Thursday, February 28, 2019
While the media and public understandably focused mostly on other aspects of Michael Cohen's testimony before Congress yesterday, the information he provided raised two significant issues relating to the soon-to-be-dissolved Donald J. Trump Foundation.
First, in his opening statement Cohen mentioned (on pages 3 and 12) that the Foundation had been involved in the purchase of a third portrait of Mr. Trump from a charity auction, this time through reimbursing the winning bidder the $60,000 purchase price, which portrait was then hung in one of Mr. Trump's country clubs. If these statements are true, this is a clear case of self-dealing in violation of Internal Revenue Code section 4941 (and comparable state law requirements as well), as was the case with the previously reported charity auction purchases of two other portraits that also ended up hanging in Trump business properties. It should be noted that the Foundation's annual IRS return for 2013 (available from GuideStar) does not show such a reimbursement and the only $60,000 payment it includes is to the American Cancer Society, although the Foundation has inaccurately reported distributions before. For coverage of this aspect of Cohen's testimony, see CNN, The Guardian, and this Surly Subgroup post by Ellen Aprill.
Second, he confirmed previous reports that Mr. Trump had steered a $150,000 payment from a Ukrainian billionaire, Victor Pinchuk to the Foundation in lieu of it being paid to Mr. Trump as a speaking fee. As Ellen Aprill and I discussed back in 2016, such arrangements raise a possible assignment of income issue in that depending on the exact circumstances Mr. Trump may have been required to include that fee in his gross income for both federal and state income tax purposes (although there may have been a full or partial offsetting charitable contribution deduction to reflect the transfer of those funds to the Foundation). Of course without seeing Mr. Trump's personal federal and state income tax returns, we can't be sure whether he included this amount in his income or not. For coverage of this aspect of Cohen's testimony, see Time.
Wednesday, February 27, 2019
Kathryn Kisska-Schulze, has posted This is Our House! -- The Tax Man Comes to College Sports.
On December 22, 2017 President Trump signed into law the Tax Cuts and Jobs Act (TCJA). Prior to January 1, 2018, college athletics had historically enjoyed favorable federal tax treatment due to the tax-exempt status of universities, athletic departments, and the NCAA. However, following the TCJA's implementation college sports took a direct tax hit for the first time in almost thirty years. Amid the mounting legal issues now enveloping college athletics, colleges and universities must also prepare for the financial impact that the TCJA could have on their athletic programs moving forward. This article (I) provides a history of the big business of college sports and early efforts to impose federal taxation on the industry, (II) reviews the applicable TCJA sections that may have a direct or indirect effect on U.S. college athletics, and (III) concludes that universities and their athletic departments must begin to account for and strategize plans to protect themselves from the financial impact of the TCJA.
Darryll K. Jones
Tuesday, February 26, 2019
From Senator Grassley's press office:
Grassley Renews Probe of Non-Profit, Tax-Exempt Hospitals
WASHINGTON – Senate Finance Committee Chairman Chuck Grassley continued his years-long effort to ensure tax-exempt hospitals are fulfilling the standards for serving communities and low-income patients as required by law. In a letter to IRS Commissioner Charles Rettig, Grassley pressed for data on how many hospitals are in compliance with the requirements for tax exempt status and the status of IRS examinations of those not in compliance. “Making sure that tax-exempt hospitals abide by their community benefit standards is a very important issue for me. As chairman of the Senate Judiciary Committee, I oversaw an investigation into the billing practices of the Mosaic Life Care hospital. That investigation resulted in debt relief of almost $17 million for thousands of low-income patients. This issue is still just as important to me now that I am chairman of the Senate Finance Committee,” Grassley wrote. Specifically, Grassley is seeking information about whether tax-exempt hospitals are meeting the statutory requirements laid out in section 501 of the Internal Revenue Code. In February 2018, Grassley and then-Chairman Orrin Hatch of Utah pressed the IRS for information on enforcement practices and compliance data on non-profit hospitals. Grassley has continually urged greater compliance among non-profit hospitals. He has even helped ensure debt relief for thousands of patients through an oversight inquiry into Mosaic Life Care. That inquiry examined the billing and debt collection practices of the care center after news reports indicated it had sued low-income patients that should have qualified for charity care.
Here is a snippet from the letter:
Unfortunately, according to reports, it appears that at least some of these tax-exempt hospitals have cut charity care, despite increased revenue, calling into question their compliance with the standards set by Coongress. So, on February 15, 2018, I sent a letter to the IRS to inquire about how the agency reviews non-profit hospital compliance with 501(r) of the Internal Revenue Code. Acting Commissioner Kautter responded that the IRS annually reviews one third of approximately 3,000 tax-exempt hospitals by reviewing Forms 990, hospital websites, and other information in order to identify the hospitals withthe highest likelihood of noncompliance. The IRSS then assigns either a compliance check or examinaton to those hospitals that appear to be most at risk of noncompliance.
The letter goes on for another page and half asking some 30 or so questions. Funny thing is, Grassley is citing to an Obama care provision for which he has voted repeal too many times to count! Here is a brief outline 501(r):
Background on Section 501(r)
The Affordable Care Act (ACA) added IRC Section 501(r), imposing significant new requirements on nonprofit hospitals. Grassley was a driving force behind Section 501(r)'s inclusion in the ACA. At a summary level, this section requires charitable hospitals to:conduct a Community Health Needs Assessment (CHNA) every three years and adopt an implementation strategy to meet the needs identified establish a written Financial Assistance Policy (FAP) and a policy relating to emergency medical care limit the amounts that it can charge individuals eligible for financial assistance under the FAP limit the way that it collects outstanding charges prior to making a reasonable effort to determine whether an individual is eligible for financial assistance under the FAPSection 501(r) provides that a hospital will not be treated as a tax-exempt organization as described in Section 501(c)(3) if it fails to meet these new requirements. In addition, a nonprofit hospital that fails to meet requirements around conducting a CHNA must pay an excise tax of $50,000.
Anyway, full text of the letter can be found here.
Darryll K. Jones and Easter Floyd-Clarke
FLASH! An Exempt Organization Can Help Build Your Dream Home and can even help pay for it with a tax deduction!
So this might not be a case of first impression, but I was still struck by seeming absurdity of taxpayer's assertion in a recent case (plus the judge's ignoring of the elephant in the room). Here are the facts from Lawrence and Linda Mann v. United States, a Maryland District Court opinion. L&L found their dream home or, more accurately, their dream homestead. Location is everything but there was a pretty expensive vintage house located on the property and for various reasons, the happy couple wanted to demolish the house and build their dream home to the specification they could see in their minds eyes. This, of course, would add substantially to the cost of their new home. Somehow, they learned about what seems like a worthy 501(c)(3) called "Second Chance Homes." Second Chance helps find low income homes and as part of its goals it takes "donations" of old homes (just like some charities take donations of old cars). It will even pick up the donated home for you and when it does, you get a tax deduction (according to Second Chance)!
L&L contact Second Chance and Second Chance agrees to "deconstruct" but not necessarily "demolish" the old home sitting on the property that L&L wish to build upon. The Court explains that deconstruct means to take away all the constituent and apparently re-usable materials that constitute the home. Demolish, I guess, means to just knock the whole thing down and cart it all the way. I suppose the salvage value in that case might support a charitable contribution. In either case, it likely would have cost L&L quite a bit of money to clear the land and then rebuild their dream home. So Second Chance deconstructs the house, promising L&L that any usuable materials it recovers would be viewed as a donation. The deconstruction process will net Second Chance materials valued at about $150,000. The cost of deconstruction -- unhooking and uninstalling pipes and so forth --will cost Second Chance about $14,000. In due time, Second Chance deconstructed the home and issued the proper substantiation to L&L. The appraised value of the home completely in-tact (meaning if the house were picked up and moved someplace else), according to one appraiser, was $650,000; the value of the disaggregated materials was more like $330,000 according to another appraiser. Taxpayers paid for both appraisers. Second Chance took the disaggregated materials but L&L still claimed a contribution deduction of $650,000. Oh, and one more interesting fact. As part of the donation process, L&L had to make another "cash donation" of $20,000 to Second Chance to help with the deconstruction process. In Partnership Tax, this set of facts would trigger a "disguised sale" inquiry but the Court never mentions that possibility.
The Service did not play along. The opinion, though, is all about valuation and the qualified appraiser requirement (with a few lines tucked in about the inability to take a charitable contribution without contributing a taxpayer's "entire interest in property)." IRC 170(f)(3)(A). The Court denied both the $650,000 charitable contribution deduction and, when L&L sought to reduce it to $330,000 the Court denied that too. Both denials were based on faulty appraisals. The Court did, though, allow the $20,000 deduction (actually it was more like $13,000 because L&L did not pay the entire $20,000).
Clearly, though, this was not a contribution whether the appraisals were correctly conducted or not. Instead, it was a straight purchase of services! Second Chance's raison d'etre, by the way, is that it provides job training for low income and unskilled workers, some of whom are recently released from prison. That's fine and dandy but this case stinks. And the Court's dance around the quid pro quo makes it seem like had the appraisal been done correctly, taxpayers might have enjoyed at least a $330,000 deduction. Unless I am just missing something!
Darryll K. Jones
As reported by the New York Times last week, both the Southern Poverty Law Center and the Anti-Defamation League have issued separate reports discussing the rise in hate groups around the country. The SPLC report is nearly 100 pages, while the ADL report is about half as long. According to the ADL report, right wing extremists are responsible for 73% of the 427 ideologically motivated killings in the United States during the ten year period from 2009-18; Islamist extremist have been responsible for about 23%, with left wing extremist responsible for about 3%. No mention about the number of hyper-dangerous Mexican mothers with children in tow. But I digress. A substantial number of the domestic extremist groups are tax exempt under IRC 501(c)(3) and the unsatisfying, though not universally held consensus, is that tax exemption cannot be withheld from extremist groups without violating the First Amendment to the United States Constitution. I have been thinking about that consensus for some time now and hopefully by the end of the summer I can articulate a defensible theory to deny tax exempt status to hate groups. In the meantime, I want to report on some legal guerrilla warfare going on in the Courts. Ironically, it involves hate groups -- who insist on the right to tax exemption to support hate speech [and the inevitable consequences, in my view] -- attacking groups like SPLC and ADL for using speech to call out those hate groups.
Consider, for example, Glen K. Allen v. Heidi Beirich, Mark Potok, and The Southern Poverty Law Center, Inc. SPLC is a long-time 501(c)(3) civil rights organizations that uses the courts to fight the consequences sometimes shown to be supported or provoked by hate groups. One of its main tools, of course, is public exposure. Here is where the plaintiff, Mr. Allen comes in. According to a Baltimore Newspaper:
The lawyer, Glen K. Allen, has had a long career as a Maryland civil litigator. He has represented various clients ranging from the giant cigarette company Philip Morris, to the Afro-American newspaper. He recently retired from the giant firm DLA Piper and was hired as a contract attorney by the city for its Litigation and Claims Practice Group, the largest division within the Law Department. Allen's financial support of the National Alliance, a neo-Nazi organization, and his work for The American Eagle Party, a fringe political party based in Tennessee, were brought to light yesterday by the non-profit Southern Poverty Law Center. "Allen may well be a skillful attorney," the SPLC's expose says. "But at a time when Baltimore and its police department are facing devastating criticism over their policing practices, and a crisis over their treatment of minority residents, the hiring of a known neo-Nazi to litigate for them surely raises questions."
One can only wonder how Mr. Allen survived at DLA Piper for so long. In any event, the City of Baltimore fired him shortly after SPLC started speaking out about his record. That led to Mr. Allen filing a federal lawsuit in the District Court for the District of Maryland. Neither the IRS nor the Treasury Department are named as defendants but here is the interesting part. The 81 page complaint uses a whole lot of ink to discuss the proper role of a 501(c)(3) in an effort to show that the SPLC is not acting properly and should have its 501(c)(3) status revoked. The complaint, by the way, is part of a larger "vast right wing conspiracy" in which right wing groups attack the exempt status of groups that monitor and speak out against hate groups and those affiliated with them. None of the suits name Treasury or the Service. And you are just gonna have to skim through the entire complaint yourself if you want to see the ad hominem allegations supporting the plaintiff's demand that the federal court revoke tax exempt status even without the Treasury or Service's involvement. After the fold, though, you can read the count wherein Allen specifically alleges his right as a citizen to demand the revocation of SPLC's 501(c)(3) status (based on things I never thought applicable to the determination of exempt status!). I suppose anybody can sue ya!
Darryll K. Jones
Monday, February 25, 2019
IRS Issues Guidance on Nonprofit Executive Compensation, but Challenges Remain for Tax-Exempt Health Care Systems
In their article Erika Mayshar and Ralph DeJong explain how the new tax on high earning nonprofit executives work and what employees the tax applies to. On December 31st, the IRS issued their guidance regarding the 21% excise tax on nonprofit executives. Their guidance explains that the 21% tax applies to executives who earn over $1 million and tax-exempt employers who pay excessive parachute payments to covered employees. "A parachute payment refers to any payment that is contingent on an employee’s separation from employment, where the aggregate payment is three times or more the employee’s average annual taxable compensation in the preceding five years.” The tax applies to the amount of the payment that exceeds the annual average amount. For example, if the employee’s annual salary is $500,00, and the employee gets a parachute payment of $1.5 million, the tax applies to the amount exceeding $500,000. To learn more about the how the executive compensation tax works and will be applied, click here.
Friday, February 22, 2019
In their article, Tim Delaney and David Thompson give their opinions on the 2019 tax policy decisions. They believe that 2019 will be a big year for deciding whether nonprofit organizations’ missions will be constrained for decades by extra financial burdens imposed by the government. They predict that by the end of the year nonprofits will finally have answers to questions left by the 2017 federal tax law. For example, will donations decrease for charitable organizations? Early reports showed fewer small to midsize donation, which is troubling because of the decline in the number of donors because of the doubling of the standard deduction in the 2017 federal tax law. Will nonprofits owe more in income tax because of the new taxes levied on fringe benefits and non related business income? This question comes with some good news because many state level governments see no sense in taxing nonprofits for parking and transit passes. To learn more about Tim and David’s predictions for 2019, click here.
Thursday, February 21, 2019
This past December the Treasury Department and IRS released guidance that officials designed to minimize the impact of the tax on nonprofits’ parking-benefit expenses. Steven Mnuchin said in a press release, “The Treasury is offering tax exempt organizations a roadmap for navigating their responsibilities. The guidance issued today aims to provide flexibility while minimizing the burden on non-profit groups that provide employee parking.” The 2017 tax law eliminates tax exempt organizations’ ability to deduct expenses they incur while providing employees with fringe benefits, like parking. The new law also subjects nonprofits to a 21% tax on transportation benefits. The 21% tax received heavy criticism from nonprofits, who argue that the tax will cause them to divert resources that without the tax would be used to further their missions. To learn more about the Treasury’s guide, click here.
Wednesday, February 20, 2019
This article discusses when nonprofit’s owe tax on their income. The article explains that even though nonprofits by definition exist not to make money, but to fulfill a charitable purpose, they are still able to make a profit. Whether this profit is taxed depends on if the income is related to the nonprofit’s purpose or not. When tax-exempt organizations make a profit from activities to further their purpose this profit is not taxable income. While profits made from activities that do not further the nonprofit’s purpose is considered taxable income. For example, if a 501(c)(3) organization called Friends of the Library, Inc holds a lecture series featuring famous authors, any of these profits would not be taxable income. This is because the profits made further the nonprofits purpose of furthering the appreciation of literature. To learn more about which profits can be taxed and which cannot, click here.
Tuesday, February 19, 2019
Attorneys from the tax exempt group at Ropes & Gray have produced a podcast summarizing the changes to tax laws pertaining to exempt organizations. Click on the Podcast link centered above to listen during your lunch time. The podcast is about 20 minutes. Here is a summary from the transcript:
Morey Ward: Hi, everyone, and thanks for joining us for this Ropes & Gray podcast. I'm Morey Ward, counsel in our tax-exempt group. I am joined by my colleagues Kendi Ozmon, Gil Ghatan and Brittany Cvetanovich, who also focus their practices on representing tax-exempt organizations. Today's podcast is called "Tax Reform and Its Impact on Exempt Organizations, One Year In." This is meant to provide listeners with an update on the provisions of the Tax Cuts and Jobs Act (the "TCJA"), that specifically target tax-exempt organizations, including some major guidance issued on these provisions in late 2018. We'll also mention some questions about the TCJA that remain unanswered. Brittany and Gil will begin by talking about some changes to the rules on unrelated business taxable income, (or "UBTI"). Brittany will address questions about the new "silo" rule for calculating UBTI, and Gil will talk about the new tax on parking expenses. We'll then turn the focus of our discussion to two excise taxes the TCJA imposed on exempt organizations. Kendi will talk with me about the excise tax on executive compensation, and we'll wrap up with an update on the excise tax on certain college and university endowments.
Darryll K. Jones and Easter L. Floyd-Clarke
There was an interesting article in yesterday's L.A. Times regarding something the left coasters call "behested payments." On the right coast, the practice is probably more often referred to as "pay to play." Anyway, yesterday's L.A. Times article described left coast politicians' habit and history of soliciting charitable donations to their favored causes. Sounds ok so far. "These payments are not considered campaign contributions or gifts," the state's political watchdog explains, "but are payments made at the 'behest' of elected officials to be used for legislative, governmental or charitable purposes." The more sinister implication is that the donors are doing two bad things. First, they are avoiding campaign donation limitations by steering campaign contributions to a candidate's favorite charity, through which the candidate receives some sort of implicit benefit associated with the donation. Secondly, the donor is buying access to city hall. Los Angeles Councilman Mitchell Englander has caused many a donor to contribute, at Councilman Englander's "behest," to a charity at whose well attended events Councilman Englander is a frequent and featured guest speaker. For federal tax purposes the implication is that in exchange for benefitting from a politician's fundraising prowess, charities are providing focused and featured face-time and feel good associations for the candidate. In other words, the candidate who can steer donations to a charity by sending out personal "behests' [sic], is treated as the charity's favorite son or daughter, though the charity never implicitly tells its stakeholders to "vote for so and so because he supports us." A 2017 article graphically illustrated the potential in this graphic regarding behested payments solicited by Mayor Eric Garcetti:
Mayor Garcetti has raised a boat load of money mostly for the Mayor's Fund of Los Angeles, a 501(c)(3) he set up himself and which generally does its good works in partnership with L.A. city government, especially the incumbent Mayor. One commentator describes Garcetti's success with behested payments thusly:
Garcetti has raised more than twice as much in behested payments as California Gov. Jerry Brown and more than 40 times the amount of Lt. Gov. Gavin Newsom over the same time period, according to a KPCC analysis of reports filed by the politicians. Most of the donations Garcetti raised went to a charity he helped create after his election, the Mayor's Fund for Los Angeles, according to reports he filed with the Los Angeles City Ethics Commission. Other contributions given at his request benefited other efforts, including two that are dear to his heart: L.A.'s Olympic bid and The GRYD Foundation, which runs a summertime park program Garcetti has supported for years. “It strikes me that he’s taking advantage of the law more than anybody else has ever done,” said Bob Stern, a former California Fair Political Practices Commission general counsel who helped write the state's 1974 Political Reform Act.
California has disclosure rules that require politicians to disclose "behested payments." I suppose transparency in politics is a good thing so I don't have a philosophical bent against campaign disclosure laws. But what exactly is the public to conclude from, for example, the disclosure that a political incumbent has generated -- "behested" -- millions of dollars for a charity whose glow benefits everybody with whom the charity associates, including its political incumbent rainmaker? The answer to that question begs the question what exactly is the politician purchasing from the charity who benefits from behested payments and what implication does that expectation have for charitable organizations prohibited from campaign intervention. I will talk about that in my next post.
Darryll K. Jones
Friday, February 15, 2019
Ellen Aprill's Review of Hamburger's "Liberal Suppression: Section 501(c)(3) and the Taxation of Speech"
Ellen Aprill (Loyola-LA) recently posted a review of Professor Philip Hamburger's (Columbia) "Liberal Suppression: Section 501(c)(3) and the Taxation of Speech" at HistPhil.org. HistPhil, which is "a web publication on the history of the philanthropic and nonprofit sectors, with a particular emphasis on how history can shed light on contemporary philanthropic issues and practice." Prof. Hamburger's book argues that, as a constitutional law matter,
... theopolitical fears about the political speech of churches and related organizations underlay the adoption, in 1934 and 1954, of section 501(c)(3)’s speech limits. He thereby shows that the speech restrictions have been part of a broad majority assault on minority rights and that they are grossly unconstitutional.
Seeking Nominations for the
2019 Outstanding Nonprofit Lawyer Awards
WASHINGTON, D.C.—February 11, 2019: The Committee on Nonprofit Organizations of the American Bar Association’s Business Law Section is calling for nominations for the “2019 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 18, 2019.
For a nomination form, please go to the Nonprofit Organizations Committee webpage and scroll down to find the form under “2019 Outstanding Nonprofit Lawyer Awards." The Awards will be announced at the Business Law Section's Spring Meeting at the end of March.
Send nomination forms by March 18, 2019 to:
David A. Levitt
Adler & Colvin
135 Main Street, 20th Floor
San Francisco, California 94105
(415) 421-0712 (fax)
Darryll K. Jones
Thursday, February 14, 2019
The 2019 AMT organizing committee—Michelle Drumbl, Heather Field, Miranda Fleischer, Brian Galle, Shu-Yi Oei, and Darien Shanske—welcomes proposals for our annual conference.
AMT is a recurring conference intended to bring together relatively recently tenured professors of tax law for frank and free-wheeling scholarly discussion. Our fifth (!) annual meeting will be held on Thursday and Friday, June 13 and 14, 2019, at the lovely & temperate campus of the University of San Diego. We’ll begin early on Thursday and adjourn by noon on Friday. Sunscreen is not provided but strongly recommended.
Thanks to the support of USD and its outstanding graduate tax program, AMT is able to provide attendees with conference meals and refreshments. Attendees will be expected to cover remaining expenses incurred while away from home in the pursuit of their trade or business. Conference-rate housing will be available. AMT takes no position on the interaction of sections 132(d), 67, or other potentially applicable provisions. Your in-house finance office probably has it wrong, though.
Eligible participants are those who have been voted tenure by a graduate-degree-granting institution within the past ten years (as of June 13, 2019). Send in your proposal now!
Proposals should provide a brief description (not to exceed one double-spaced page) of a working paper or “incubator” idea that the participant would present at the conference. Participants are expected to read all of the presented papers, and each will serve as lead discussant for one paper. In your proposal, please note additional areas of topical interest for which you would be willing to serve as discussant. In the spirit of recent legislative efforts, the committee can commit to assembling the final program hastily behind closed doors without a formal hearing; there will be no revenue estimates.
Proposals may be submitted to: [email protected] under the subject header “AMT Proposal.” Proposals should be received no later than 5 pm EST on Friday, March 15, 2019. Proposals containing gratuitous Julius Caesar jokes or those otherwise addressing §82 will receive bonus points.
Wednesday, February 13, 2019
From the conclusion of Lester M. Salamon and Chelsea L. Newhouse, "The Nonprofit Employment Report," Nonprofit Economic Data Bulletin No. 47 (Baltimore: Johns Hopkins Center for Civil Society Studies, January 2019):
The data presented in this report demonstrate that the nonprofit sector is not only a significant employer, but also a significant contributor to employment growth even in recessionary periods of the sort that occurred in the wake of the 2007 financial crisis. This resilience is due in important part to the overall shift in America toward a service economy, demographic trends such as the aging of the population and the expanded female participation in the labor force that are boosting demand for the kinds of services that nonprofits have traditionally provided, the expansion of government funding for many of these services, and the counter-cyclical nature of many of the government “safety net” programs, which causes funding to expand when recessionary pressures disrupt normal sources of revenue.
However, nonprofits are not the only institutions benefiting from these trends. To the contrary, for-profit firms have increasingly entered these service fields as well. The fact that government has shifted from producer-side subsidies such as grants to consumer-side subsidies such as tax expenditures and vouchers has intensified this trend by channeling increasing shares of government support through the market, where for-profits have inherent advantages. For-profits also benefit from their superior access to investment capital through the issuance of stock, which gives them an edge in responding quickly to increases in demand occasioned by new or expanded governmental support. In addition, for-profits are less held back than are nonprofits by mission-related constraints on the types of clients they should primarily serve, giving them greater access to paying customers. The upshot has been an uneven playing field for nonprofit providers and a resulting steady loss of nonprofit market share even as the overall scale of nonprofit employment has increased.
While competition certainly has its place in this field as in many others, the competition needs to be on a level playing field, particularly given the special contributions that nonprofits have been found to make in devising innovative forms of service, serving more disadvantaged clients, and staying the course even when economic circumstances turn sour. These findings therefore have significant practical implications for both nonprofit stakeholders and policy makers. In the first place, they demonstrate the significant job creation potential of the nonprofit sector, especially during recessions, and therefore highlight the need to keep this sector’s potentials in view as national and regional efforts to boost job growth are put in place. Among other things, these findings demonstrate why job promotion efforts that operate exclusively through the income tax mechanism are insufficient because they discriminate against this important set of job-creators for which income tax incentives have little effect. So, too, government contracting regimes that select providers of government-funded services purely on the basis of the lowest unit cost of services can inadvertently squeeze out some of the major features that make nonprofits special, such as their community-building activities and their charity care. Finally, expanded efforts are needed to overcome the structural impediment that nonprofits face in raising capital due to the prohibitions that bar them from sharing profits with investors and therefore prevent their access to equity finance through the issuance of shares. Expanded interest subsidies and loan guarantees are among the interventions that can help in this area.
Despite the growth of the for-profit presence in many traditional nonprofit fields, the nonprofit sector remains a crucially important provider. To date, the sector has shown remarkable resilience in the face of significant economic pressures and competitive challenges. With public funding under siege and private resources strained, however, the nonprofit job engine is under increasing pressure, with clear evidence of loss of market share in crucial fields. If evidence of the sort provided here can call attention both to the strengths that this sector has displayed and some of the challenges it now faces, it will have served its purpose well.
Darryll K. Jones and Easter Floyd-Clarke
Tuesday, February 12, 2019
Revenue Procedure 2019-12 provides for a seemingly unjustifiable horizontal inequity when it comes to individual state and local taxes. I could be wrong, these are just my first thoughts and I should probably ponder it a little more. But deadlines never stop! Recall that as a result of the TCJA, individual deductions for state and local taxes are capped at $10,000. State law efforts to use charitable deductions to "work around" SALT limitations were likely thwarted when the Treasury Department issued proposed regulations concluding that charitable contributions will not be allowed to avoid or undermine the $10,000 SALT limitation. In other words, if a state reduces state or local taxes by the amount of charitable contributions made, the federal contribution amount will be reduced by the amount of SALT reduction at the state level. Historically, corporations and other profit making entities could not make charitable contributions, proper, because a business entity is limited to profit-making purposes. Corporations exist to make profit not give away investors' money even for the most worthy cause. That was the lesson in Dodge v. Ford, a classic introductory case in every business organizations text. The oft-repeated distinction is that a corporation has the power to make a charitable contribution, but only for the purpose of making money. Today, the social purpose and benefit corporation statutes allow certain profit making corporations to have charitable purposes, even if they are not exempt under 501(c)(3). And corporate charitable contributions are generally viewed as "good business" leading to more profits in the long term.
So anyway, the proposed regulations effectively prevent charitable workarounds by individuals. The Revenue Procedure allows through a backdoor what the proposed regulations prevent through the front door, in limited but significant circumstances. In federal tax law, a passthrough entity -- especially a partnership -- works like a magic hat. Although it appears empty, the right person can stick his hand into the hat and pull out a rabbit! Individuals who want to make charitable contributions to reduce state and local taxes can use passthrough entities to get the charitable workaround that the proposed regulations deny to individuals who make the same charitable contribution directly. They simply have to stick their hand into the partnership hat and out pops a rabbit! Since corporations and partnerships exist to make money, theoretically every payment -- even a charitable contribution properly made for a profit seeking purpose (like the generation of good will and more customers) -- is a trade or business expense (or perhaps an expenditure). And trade or business deductions under IRC 162 are not reduced by the receipt or expectation of return benefit. The whole reason for making the deductible payment is to obtain a return benefit, albeit a profit making one. So here is what Revenue Procedure 2019-12 says about individuals who make charitable contributions through a partnership even if the payment reduces a state and local tax liability:
.03 Safe harbor. If a specified passthrough entity described in section 4.02 of this revenue procedure makes a payment to or for the use of an organization described in section 170(c) and receives or expects to receive a tax credit described in section 4.02(4) of this revenue procedure that the entity applies or expects to apply to offset a state or local tax described in section 4.02(3) of this revenue procedure other than a state or local income tax, the specified passthrough entity may treat such payment as meeting the requirements of an ordinary and necessary business expense for purposes of section 162(a) to the extent of the credit received or expected to be received.
(1) Example 1. P is a limited liability company (LLC) classified as a partnership for federal income tax purposes under section 301.7701-3 and is owned by individuals A and B. P is engaged in a trade or business within the meaning of section 162 and makes a payment of $1,000 to an organization described in section 170(c). In return for the payment, P receives or expects to receive a dollar-for-dollar state tax credit to be applied to P’s state excise tax liability incurred by P in carrying on its trade or business. Under applicable state law, the state’s excise tax is imposed at the entity level (not the owner level). Under section 4 of this revenue procedure, P may treat the $1,000 payment as meeting the requirements of an ordinary and necessary business expense under section 162.
(2) Example 2. S is an S corporation engaged in a trade or business and is owned by individuals C and D. S makes a payment of $1,000 to an organization described in section 170(c). In return for the payment, S receives or expects to receive a state tax credit equal to 80 percent of the amount of this payment ($800) to be applied to S’s local real property tax liability incurred by S in carrying on its trade or business. Under applicable state and local law, the real property tax is imposed at the entity level (not the owner level). Under section 4 of this revenue procedure, S may treat $800 of the payment as meeting the requirements of an ordinary and necessary business expense under section 162. The treatment of the remaining $200 will depend upon the facts and circumstances and is not affected by this revenue procedure.
In both examples, the charitable contribution reduces state taxes (other than income taxes) payable at the entity level; for federal purposes the payment passes through to the members (in the LLC) and the shareholders (in the S Corporation) and reduces federal income dollar for dollar. But the passed-through charitable contribution deduction does not apply towards the $10,000 SALT limitation at the federal level, nor is it reduced for federal purposes by the amount of state tax liability reduction, because it retains its entity level characterization as an ordinary and necessary business expense (almost as if it were not an intentional workaround the SALT limitation when we know it is). Had the members or or shareholders made the charitable contributions directly and in return for the same state level tax reduction, the charitable contribution deduction would have been reduced by the amount of the state tax reduction. Importantly, the magic hat trick works only if the passthrough entity is subject to a state entity level tax and according to AICPA so far only thirteen states impose taxes at the entity level for an entity treated as a passthrough for federal purposes. Apparently, the only distinction between an individually made state tax offsetting charitable contribution and one made via a passthough is that in the latter circumstance, the individual has a profit-seeking purpose as a matter of law because of the existence of the partnership through which the contribution was made. The distinction does not resolve my cognitive dissonance! Maybe somebody can make an argument in defense of the outcome or better yet explain what I am missing! Or maybe this is not such a big deal. Somehow it does not feel right. In any event, AICPA reports that more states are considering enacting entity level taxes on partnerships so that partners may take advantage of the magic hat that is partnerships!
Darryll K. Jones and Harry Germeus
Monday, February 11, 2019
The thing that caught my attention last week regarding Florida Coastal School of Law's planned conversion to nonprofit status was the suggestion that after the conversion, Infilaw, the current owner, might continue its relationship with the school under a management agreement. A word of unsolicited advice is perhaps in order. When the owners of a for-profit entity decide or even consider converting to nonprofit status (with an application for tax exempt status as part of the conversion), its probably not a good idea to announce ex ante that the current for-profit owners will enter into a management contract with the soon to be formed exempt nonprofit. I am not even quite sure what law school operations a for-profit management company can actually and legitimately manage if the school is to operate in accordance with the accreditation standards. Will the management company select the Dean, hire faculty, set class sizes, make admissions decisions, determine curricular content or determine tenure and promotion standards? I can think of a host of accreditation concerns with regard to a for-profit management company doing any of those things.
Let's assume a privately managed tax exempt Coastal can get around the accreditation questions. Even so, and as Corso might say, "not so fast, my friend!" In the world of "big time tax exemption," management contracts are fraught with private benefit issues, especially when the management company has or had a financial interest in the exempt organization. Consider this excerpt from the analysis of Situation 2 in Revenue Ruling 98-15 (I have substituted Florida Coastal and Infilaw, respectively, for the principals named in Rev. Rul. 98-150):
The primary source of information for [Florida Coastal's] board members will be the chief executives, who have a prior relationship with [Infilaw], and the management company, which is a subsidiary of [Infilaw]. The management company itself will have broad discretion over [Florida Coastal’s] activities and assets that may not always be under the board’s supervision. For example, the management company is permitted to enter into all but "unusually large" contracts without board approval. The management company may also unilaterally renew the management agreement.
Maybe its safe to assume that Infilaw will do its homework before the conversion. Still, I really doubt that Old Florida Coastal can decide ex ante that Infilaw or an Infilaw controlled entity will serve as New Florida Coastal's manager, at least not without serious private benefit issues arising. Its hard to imagine a compensation structure for that management agreement that would not put the Infilaw owners in almost the same position they would have been in absent the conversion. Nor can I imagine any set of contractual terms that would require the former for-profit owners to manage new Florida Coastal in a manner that ensures charitable goals take precedence over profit making. As a matter of law, new [exempt] Florida Coastal would have to engage in serious due diligence, wholly independent from the thinking or plans of Infilaw, before awarding a management contract. Common law fiduciary duties and the tax law duties to conserve charitable assets and avoid private benefit mandate that the board select an independent management company with no incentives to relegate the charitable goal to the company's profit making goals. See below the fold for more on management contracts.
Darryll K. Jones and Harry Germeus
Friday, February 8, 2019
David Hemel (Chicago) has posted The State-Charity Disparity Under the 2017 Tax Law, Washington University Journal of Law and Policy (forthcoming). Here is the abstract:
Since December 2017, several states have enacted laws granting state tax credits for charitable contributions that go toward public education or public health. One purpose of these laws is to allow individuals to claim federal charitable contribution deductions for payments that simultaneously serve to reduce those individuals’ state tax liabilities and to support programs that state governments would otherwise fund. The strategy adopted by these states — if effective — would mitigate the impact of the $10,000 cap on individual state and local tax deductions imposed by the December 2017 tax law. The U.S. Treasury Department and the Internal Revenue Service (“IRS”) have proposed, but not yet finalized, regulations aimed at shutting down that strategy.
The ongoing debate regarding state charitable credit programs and the proposed Treasury regulations raise a number of interesting legal questions — some of which may be addressed at subsequent stages of the rulemaking process, others of which will likely be resolved by litigation. Rather than trying to answer any of those questions, this Essay — an edited transcript of remarks at the Washington University Journal of Law & Policy-Missouri Department of Revenue 2018 Symposium on State & Local Taxation — focuses instead on a separate, though related, question, a question that is implicated by the charitable credit debate but that will linger long after any litigation is resolved. That is: Why should federal tax law allow more favorable treatment to charitable contributions than to state and local tax payments? What are the essential differences between non-governmental charities and sub-national governments, or between contributions and tax payments, that justify this lack of parity?
Ultimately, this Essay concludes that there is little justification for allowing a virtually unlimited charitable contribution deduction while capping the deduction for SALT. That conclusion gives rise to a critique of the December 2017 tax law, but also to a critique of presidential candidate Hillary Clinton’s tax plan, which would have capped the rate at which state and local tax payments could be deducted without applying the same cap to charitable contributions. The Essay ends with reflections on the long-term implications of the state charitable credit programs for tax policy and politics.
Hat tip: TaxProf Blog
Marianne Bertrand (Booth School of Business, University of Chicago), Matilde Bombardini (Vancouver School of Economics, University of British Columbia), Raymond Fisman (Economics, Boston University), Bradley Hackinen (University of British Columbia), and Francesco Trebbi (University of British Columbia) have posted a National Bureau of Economic Research working paper titled Hall of Mirrors: Corporate Philanthropy and Strategic Advocacy. Here is the abstract:
Politicians and regulators rely on feedback from the public when setting policies. For-profit corporations and non-pro t entities are active in this process and are arguably expected to provide independent viewpoints. Policymakers (and the public at large), however, may be unaware of the financial ties between some firms and non-profits - ties that are legal and tax-exempt, but difficult to trace. We identify these ties using IRS forms submitted by the charitable arms of large U.S. corporations, which list all grants awarded to non-profits. We document three patterns in a comprehensive sample of public commentary made by firms and non-profits within U.S. federal rulemaking between 2003 and 2015. First, we show that, shortly after a firm donates to a non-profit, the grantee is more likely to comment on rules for which the firm has also provided a comment. Second, when a firm comments on a rule, the comments by non-profits that recently received grants from the firm's foundation are systematically closer in content similarity to the firm's own comments than to those submitted by other non-profits commenting on that rule. This content similarity does not result from similarly-worded comments that express divergent sentiment. Third, when a firm comments on a new rule, the discussion of the final rule is more similar to the firm's comments when the firm's recent grantees also comment on that rule. These patterns, taken together, suggest that corporations strategically deploy charitable grants to induce non-pro fit grantees to make comments that favor their benefactors, and that this translates into regulatory discussion that is closer to the firm's own comments.