity-spent-185-million-on-expenses/

http://www.nydailynews.com/entertainment/gossip/questions-rise-lady-gaga-foundation-spending-article-1.1720884

http://bornthiswayfoundation.org/pages/our-mission/

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New Hampshire nonprofits no longer fear proposed business enterprise taxes

New Hampshire nonprofits can breath a little easier now that the legislature has officially rejected a proposed bill that would have required the state’s largest nonprofit organizations to pay business enterprise taxes. The legislation would have “required nonprofits that earn more than $2 million in fees for service annually to pay the tax that is currently paid by businesses in the state with more than $150,000 in gross receipts.”

Currently, the business enterprise tax in New Hampshire is at 0.75%, but the bill would have “reduced that to 0.68% by including hospitals, universities, and other large nonprofits.”

David Hess (R-Hookset), the person who first introduced the bill, explained the bill targeted organizations “which receive a substantial amount of their revenue from ‘program service revenue.’” However, critics of the bill argued it would “put fragile nonprofits at too much risk” and it would “open the door to taxing nonprofits for earned revenue.”

https://nonprofitquarterly.org/policysocial-context/23809-new-hampshire-nonprofits-dodge-a-tax-bullet.html

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Atlanta City Council decide whether to donate taxpayer funds to community nonprofits

Members of the Atlanta City Council will soon debate and vote on whether they should be able to donate taxpayer funds to nonprofit community organizations and charities. Critics take issue with the fact that the office budgets of Atlanta City Council members exceed $100,000 annually.

Should elected officials be permitted to use public dollars to contribute to and support charities?  Why or why not? If so, should there be any limitations? Is there any other way for elected officials to support community charities without using taxpayer funds?

http://www.myfoxatlanta.com/story/24919609/atlanta-city-council-considers-using-taxes-for#axzz2vhl2yoL3

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Thoughts on recent charitable deduction proposal

Last week the Chairman of the House Ways and Means Committee, Dave Camp, proposed a 2% floor on charitable deductions. The 2% floor means a taxpayer “would have to contribute at least 2% of their income to charity in order to claim a deduction.”

The proposal seems to be getting mixed reviews among those in the nonprofit world.

Steve Taylor, senior vice president of United Way Worldwide, explains, “[p]eople in America of all income levels donate to charity, and they donate what they can. This proposal is a proposal that would impact more people who are in the middle class.”

Jan Masaoka, CEO of the California Association of Nonprofits, claims the 2% floor could potentially encourage more charitable giving as some people near the floor give more money to reach the 2%.

With the charitable deduction costing the United States government about $44 billion a year, is a 2% floor an efficient reform proposal? How do arguments like Taylor’s and Masaoka’s affect the analysis?

http://www.usatoday.com/story/news/politics/2014/03/03/tax-reform-charitable-contribution-floor/5885579/

http://www.foxnews.com/health/2014/03/10/capping-charitable-tax-deductions-will-hurt-nonprofits/

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New North Carolina tax law forces many nonprofits into higher admission costs

On January 1, 2014, a North Carolina state law took effect and “expanded the sales tax to admission charges for entertainment and live events, such as concerts, plays, movies museums, and professional and college sports.”

Many North Carolina nonprofit organizations now worry that the new law, which will add 6.75% to the cost of admissions, will hurt ticket sales.

Richard Whittington, managing director of a local professional theatre located in downtown Greensboro says the new law is “definitely disappointing.” Whittington explains the newly imposed tax “is something that we are having to add that doesn't help us further our goals or achieve our mission, which is to provide top quality theatre at prices the entire community can afford.”

Are the fears of the North Carolina nonprofit organizations legitimate? Is Whittington correct in his assessment that the new tax law does nothing to help further the goals or achieve the mission of the nonprofit theatre?

http://www.news-record.com/news/local_news/article_d484e564-a4d7-11e3-bcaa-001a4bcf6878.html

http://triadstage.org/

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Meridian International Center loses property tax exemption

The Meridian International Center (MIC) is an eminent nonprofit organization whose mission is “to create innovative exchange, education, cultural, and policy programs that advance three goals:

1)    Strengthen U.S. engagement with the world through the power of exchange;

2)    Prepare public and private sector leaders for a complex global future; [and]

3)    Provide a neutral forum for international collaboration across sectors.”

After enjoying a property tax exemption for 50 years, MIC lost it’s exemption after the Office of Tax and Revenue concluded the organization’s mission “does not directly benefit the residents of D.C. as the law requires.”

CFO Jeffrey DeWitt explains, “Meridian’s activities primarily focus on international affairs and strengthening international understanding through the exchange of people, ideas and culture between the United States and foreign countries….Based on a review of Meridian’s activities, OTR determined that Meridian did not meet the requirements for exemption as a public charity or school.”

However, in an attempt to distinguish MIC from other D.C. nonprofits whose tax exemptions were revoked for the same reasons, Ambassador Stuart Holiday argues that MIC does directly impact D.C. residents by working with school children, working with the D.C. government on international outreach, MIC’s museum is open to the people, it receives grants from the city, and it was chartered as an educational and cultural institution.

Are Holiday’s arguments persuasive?

http://www.bizjournals.com/washington/breaking_ground/2014/03/prominent-dc-nonprofit-fights-for.html

http://www.meridian.org/

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Seeking Nominations for the 2014 Outstanding Nonprofit Lawyer Awards

The Committee on Nonprofit Organizations of the American Bar Association’s Business Law Section is calling for nominations for the “2014 Outstanding Nonprofit Lawyer Awards.” The Committee presents the Awards annually to outstanding lawyers in the categories of Academic, Attorney, Nonprofit In-House Counsel, and Young Attorney (under 35 years old or in practice for less than 10 years). The Committee will also bestow its Vanguard Award for lifetime commitment or achievement on a leading legal practitioner in the nonprofit field. Nominations are due by March 10, 2014.

For a nomination form, please go to the Nonprofit Lawyer Awards Subcommittee's webpage and scroll down to the bottom under "Nonprofit Lawyer Awards Documents."  You will also find a list of prior award recipients. The Awards will be announced at the Business Law Section's Spring Meeting in April.

Send nomination forms by March 10, 2014 to:
William M. Klimon
Caplin & Drysdale, Chartered
One Thomas Circle, N.W.
Suite 1100
Washington, D.C. 20005-5894
(202) 862-5022
(202) 429-3301 (fax)
[email protected]

Discerning “religious” as a purpose for tax-exempt status

Last year, the Porter County Tax Assessment Board of Appeals brought up the religious exemption of Preachit for examination. Preachit is an Indiana organization whose website describes it as providing “resources for ministers by ministers.” The website further describes itself as “an Apostolic/Pentecostal resource web site with over 3900 manuscript and outlined sermons of various topics.” Preachit’s 2012 Form 990 lists its mission as “Scriptural/Ministry Evangelization.”

In 2009, Preachit received a religious exemption for part of its property and has not been paying taxes on any part of it since that time. The property is a facility with a “two-story home, several outbuildings, a pond, and more.” Additionally, the head of Preachit, Rev. James Smith, uses the building as his home along with his wife. However, Smith also uses it as the location for Preachit offices, meeting spaces, and a space to produce materials.

Porter County’s property tax exemption law mandates that the property owner be exempt from the federal income tax by section 501(c)(3) as an essential element of obtaining county property tax exemption.  While § 501(c)(3) explicitly names religious purposes as one of the permissible purposes, neither § 501(c)(3) nor Treas. Reg. §1.501 defines the term “religious.” Instead, much of the law on this issue has been developed from case law.

Should Preachit qualify for tax-exempt status? What arguments can be made in support of and against granting Preachit tax-exempt status?

https://nonprofitquarterly.org/policysocial-context/23638-a-church-is-a-church-or-is-it-and-is-it-tax-exempt.html

http://www.preachit.org/

http://www.legalzoom.com/taxes/other-tax-topics/what-constitutes-church-under

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Proposed Act to repeal public charity status for Type II and Type III supporting organizations

Last week Chairman of the U.S. House of Representatives Ways and Means Committee, Dave Camp, released the “Tax Reform Act of 2014.” The tax reform package “addresses a number of rules and laws applicable to tax-exempt organizations” and is described as having the potential to “impose significant new tax liabilities on nonprofits.”

The key aspects of the proposed legislation includes making changes to the Unrelated Business Income Tax, royalties, corporate sponsorships, UBIT deductions, excise taxes and intermediate sanctions, and penalties.

Another key aspect of the Act is that it would change the tax-exempt status of different types of nonprofits. For example, in addition to repealing tax-exempt status for professional sports leagues like the NFL, the proposed legislation would also repeal public charity status for Type II and Type III supporting organizations. Thus, supporting organizations would be limited to those organizations “operated, supervised, or controlled by their supporting organizations.”

What are the implications of proposing to repeal public charity status for Type II and Type III organizations? What are the arguments in support of and against this proposed change?

http://www.mondaq.com/unitedstates/x/296830/tax+authorities/Key+House+Committee+Chairman+Releases+LongAwaited+Tax+Reform+Overhaul+Major+Changes+Proposed+for+Nonprofits

http://waysandmeans.house.gov/uploadedfiles/statutory_text_tax_reform_act_of_2014_discussion_draft__022614.pdf

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Income From Charitable Organization’s Sale of Mitigation Bank Credits is not Unrelated Business Taxable Income

In Private Letter Ruling 201408031, the IRS ruled that (1) a § 501(c)(3) organization’s stream mitigation activities are substantially related to its exempt purpose and do not constitute an unrelated trade or business and (2) the income the organization will receive from the sale of mitigation credits is not unrelated business taxable income.

The exempt purposes of the organization, as set forth in its articles of incorporation, include “protecting the natural and scenic spaces of real property, protecting natural resources, and maintaining or enhancing water and air quality.” The organization partnered with a political subdivision of a state (the Commission) regarding the protection of certain land the Commission owns within a watershed and has covenanted to protect as stream buffers. The Commission conveyed a perpetual conservation easement with respect to the land to the organization, and the organization represented to the IRS that the perpetual easement will ensure that the land is kept undeveloped and its conservation values are preserved.

To raise the funds necessary to conduct stream remediation activities and address nonpoint sources of water pollution, the organization plans to form a stream mitigation bank with the support of the Commission. By conducting stream mitigation activities the organization will generate mitigation credits that can be sold to private developers or governmental entities that have projects that may cause stream disturbances somewhere else in the watershed. Once all the mitigation credits are sold, there will be no additional proceeds from the bank, but the owner/sponsor of the bank will be responsible for the monitoring and maintenance of the restored streams for seven years after the completion of the final phase and, in the case of the organization, it is charged with management of the water resources in perpetuity.

In ruling that the organization’s stream mitigation activities are substantially related to its exempt purpose, and that the income the organization will receive from the sale of mitigation credits will not be unrelated business taxable income, the IRS noted, in part, that:

The Commission covenanted to maintain a significant part of the land as stream buffers.

The Commission assigned its conservation obligations contained in the conservation easement to the organization, requiring the organization to maintain the land in essentially pristine condition and seek Commission's approval before making any capital improvements.

The Commission authorized the organization to negotiate the mitigation banking instrument and remediate the waterways, and delegated to the organization all responsibilities for the planning, funding, developing, and monitoring of the bank, as well as the authority to sell the credits generated by the bank.

By carrying out these activities, the organization will be fulfilling the Commission's conservation and legal obligations and lessening the government’s (the Commission's) burden.

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. McLaughin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law

Route 231 v. Commissioner - Allocation to 1% Partner of 97% of Tax Credits Generated by Conservation Easement Donations Treated as Disguised Sale

In Route 231, LLC v. Commissioner, T.C. Memo. 2014-30, the Tax Court held that a partnership’s transfer to a 1% partner who had contributed $3.8 million to the partnership of 97% of the state tax credits the partnership received for making charitable contributions of conservation easements and land was a taxable disguised sale under IRC § 707. The partnership (Route 231) treated the transaction as a $3.8 milliion capital contribution by the partner followed by an ”allocation” of the tax credits to that partner. In holding that the transaction was, in substance, a disguised sale, the Tax Court relied on Virginia Historic Tax Credit Fund 2001 LP v. Commissioner, 639 F.3d 129 (4th Cir. 2011), which the court found to be “squarely on point.” The Tax Court also explained that IRC § 707 “prevents use of the partnership provisions to render nontaxable what would in substance have been a taxable exchange if it had not been ‘run through’ the partnership.”

In Virginia Historic, three individuals set up a web of partnerships for the purpose of passing Virginia historic rehabilitation tax credits to investors. The partnerships solicited investors who contributed money to the partnerships’ capital accounts in return for (i) small (generally 0.01%) partnership interests and (ii) the partnerships’ promise to provide them with a fixed amount of Virginia historic rehabilitation tax credits. The IRS determined that these transactions were disguised sales under IRC § 707 and the Fourth Circuit agreed.

The Tax Court found “compelling similarities” between the transactions at issue in Virginia Historic and the transaction at issue Route 231. Just as in Virginia Historic, Route 231 involved a contribution of money to a partnership in return for (i) a small (1%) partnership interest and (ii) the partnership’s promise to provide the contributor with a fixed amount of tax credits.

There were some factual differences between the transactions at issue in the two cases. Virginia Historic involved a complex web of partnerships with hundreds of investors, most of whom received a 0.01% interest in the partnerships, while Route 231 is a stand-alone partnership with only three partners, including the 1% partner. Unlike the investors in Virginia Historic, who were partners in the partnerships for only approximately five or six months (characterized by Route 231 as “grab the tax credits and run” cases), the 1% partner in Route 231 is still a partner in that partnership. In addition, in Virginia Historic the IRS argued that the investors were not valid partners, whereas in Route 231 the IRS did not question whether the 1% partner was a valid partner. The Tax Court was unmoved by these factual differences, finding that they did not detract from the compelling similarities between the two cases.

Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law