Tuesday, December 22, 2015
Buried in the “Additional Provisions” section of the “Miscellaneous Provisions” Title of the PATH Act is a new rule (pages 195-198) on agricultural research organizations (AROs). This would provoke yawns (even for us) except that the ARO rule is a reminder that Congress understands how to write a payout rule when it wants to – which has clear significance to donor advised funds.
AROs normally might be private foundations. But under the PATH Act, they get two benefits.
First, an ARO qualifies as a per se public charity. Just like a church, university, or hospital, an ARO automatically gets public charity status because of its function and without having to rely on a public support test. Congress here has made a judgment that an ARO should not be subject to the private foundation excise tax regime and so has carved them out.
Second, contributions to an ARO may be subject to the 50 percent limit, instead of the 30 percent limit that applies for contributions to private foundations. In order for the contribution to qualify for the 50 percent limit, the ARO “must be committed to spend the contribution for . . . research before January 1 of the fifth calendar year which begins after the date of the contribution.”
For those engaged in the debate about donor advised funds and whether Congress or the IRS should impose a fund-based payout, Congress’s action on AROs shows that a contribution-based spending rule is familiar (this rule already applies to medical research organizations) and under some circumstances appropriate as an attribute of public charity status.
Donor advised funds of course are different from AROs and medical research organizations, but there is precedent in the Code for requiring that contributions be spent down over a set time period.
The donor advised fund debate on this (and other issues) was recently featured at a conference sponsored by the Boston College Forum for Philanthropy and the Public Good (including video). My paper on the topic is available here and on the Boston College Forum website, along with papers by historians, economists, practitioners, and professors -- covering the DAF issues from many points of view.
Monday, December 21, 2015
We continue to blog about the Protecting Americans from Tax Hikes Act signed into law by the President on December 18. Today a note on aspects of the tax extender provisions affecting nonprofits.
The big news is that Congress has removed an annual headache for many taxpayers and nonprofit organizations by removing the expiration dates for several provisions that have been subject for years to the whims and uncertainties of the annual legislative process (sections 111-115 of the Act, explained here, pages 12-25). These special charitable tax breaks are for contributions of conservation easements, distributions from an IRA to charity, and business contributions of food inventory. Two other provisions relate to contributions by S Corporation shareholders and the general (nontaxation) of payments by controlled subsidiaries of a charity to the (parent) charity.
Much as it is easy to welcome certainty, in some ways it was appropriate for these tax provisions to be up for renewal every year, just like a regular appropriation. When tax expenditures like these become non-expiring (a.k.a. permanent), there is a dark side: the spending they represent becomes more like entitlement spending, a fixture of the tax code. And even worse (or better, depending on your point of view), as a tax expenditure, they escape notice in the regular budget as “spending,” making them more immune to change.
“Permanence” of course is relative, as Congress could eliminate some of these tax-spending provisions as part of tax reform. Indeed, maybe now with the annual extender dance reduced in significance, Congress will fill the legislative vacuum with a serious tax reform effort.
As to the merits of the now non-expiring provisions, a few warrant comment. One of the more unfortunate provisions relates to conservation easements. Professor McLaughlin has already made the point (posted below) that the conservation easement tax expenditure is laden with problems. It is cavalier for Congress permanently to expand a remarkably generous tax incentive without any effort to improve known difficulties. One of the reasons provisions are made temporary in the first place is uncertainty on the underlying policy. When that uncertainty remains, why make the policy permanent?
The IRA distribution provision is the most significant in terms of revenue and as a charitable giving measure. Permanence for this incentive is both a victory and a defeat for advocates, however. The victory is obvious, in that now charities can reliably market the ability to transfer up to $100,000 annually from an IRA (upon age 70.5) to charity without tax consequence. This is good for charity, as the exclusion is available for planning purposes and it makes available funds for donation that otherwise donors might withhold. So that’s a good feature. There are costs though, not just in terms of revenue, but IRA donors get more than just avoidance of the percentage limitations. Donors also can ignore the IRA distribution in calculating their adjusted gross income (AGI), which means a nominally lower AGI. This can mean that donors become eligible for tax benefits that have nothing to do with charitable giving but are based on maintaining a relatively low AGI (e.g., avoiding phaseouts). Thus, the provision represents a way IRA owners can get around rules that apply generally, including the charitable percentage limitations. Why favor IRA owners over others?
The provision is a defeat for advocates however, in that many had hoped that the $100,000 annual cap on the exclusion would be removed and that eligible donees would include donor advised funds, supporting organizations, and private foundations. Evidently, Congress has decided that policy issues remain unresolved for these more passive grant-making forms of giving. We can expect these issues to recur.
It might be tempting to conclude that Congress decided not to expand the IRA distribution provision because all it wanted to do here was just a straight extension, i.e., no changes or expansions to the underlying provision. But oddly enough, Congress opted to expand other extenders. The biggest expansion was for the enhanced deduction for food inventory. One change allows business donors to base their inventory deduction on a fake value. When the business donor is unable to sell the food inventory because of “internal standards,” a “lack of market” or “similar circumstances,” then the donor may donate the inventory and determine value by ignoring the lack of a sales market or the donor’s internal standards. The well-intentioned general idea is that donors with days-old bread do not have to value the bread as if it is days old, but instead can pretend for tax purposes that it is fresh. This means a higher deduction. The question is whether this increased cost for taxpayers really means that charities are getting more and better donations, or whether businesses will just get bigger deductions and charities lower quality items (but valued as higher quality items). Donors had been lobbying for this provision since the last century, and finally succeeded. Inventory contributions (not just food) are an area where data is sparse and concerns about abuse and the benefits to charity are real. (See discussion here, about donated coconut M&Ms, among other things, pages 311-317.) But as with conservation easements, expansion without serious consideration of reform won the day.
Sunday, December 20, 2015
On December 18, 2015, President Obama signed into law the Protecting Americans from Tax Hikes Act of 2015 (the PATH Act). One of the provisions of the PATH Act makes permanent the “enhanced incentives” for conservation and façade easement donations.
As a general rule, a property owner could claim the deduction generated by an easement donation to the extent of 30% of the property owner’s adjusted gross income (AGI) in each of the year of the donation and the following five years. Based on changes made in 2006, which were temporary and repeatedly extended temporarily, easement donors were permitted to claim the resulting deduction to the extent of 50% of the donor’s AGI in each of the year of the donation and the following 15 years, or, for qualifying farmer and rancher donations, 100% of the donor’s AGI for the 16 year period. The PATH Act makes these favorable rules for easement donations permanent. In addition, beginning in 2016, the Act also allows a Alaska Native Corporation donating a conservation easement with respect to certain lands to claim the resulting deduction to the extent of 100% of taxable income in each of the year of the donation and the following 15 years. Accordingly, farmers, ranchers, and Alaska Native Corporations that make qualifying easement donations can avoid paying any income tax for up to 16 years.
The PATH Act makes these enhanced incentives permanent without implementing any reforms to curb abuses, as recommended by, among others, the Treasury Department, Professor Halperin, Professor Colinvaux, Professor Gerzog, Jeff Pidot (retired Chief of the Natural Resources Division, Maine Attorney General's Office), and me. With regard to abuses, below are twenty cases involving disallowed or significantly reduced deductions in this context in 2014 and 2015 alone:
- Atkinson v. Comm’r, T.C. Memo. 2015-236,
- Legg v. Comm’r, 145 T.C. No. 13 (Dec. 7, 2015),
- Minnick v. Comm’r, 796 F.3d 1156 (9th Cir. 2015),
- Bosque Canyon Ranch v. Comm’r, T.C. Memo. 2015-130,
- Costello v. Comm’r, T.C. Memo. 2015-87,
- Kaufman v. Comm’r, 784 F.3d 56 (1st Cir. 2015),
- Balsam Mountain v. Comm’r, T.C. Memo. 2015-43,
- Mitchell v. Comm’r, 775 F.3d 1243 (10th Cir. 2015),
- Belk v. Comm’r, 774 F.3d 221 (4th Cir. 2014),
- Reisner v. Comm’r, T.C. Memo. 2014-230,
- Zarlengo v. Comm'r, T.C. Memo. 2014-161,
- Seventeen Seventy Sherman Street v. Comm’r, T.C. Memo. 2014-124,
- Schmidt v. Comm'r, T.C. Memo. 2014-159,
- Scheidelman v. Comm’r, 755 F.3d 148 (2d Cir. 2014),
- Whitehouse Hotel v. Comm’r, 755 F.3d 236 (5th Cir. 2014),
- Chandler v. Comm’r, 142 T.C. No. 16 (2014),
- Palmer Ranch Holdings v. Comm'r, T.C. Memo. 2014-79,
- Wachter v. Comm’r, 142 T.C. No. 7 (2014),
- Esgar v. Comm’r, 744 F.3d 648 (10th Cir. 2014), and
- Mountanos v. Comm’r, T.C. Memo. 2014-38.
Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law
I recently posted an article on SSRN entitled Conservation Easements and the Valuation Conundrum, forthcoming in the Florida Tax Review. The article addresses valuation and valuation abuse in the conservation and facade easement donation context. Here is the abstract:
For more than fifty years, taxpayers have been able to claim a federal charitable income tax deduction under Internal Revenue Code § 170(h) for the donation of a conservation easement or a façade easement. For just as long, the deduction has been subject to abuse, including valuation abuse. Dismayed by the expenditure of significant judicial and administrative resources to combat abuse in the easement donation context, the Treasury Department recently proposed reforms, including reforms to address valuation abuse. The reforms were proposed in somewhat of an analytical vacuum, however, because there has been no comprehensive analysis of the easement valuation case law. This article fills that void. It examines the easement valuation case law and discusses the most common methods by which taxpayers or, more precisely, their appraisers overvalue easements. It also proposes alternative reforms informed by the lessons learned from the case law. Concise summaries of the relevant facts and holdings of the cases are included in appendices.
Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law
Friday, December 18, 2015
The almost certain to be approved omnibus spending bill and related tax bill illustrates in a nutshell the effects of the IRS scandal that blew up after it became known that the Service had subjected some conservative groups to greater scrutiny when they applied for tax-exempt status under Code section 501(c)(4).
No New 501(c)(4) Guidance. The provision garnering the most media attention in this area is Division E, Section 127 of the omnibus bill. It prohibits spending on guidance relating to section 501(c)(4) organizations and locks in "the standard and definitions" relating to that status "as in effect on January 1, 2010" (shortly before the Supreme Court's decision in Citizens United). While the provision only applies during the current fiscal year, which ends on September 30, 2016, it may kill any momentum such guidance had and so have more long-term effects. But if such guidance is only paused, a possible silver lining is that this delay ensures Treasury and the IRS will not issue it until after the end of the current presidential campaign.
Section 127 also does not address guidance for other types of section 501(c) organizations, including section 501(c)(5) labor unions and section 501(c)(6) chambers of commerce and trade associations. So in theory Treasury and the IRS could still issue guidance relating to the amount and definition of political activity for these entities. But given that such guidance could not be synced with guidance for section 501(c)(4) organizations until next fall at the earliest, it seems unlikely that they will pursue this course.
(The omnibus bill also bars spending by the SEC on guidance "regarding disclosure of political contributions, contributions to tax exempt organizations, or dues paid to trade associations" (Division O, Section 707) and on the Executive Branch of the President requesting "a determination with respect to the treatment of an organization described in section 501(c)" (Division E, Section 601(a)(2).)
Changed (Better?) IRS Procedures. The tax bill, which is also Division Q of the omnibus bill, contains several procedural changes that can be traced to the scandal:
Section 402. IRS employees prohibited from using personal email accounts for official business.
Section 403. If a person whose return or return information is improperly disclosed complains to Treasury regarding that disclosure, Treasury may inform that person about whether an investigation has been initiated, whether it is open or closed, whether any such investigation substantiated the improper disclosure by any individual, and whether any action has been taken with respect to that individual. (The provision also relates to other unlawful acts by federal employees with respect to the tax laws, as listed in Code section 7214.)
Section 404. Codifies the already available administrative appeal process relating to adverse determinations of tax-exempt status under section 501(c) and certain related determinations.
Section 405. New notification requirement for section 501(c)(4) organizations with a deadline for submitting the notice of 60 days after establishment of the organization. It applies both to entities organized after the bill's enactment and existing entities that have neither filed an application nor submitted an annual return or notice previously. There also is a provision allowing such an entity to "request" that it be treated as a section 501(c)(4) organization, in response to which Treasury (and so the IRS) "may issue a determination," and another provision allowing Treasury by regulation to require additional information supporting a new group's claimed 501(c)(4) status in their first annual return.
Section 406. Extending to all organizations seeking tax-exempt status under section 501(c) the existing declaratory judgment provision currently available to organizations seeking that status under section 501(c)(3).
Section 407. Adding to the list of "deadly sins" for IRS employees "performing, delaying, or failing to perform" any official action either for "personal gain or benefit or for a political purpose."
Section 408. Exempting from the gift tax transfers to any tax-exempt organization described section 501(c)(4), (5), or (6).
Other than the gift tax provision none of these appears problematic on its face, and the expansion of declaratory judgment option to all 501(c) is a welcome change. While the gift tax provision may draw some criticism, the reality is the IRS had already abandoned this fight (and I personally think this is the right call from a tax perspective, for reasons I plan to detail in an upcoming article). The one provision that may lead to some interesting questions and so require guidance is the new notice requirement, including how it relates to the existing (optional) application process for organizations seeking section 501(c)(4) status.
Frozen Budget for the IRS . The IRS budget continues to be frozen (and so losing ground once inflation is taken into account). More specifically, Division E provides the following, all of which are the same as for last fiscal year:
- Taxpayer Services: $2.16 billion
- Enforcement: $4.86 billion
- Operations Support: $3.64 billion
- Business Systems Modernization: $290 million
It also prohibits spending on targeting citizens for exercising their First Amendment rights and on targeting groups based on their ideological beliefs.
Bottom Line. The IRS continues to pay the price for the scandal in the form of congressional micromanagement and less funding. Any hopes of significant IRS enforcement relating to tax-exempt organizations and political activity are therefore unlikely to come to fruition in the foreseeable future.
UPDATE: For more information, see the Joint Committee on Taxation Technical Explanation for the tax bill.
Thursday, December 17, 2015
Every year in my Nonprofits class, in lieu of a standard exam, I give my students a project: take a hypothetical charitable client through the organizational stages of state law creation and preparation of the Form 1023. Typically, I give my students a client based on superheroes, comic books, movies, etc. I do this for a number of reasons - it provides a rich back drop of characters and info for those who wish to use it (but they need not); it engages some students that are often unengaged; it makes reading 20 Forms 1023 that much more bearable; and most importantly, it teaches students to think about clients as they are and to apply general principles of law to even the most outlandish situations. So maybe Charles Xavier isn't coming into your office to form a mutants' rights organizations any time soon, but the issues of politics, lobbying and advocacy remain the same. Clients are clients, the law is the law, and you just never know what will come through the office door.
I really wanted to do a church this year. With all the news around the Satanic Temple and abortion, the Indiana pot church, and the renewed focus on what is a bona fide religious belief brought to you courtesy of Hobby Lobby, I thought the timing was perfect. Trying to find a church was rather difficult, however, as you want something robust enough to be engaging as a teaching tool but you also have to tread pretty lightly around the topic. I toyed with Apocalypse and the Four Horsemen of X-Men fame, but thought it might be too obscure. The pot church was taken.
So, in honor of The Force Awakens, this year my class formed the First Church of the Jedi Knights in America. Many kudos to my colleague Atiba Ellis (go check him out at the Race and the Law Prof Blog) who appeared in class in full Jedi robe as Mace Windu, Jr., the organizer of the First Church, available for student interrogation. As with every project, it had fits and starts. For example, the class soon discovered that the West Virginia Constitution prohibits churches from organizing in corporate form. Who knew? Most shockingly, I had students who hadn't yet seen Star Wars... oh, the humanity!
Life imitates art. Some of you may know that there are actual Jedi Churches in the U.K. especially, so this particular fact pattern wasn't quite as far from reality as say, dealing with the corporate governance issues that arise when members of your board morph into evil lizards (I'm looking at you, Doc Connors!) in that after the final project was done, one of my students emailed me the following article from The Telegraph:
So who knows? Maybe one of my student really will represent Mace Windu, Jr. one day....
Wednesday, December 16, 2015
In honor of Star Wars Day 2015, I'm linking to this article from the Tax Foundation, which clarifies that but for taxes, we wouldn't have the entire Star Wars series, thus proving what I tell my students... tax is, indeed, everywhere....
Linking two things I love, cosplay and charities (I'm a really big nerd) ... may I introduce you to one of my favorite things, the 501st Legion, helping a charity event near you (who said all Stormtroopers are on the Dark Side!)
Now, get in costume, get in line, and may the Force be with you!
(and for the love of all that is the Light Side of the Force, no spoilers!)
Monday, December 14, 2015
There's been an awful lot of pearl clutching going on out there in the media about the Chan-Zuckerberg Initiative, now famously known to be organized as a Delaware Limited Liability Company (LLC - not limited liability corporation, media folks! And yes, it makes a difference.) The December 11th Chronicle on Philanthropy update, which I get in my email, had not one but TWO opinion pieces on it. Personally, I don't quite get all the drama, but I have three working theories, none of which are mutually exclusive. ( I do have to put one caveat out there - my comments are based on the structure as I understand it from media reports, which may or may not be reliable.)
- Tax Deduction? We Don't Need No Stinkin' Tax Deduction. So the first line of attack appears to be that it's all a big tax scam - they get the deduction but they give nothing to charity. As far as I can tell, however (and sort of confirmed in a non-technical way by Zuckerberg himself) is that the LLC is, not surprisingly, not a tax-exempt entity. As a result, the C-Zs won't get an income deduction for funding the LLC; an income tax charitable deduction might pass through to them if and when the LLC actually makes a contribution to a recognized, qualified charity. Which makes it no different than any other for-profit business out there that makes contributions to charity - albeit with way more fanfare and more decimal places at stake.
So maybe all of it is just a fundamental misunderstanding of the tax implications of the LLC? If the notion is that the tax-paying public has a right to certain expectation of a charitable endeavor as a condition of tax exemption, then that notion is misplaced here - at least with respect to the federal charitable income tax deduction and/or tax-exemption from the income tax. I've seen some speculation that there may be some estate and gift planning going on here - but there is a great deal of speculation on that and even so, what makes that any different than any other wealthy person out there? I've also seen reference to evading California income taxes - not sure on that one, but it seems unlikely from my rudimentary knowledge of the California income tax. Would love to hear from anyone from CA with thoughts on that issue.
One set of taxes the Initiative is most certainly dodging is the private foundation excise taxes, which generally were designed to make sure that assets for which a charitable income tax deduction is granted are used for those charitable purposes. It hardly seems surprising that the private foundation excise taxes don't apply to a for-profit entity, for which no charitable income tax deduction has been granted.
2. Let The Eat Charitable Cake. My second theory is a concern over philanthropic oligarchy - in the US, a concern that goes back (at least) to the creation of the first large private foundations during the Industrial Revolution era. If you've read the legislative history to the private foundation excise taxes, one of the repeated themes is an anti-trust type concern (not surprising, I suppose) - the ultra wealthy concentrating and controlling wealth not only in the business sector, but in charitable vehicles as well. I couldn't help but hear the echos of the Patman hearings and reports (which formed much of the basis for the passage of chapter 42) in the criticisms of C-Z. Some also cite to Zuckerberg's recent and widely-criticized foray into donor controlled philanthropic experimentation in the form of the Newark school system. In the Jacobin article linked at the beginning of this paragraph, the author notes, "People like Zuckerberg and Gates are unelected and unaccountable to anyone and face few, if any, repercussions for the negative consequences of their social experiments." In my mind, these concerns undergird the suggestions of Pablo Eisenberg in his editorial in the Chronicle of Philanthropy, which suggests that the C-Z Initiative ought to make public reports, have an independent board, and champion issues of poverty. As Eisenberg states, "The overwhelming majority of superwealthy donors who have signed the giving pledge do not give much, if any, of their money to fight poverty or help marginalized citizens, the neediest nonprofits, or advocacy organizations. Despite what they often claim, tech billionaires are not giving money that disrupts the status quo."
I'm struggling with the question of why? If this is a private enterprise not subsidized by public funds through the charitable deduction, what standing do we have as a society to demand such things? If the entity is not itself charitable as a legal matter, then... so what? Which raises the final question...
3. Or Maybe, We Just Don't Know What Charity Is Any More...? Fundamentally, I really think this is about our fundamental notions of charity as a society. In the initial letter to his daughter announcing the pledge to the initiative, the C-Zs stated...
Sunday, December 13, 2015
Vermont Law School Professors John Echeverria and Janet Milne have developed recommendations for protecting Vermont’s perpetual conservation easements (the project was supported by the Lintilhac Foundation).
In a VTDigger article, Echeverria and Milne explain:
"Vermonters have invested a great deal of property, money, time and effort to create a network of conservation easements that protects a significant fraction of the state’s landscape. Virtually all of these easements were granted in 'perpetuity,' to place the lands off limits to development forever. Now the challenge facing Vermonters is to figure out how to ensure that these commitments to perpetual protection are upheld.
When a landowner places a conservation easement on her property, she does so to protect the particular conservation values of her specific parcel. When a land trust or a government agency accepts the conservation easement, it makes a legal commitment to uphold the easement restrictions on the property in perpetuity.
Absent rigorous safeguards, however, easement protections are at serious risk of erosion over time. Ownership of lands protected by easements will eventually pass from the original easement grantor to new owners. Legally, the easement restrictions will remain in place despite the changes in land ownership. But the new owners may lack the same level of commitment to conservation as the original land owner. Moreover, the new owners could profit from developing the land if the easements restrictions could be lifted. Inevitably, some future owners of lands subject to easements will press for modification or even termination of easement restrictions.
Several years ago some Vermont conservation groups proposed legislation that would have vested significant discretion in a new, politically appointed body, and in the groups themselves, to authorize amendment or termination of conservation easements. Under the proposal, an easement amendment or termination would have been allowed so long as the change served the larger cause of conservation, even if it resulted in destruction of the specific conservation values of the land originally placed under protection; thus, a conservation group could have moved an easement from one property to another or even from one town to another if it believed the transfer would be beneficial for the environment.
We and others criticized the proposed legislation as a breach of faith with easement donors that would ultimately undermine the cause of land conservation. A toxic mix of landowners with incentives to remove easement restrictions and liberal state policies allowing easement holders to modify easements would have undermined Vermont’s network of easement protections and defeated grantors’ legitimate expectations about easement perpetuity. It also ran afoul of federal tax rules governing donated easements. Ultimately, the groups that developed the legislative proposal withdrew their support for it. But all those involved in the debate recognized that Vermont needs some type of legislation governing the complicated issue of easement amendment and termination." Read more
Although the recommendations of Professors Echeverria and Milne focus on their home state of Vermont, the issues they highlight are of concern to us all. Ensuring the continued protection of the estimated 40 million acres now encumbered by conservation easements throughout the nation, as well as the billions of public dollars invested in the easements, should be a priority for policymakers and regulators at both the federal and state levels.
Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law
Saturday, December 12, 2015
In Legg v. Commissioner, 145 T.C. No. 13 (Dec. 7, 2015), the Tax Court held that the IRS’s determination that a conservation easement donor was liable for 40% gross valuation misstatement penalties was proper. The court found that the IRS had satisfied the procedural requirements for imposition of the penalties.
In 2007, Brett and Cindy Legg donated a conservation easement on 80 acres to the Colorado Natural Land Trust. The Leggs asserted that the easement had a value of over $1.4 million and they claimed deductions for the donation over a four-year period.
The IRS challenged the deductions, arguing that the deduction requirements were not met and the value of the easement was zero. The IRS examiner’s report, which was sent to the Leggs, stated that the Leggs were liable for 20% accuracy-related penalties under IRC § 6662(a) or, alternatively, 40% gross valuation misstatement penalties under IRC § 6662(h). The report calculated the proposed penalties using the 20% rate and the examiner’s immediate supervisor signed the report in writing.
After issuance of the notice of deficiency, the IRS and the Leggs stipulated that (1) the value of the conservation easement was only $80,000, (2) the Legg’s reported $1.4 million value for the easement constituted a gross valuation misstatement (the value for the easement reported on their tax returns was more than two times, or 200%, of the amount determined to be the correct value), and (3) the Leggs could not invoke a reasonable cause defense against the gross valuation misstatement penalties (for returns claiming conservation easement deductions filed after August, 17, 2006, the gross valuation misstatement penalty is a strict liability penalty).
IRC § 6751(b)(1) requires that no penalty be assessed “unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination.” Prior law allowed the imposition of some penalties without supervisory approval. Congress enacted IRC § 6751 because it believed “that taxpayers are entitled to an explanation of the penalties imposed upon them” and “penalties should only be imposed where appropriate and not as a bargaining chip.”
The Leggs argued that the IRS examiner did not make an “initial determination” of the 40% penalties because the examination report calculated the penalties using the 20% rate. They further argued that the 20% calculation suggested that the IRS never considered imposing the 40% penalties and, thus, the examiner’s immediate supervisor could not have approved the 40% penalties in writing.
The Tax Court disagreed. It determined that even though the 40% penalties were posed as an alternative position in the examination report, the report made an “initial determination” that the Leggs were liable for the 40% penalties. The court explained that its conclusion was consistent with congressional intent. Congress enacted IRC § 6751(b) to ensure that taxpayers understand the penalties the IRS is imposing on them. The examination report sent to the Leggs clearly explained why the Leggs were liable for the 40% penalties; it applied IRC § 6662(h) and the relevant regulations to the specific facts and concluded that the Leggs were liable for the 40% penalties. Accordingly, the Leggs could not contend that they lacked an understanding of the penalties imposed upon them simply because the 40% penalties were posed as an alternative position.
In sum, because the IRS made an “initial determination” regarding the 40% penalties in the examination report and the report was approved, in writing, by the examiner’s immediate supervisor, the IRS satisfied the procedural requirements of IRC § 6751(b) and its determination of the 40% penalties was proper.
The Colorado Natural Land Trust was involved in abuse conservation easement transactions in Colorado.
Friday, December 11, 2015
In Atkinson v. Commissioner, T.C. Memo. 2015-236, the Tax Court denied $7.88 million of deductions claimed with regard to the conveyance of conservation easements encumbering noncontiguous portions of land on and adjacent to golf courses located in a gated residential community. The court determined that the easements did not satisfy either the habitat or open space protection conservation purposes tests of IRC § 170(h). The court declined to impose penalties, however, finding that the taxpayers qualified for the reasonable cause exception.
St. James Plantation is a gated community consisting of residential areas, recreational facilities (including four golf courses), and undeveloped land. It was established in 1991 and covers 91% of the Town of St. James, which is west of Southport, North Carolina. The Plantation can be accessed only through three roads, each of which has a gated entrance with a staffed guardhouse. Drivers are obliged to stop at a gated entrance and state the purpose of their visit to obtain entry.
The Members Club and the Reserve Club (both limited liability companies) owned portions of the Plantation. In 2003, the Members Club conveyed a conservation easement covering approximately 79 acres in and around one of the Plantation golf courses to the North American Land Trust (NALT). The property subject to the easement consists of six noncontiguous tracts (i.e., fairways, greens, teeing grounds, ranges, roughs, ponds, and wetland areas), which range in size from 5 to 23 acres. Residential lots border most of the tracts, and a concrete golf cart path winds its way through the tracts. The tracts lie within the Cape Fear Arch, a large area that The Nature Conservancy (TNC) has identified as a biodiversity hotspot.
The Members Club reserved significant rights in the 2003 easement. The golf course can be altered “in such manner as the owner determines to be appropriate” as long as “the best environmental practices then prevailing in the golf industry” are used. The 2003 easement allows for digging (filling, excavating, dredging, and removing topsoil) as necessary for maintaining sand traps and the cultivation of sod for use on the course. Cart paths may be relocated as long as relocation does not substantially increase the surface area of the paths. Rain shelters, rest stations, food concession stands, and other structures can be constructed as long as they do not exceed a total of 2,500 square feet. The Members Club can substantially increase the amount of surface area covered by the course if it obtains prior consent from NALT “and there is no material adverse effect on the conservation purposes.” The club can also cut and remove trees that are on or within 30 feet of the golf course to build a restroom, rain shelter, rest station, or food concession stand or if the club determines that removal is “appropriate for the proper maintenance of the golf course.” The club also has the right “to operate and manage” a golf course on the property and to maintain “turf grass and other vegetation … of the Golf Course in such manner as Owner determines to be appropriate,” including by applying pesticides and other chemicals. The Members Club claimed a deduction of just over $5.2 million for the conveyance of the 2003 easement.
In 2005, the Reserve Club conveyed a conservation easement covering approximately 91 acres in and around another of the Plantation golf courses to NALT. The property subject to the 2005 easement consists of three noncontiguous tracts of approximately 30 acres each. As with the 2003 easement, the tracts consist of fairways, greens, teeing grounds, ranges, roughs, ponds, and wetland areas; the tracts are bordered in part by residential lots; and a concrete golf cart path winds its way through the tracts. The tracts subject to the 2005 easement also lie within the Cape Fear Arch, and portions lie within an areas delineated as nationally significant by TNC and the North Carolina Natural Heritage Program. The terms of the 2005 easement are almost identical to those of the 2003 easement. The Reserve Club claimed a deduction of over $2.65 million for the conveyance of the 2005 easement.
The IRS challenged the deductions and the primary issue addressed by the Tax Court was whether the easements satisfied the habitat protection or open space conservation purposes tests.
Habitat Protection Conservation Purpose Test
To satisfy the habitat protection conservation purpose test a conservation easement must “protect a significant relatively natural habitat in which a fish, wildlife, or plant community, or similar ecosystem, normally lives.” Treas. Reg. § 1.170A-14(d)(3)(i). A “habitat” is an “area or environment where an organism or ecological community normally lives or occurs” or the “place where a person or thing is most likely to be found.” Glass v Comm'r. “Significant” habitats include, but are not limited to (i) habitats for rare, endangered, or threatened species of animal, fish, or plants and (ii) natural areas that are included in, or contribute to, the ecological viability of a local, state, or national park, nature preserve, wildlife refuge, wilderness area, or other similar conservation area. Treas. Reg. § 1.170A-14(d)(3)(ii).
Both the taxpayers and the IRS presented expert testimony to establish their respective positions regarding the habitat protection conservation purposes test. The IRS apparently learned from Glass v. Comm’r and Butler v. Comm’r that it is unlikely to win a habitat protection challenge unless it offers expert testimony on the issue.
The taxpayers argued that each of the subject properties had independent conservation significance and contributed to the ecological viability of surrounding conservation areas. The IRS focused on the operation of the golf courses and argued that the rights retained in the easements negated any purported conservation purpose. Although the taxpayer generally has the burden of proving that an asserted deficiency is incorrect, the burden of proof on the habitat protection issue shifted to the IRS under IRC § 7491.
The 2003 Easement
(i) Independent Conservation Significance
The taxpayers argued that the 2003 easement protects forests, ponds, and wetlands that provide a variety of habitats for plants and animals of environmental concern, and that the location of the easement within the Cape Fear Arch supported a finding that the subject property is “significant natural habitat.”
The taxpayer’s expert testified that the most significant ecological feature on the subject property was the longleaf pine at the margins of the fairways (i.e., the “longleaf remnants” that purportedly were “protected by housing development on one side and fairways on the other”). The court found that the longleaf pine were not protected because the easement permitted cutting and removal of the trees. The court noted that, “[i]f the 2003 easement property were altered within the terms fully permitted in the 2003 easement deed, the conservation purpose would be significantly undermined.” The court also noted that the longleaf pines currently on the property were not the desired “old-growth” and were not maintained in a relatively natural state worthy of conservation.
The taxpayers contended that the subject property contained ponds that replicated natural habitat. The IRS argued that ponds could not provide a significant relatively "natural" habitat because the property did not contain any ponds before the development of the golf course. The court noted, however, that the Treasury Regulations specifically allow for the alteration of habitat so long as fish, wildlife, or plants continue to exist there in a relatively natural state, and it pointed to the example in the regulations, which provides that a “lake formed by a man-made dam or salt pond formed by a man-made dike” would meet the conservation purpose test “if the lake or pond were a natural feeding area for a wildlife community that included rare, endangered, or threatened native species.” The taxpayers argued that the unmanicured edges of the ponds created “transition zones that provide a relatively natural habitat for amphibians, reptiles and birds.” However, the court found that very few of the ponds had a natural edge and the few edges that existed were regularly sprayed with pesticides. Moreover, the IRS’s expert analyzed pond water samples and found reduced oxygen, increased salinity, and levels of nitrogen beyond EPA recommendations. He also testified that no fish or amphibians were evident in the ponds.
The taxpayers argued that the subject property, including the rough, fairways, greens, and tees, provides a relatively natural open space for foraging, migration, and feeding of animals such as the Eastern Fox Squirrel, southern flying squirrels, owls, coyotes, red foxes, raccoons and opossums. The IRS’s expert, however, testified that there are no natural fruits and seeds for foraging on the property, the property provides no cover, and animal migration is deterred by the residential development surrounding each of the noncontiguous tracts, the level of human activity, and the frequent watering. The expert concluded that, as with the ponds, the land areas provided poor habitat for plants and wildlife.
The court distinguished Glass v. Comm’r, finding that the property subject to the 2003 easement did not provide the same level of habitat as in Glass. While the property in Glass was mostly undisturbed land, the property subject to the 2003 easement was not in a “natural undeveloped state.” The fairways, tee boxes, and greens were sodded or planted with nonnative grasses, and the transition areas (24% of the property) in which Venus Flytraps and Pitcher Plants were found represented “too insignificant a portion of the 2003 easement to lead [the court] to conclude that the whole 2003 easement property is a significant natural habitat.” In addition, while acknowledging that the regulations define significant habitat to include habitat for rare plants, the court noted that the species on the Glass property were threatened or endangered, while Pitcher Plants and Venus Flytraps were only rare and not “imperiled.”
The court also found that the use of pesticides and other chemicals in the operation of the golf course injured the ecosystem on the subject property and, thus, violated the “no inconsistent use” rule of Treas. Reg. § 1.170A-14(e)(2), which provides, in part, that “the preservation of … [land] would not [satisfy the conservation purpose test] if under the terms of the contribution a significant naturally occurring ecosystem could be injured or destroyed by the use of pesticides.” The court noted that, while the 2003 easement qualifies the property owner’s reserved rights—e.g., the easement allows the owner to modify the golf course “provided that no such activity shall have a material adverse effect on the Conservation Purpose”—the easement also allows the use of chemicals in the maintenance and operation of the golf course. Accordingly, the court found that the easement did not limit the use of pesticides and other chemicals that could destroy the conservation purpose and, in fact, it was undisputed that chemicals were used on roughly 63% of the subject property. The IRS’s expert testified that chemicals were used to promote the maintenance of nonnative flora without regard to the conservation purpose of the easement, and this was implicitly confirmed by one of the taxpayer’s witnesses, who testified that “the goal in irrigation and the use of pesticides, fungicides, and herbicides is to keep the golf course in good condition for playing golf.”
Ultimately the court concluded that wildlife and plants are not “most likely” to be found and do not “normally live” on the property subject to the 2003 easement.
(ii) Contributory Role
The taxpayers argued that the property subject to the 2003 easement met the habitat protection conservation purpose because “[s]ignificant habitats … include … natural areas which … contribute to, the ecological viability of a local, state, or national park, nature preserve, wildlife refuge, wilderness area, or other similar conservation area.” The Tax Court disagreed. Although the 2003 easement was designed, in part, to contribute to a wider set of easements conveyed to NALT with regard to the Plantation, the court determined that the property subject to the 2003 easement was not a “natural area” that “contributes to” the surrounding conserved areas. The court explained that the property did not qualify as a “natural” habitat because (i) a large portion of the property was planted with nonnative grass, (ii) the ponds did not exist in a relatively natural state, (iii) the native forests that remained on the property are at risk of removal pursuant to the terms of the easement deed; (iv) the property did not act as a “wildlife corridor” or “sink” for any species because there were no natural fruits and seeds for foraging, there was no cover from humans or predators, and there were barriers to animal migration such as the surrounding homes, human activity, and nightly watering, and (v) the taxpayers failed to identify any species using the subject property for nocturnal migration.
The taxpayers also argued that the condition of the subject property was irrelevant so long as it could act as a buffer to a nearby significant habitat. They relied on Treas. Reg. § 1.170A-14(f), Example (2), which provides:
A qualified conservation organization owns Greenacre in fee as a nature preserve. Greenacre contains a high quality example of a tall grass prairie ecosystem. Farmacre, an operating farm, adjoins Greenacre and is a compatible buffer to the nature preserve. Conversion of Farmacre to a more intense use, such as a housing development, would adversely affect the continued use of Greenacre as a nature preserve because of human traffic generated by the development. The owner of Farmacre donates an easement preventing any future development on Farmacre to the qualified conservation organization for conservation purposes. Normal agricultural uses will be allowed on Farmacre. Accordingly, the donation qualifies for a deduction under this section.
The Tax Court disagreed, finding that the property subject to the 2003 easement and Farmacre were distinguishable. The court pointed out that most of the property subject to the 2003 easement (roughly two-thirds) was surrounded by a row of houses overlooking the golf course and therefore could not serve as a “compatible buffer” to natural areas on the Plantation. In addition, the court agreed with the IRS’s expert that heavy human traffic on and around the golf course diminished its benefits as a “buffer,” and noted that Example (2) specifically alludes to increased human activity as a detriment to the continued preservation of Greenacre. The court concluded that, as a whole, the property subject to the 2003 easement did not “contribute” to any “conservation area” nearby.
(iii) Retained Rights
The Tax Court declined to decide whether operating a golf course is inherently inconsistent with the conservation purpose of protecting relatively natural habitat because the easement did not satisfy the threshold requirement of having a qualifying conservation purpose (i.e., it did not preserve a “relatively natural habitat”).
The 2005 Easement
The Tax Court found that the 2005 easement suffered from the same problems as the 2003 easement—it did not preserve a “relatively natural habitat.” The court also noted, somewhat sarcastically, that the IRS’s expert observed very little wildlife on the 2005 easement property; the only birds he saw were geese, which the Plantation attempts to “control,” i.e., eliminate from the 2005 easement property, using a border collie.
Open Space Conservation Purpose Test
A conservation easement will satisfy the open space conservation purpose test if preservation of the subject property is either (i) pursuant to a clearly delineated federal, state, or local governmental conservation policy and will yield a significant public benefit or (ii) for the scenic enjoyment of the general public and will yield a significant public benefit. The 2003 and 2005 easements did not satisfy either prong of this test.
With regard to the governmental conservation policy prong, although the baseline documentation for both easements listed several North Carolina laws, it did not include any explanation for how the subject properties contributed to the purposes stated in those laws. In addition, the taxpayers did not mention or provide any analysis of governmental conservation policies in their briefs, and the Tax Court thus deemed that argument abandoned.
The taxpayers also failed to establish that preservation of the subject properties was for the scenic enjoyment of the general public. Since the golf courses were in a guarded gated community and ringed by houses, the court found that the general public did not have visual access to the properties. The taxpayers argued that the general public had visual access because most of the population of the Town of St. James lived within the Plantation. The court did not deem the population of one town to constitute “the general public,” however, and dismissed that argument.
Atkinson is one of three recent cases in which the Tax Court has denied deductions for conservation easements conveyed to NALT. See Balsam Mountain v. Comm’r and Bosque Canyon Ranch v. Comm’r. NALT was also the donee of the conservation easement at issue in Kiva Dunes v. Comm’r, which inspired the Treasury to recommend eliminating the deduction with regard to golf course easements.
Friday, December 4, 2015
Just wanted to jump in today to link this post (Back Off the Chan Zuckerbergs and Their Limited Liability Company (NOT Corporation)) from my WVU colleague Josh Fershee, who blogs at our sister site, the Business Law Prof Blog. There is a lot of discussion (and misinformation) out there about the Chan Zuckerberg Charitable LLC structure, and I thought there were some interesting views over there from our business entity friends.
See you next week! Happy finals! EWW
Wednesday, December 2, 2015
As reported by The New York Times, the Senate Finance Committee sent letters to eleven private museums created and operated by opened by private collectors, focusing on whether sufficient public benefit is present to justify such museums' federal tax-exempt status. These letters were sent by chairman Senator Orrin Hatch (Utah) to galleries such as the Brant Foundation Art Study Center in Greenwich, Connecticut, Glenstone museum in Potomac, Maryland, the Rubell Family Collection in Miami, the Kreeger Museum in Washington, DC, and The Broad in Los Angeles, requesting additional information about visiting hours, donations, trustees, and valuations. Senator Hatch commented that: “Tax-exempt museums should focus on providing a public good and not the art of skirting around the tax code. While more information is needed to ensure compliance with the tax code, one thing is clear: Under the law, these organizations have a duty to promote the public interest, not those of well-off benefactors, plain and simple.” The Senator's letter acknowledged the important role that charitable organizations play in our society, but questioned whether "some private foundations are operating museums that offer minimal benefit to the public while enabling donors to reap substantial tax advantages."
The New York Times article opined that the Hatch letters were sent after another of its articles published in January 2015 "examined the proliferation of tax-exempt private museums created by wealthy art collectors, sometimes in their own backyards. Some of the galleries severely limit public access, closing their doors to outsiders for several months at a time, shunning signs and advertisements, and requiring visitors to make advance reservations." According to the article, this inquiry was part of a broader effort to re-examine institutions, including private museums and universities, which have enjoyed tax-exempt status for many decades.
Brian Mahany (Mahany Law) posted Non-Profit Hospitals and the False Claims Act to his firm's Due Diligence (Blog):
Eric C. Chaffee (Toledo) has posted Collaboration Theory: A Theory of the Charitable Tax Exempt Nonprofit Corporation to SSRN:
Legal scholarship regarding tax exempt nonprofit entities is meager at best. Although some excellent treatises, book chapters, and journal articles have been written, the body of scholarship relating to these entities is not nearly as healthy and robust as the scholarship relating to their for-profit companions. This is especially troubling considering that nonprofit entities help to improve our society in a myriad of different ways.
This Article seeks to fill a void in the existing scholarship by offering an essentialist theory for charitable tax exempt nonprofit corporations that helps to explain the essence of these entities. Beyond the purely academic metaphysical inquiry into what is a corporation, understanding the essential nature of these corporations is important because it helps to determine how they should interact with society, what rights they should have, and how they should be governed by the law. This discussion is especially timely because the recent opinions by the Supreme Court of the United States in Citizens United and Hobby Lobby have reinvigorated the debate over the essence of the corporation.
This Article breaks new ground by offering a new essentialist theory of the corporation, which shall be termed “collaboration theory.” The decades of debate over the essence of for-profit corporations has coalesced into three prevailing theories of the corporation, i.e., the artificial entity theory, the real entity theory, and the aggregate theory. The problem is that none of these prevailing theories fully answers the question of what is a corporation.
Collaboration theory suggests that charitable tax exempt nonprofit corporations are collaborations among the state governments, federal government, and individuals to promote the public good. Unlike the prevailing theories of the corporation, collaboration theory explains both how and why charitable tax exempt nonprofit corporations exist, which provides a fuller and more robust understanding of these corporations. Collaboration theory advances the existing scholarship by finally offering an essentialist theory for nonprofit corporations, and it shows remarkable promise for understanding the essential nature of for-profit corporations as well.
Jessica Owley (SUNY-Buffalo) and Adena R. Rissman (Wisconsin): Trends in Private Land Conservation: Increasing Complexity, Shifting Conservation Purposes and Allowable Private Land Uses, Land Use Policy 51, 76-84 (2016 Forthcoming):
The terrain of private-land conservation dealmaking is shifting. As the number of acres of private land protected for conservation increases, our understanding of what it means for a property to be "conserved" is shifting. We examined 269 conservation easements and conducted 73 interviews with land conservation organizations to investigate changes in private-land conservation in the United States. We hypothesized that since 2000, conservation easements have become more complex but less restrictive. Our analysis reveals shifts in what it means for private land to be "conserved." We found that conservation easements have indeed become more complex, with more purposes and terms after 2000 compared to conservation easements recorded before 2000. However, changes in restrictiveness of conservation easements varied by land use. Mining and waste dumping were less likely to be allowed after 2000, but new residences and structures were twice as likely to be allowed. We found a shift toward allowing some bounded timber harvest and grazing, and a decline in terms that entirely allow or prohibit these working land uses. Interviews revealed staff perceptions of reasons for these changes. Our analysis suggests that "used" landscapes are increasingly important for conservation but that conserving these properties stretches the limits of simple, perpetual policy tools and requires increasingly complex and contingent agreements.
Gerald Korngold (New York Law School), Semida Munteanu (Lincoln Institute of Land Policy), and Lauren E. Smith (London Fischer LLP): An Empirical Study of Modification and Termination of Conservation Easements: What the Data Suggest About Appropriate Legal Rules, NYU Environmental Law Journal, Vol. 24, No. 1 (2016):
The acquisition of conservation easements by nonprofit organizations (“NPOs”) over the past twenty-five years has revolutionized the preservation of American land. Recently, however, legislatures, courts, practitioners, and commentators have debated whether and how conservation easements should be modified and even terminated. The discussion has almost always been on a theoretical level without empirical grounding and has sometimes generated much heat but little light. The discussion has lacked the necessary empirical context to allow legislatures and courts to thoughtfully develop resolutions to these issues free from sloganeering and posturing.
This article provides and analyzes a previously uncollected dataset that offers guidance on the appropriate rules of law for conservation easement modification. It examines policy goals in light of the data to suggest various modification rules that would be more effective than current practice. The dataset represents a significant sample of easement modifications that have been made during a six year period (2008-2013) and indicates several findings: first, modifications have actually been taking place, despite claims that conservation easements are “perpetual,” apparently indicating that NPOs need flexibility in at least some areas; most of the changes have been “minor” and have been either conservation neutral or conservation positive, though one would expect pressure for more significant alterations over time due to shifts in the environment and human needs; there is a range of types and degree of modifications to this point, suggesting that there should be a spectrum of procedural and substantive requirements for the different varieties of modifications; and, a mandate for a stand-alone, state registry of conservation easements and modifications would allow for improved policymaking.
The article suggests that a doctrine that requires different procedures and substantive rules for various categories of modifications — a sliding scale — may yield the best, policy-based results. The work also identifies and analyzes existing doctrines — federal tax law, specific state statutes, charitable trust doctrine, standing rules, and director liability — that would need to be altered or clarified to adopt effective modification rules.
Amy L. Moore (Belmont), Rife with Latent Power: Exploring the Reach of the IRS to Determine Tax-Exempt Status According to Public Policy Rationale in an Era of Judicial Deference, 56 S. Tex. L. Rev. 117 (2014):
[Hat tip: TaxProfBlog]