Nonprofit Law Prof Blog

Hackney, Dark Money Darker? IRS Shutters Collection of Donor Data

Philip Hackney (Pittsburgh) has posted Dark Money Darker? IRS Shutters Collection of Donor Data, which will be published in the Florida Tax Review. Here is the abstract: 

The IRS ended a long-time practice of requiring most nonprofits to disclose substantial donor names and addresses on the nonprofit annual tax return. It is largely seen as a battle over campaign finance rather than tax enforcement. Two of the nonprofits involved, social welfare organizations and business leagues, are referred to as “dark money” organizations because they allow individuals to influence elections while maintaining donor anonymity. Many in the campaign finance community are concerned that this change means wealthy donors can avoid campaign finance laws and have no reason to fear being discovered. In this Article, I focus on whether the information is needed for the enforcement of the tax law and/or to support ancillary legal goals. I contend the IRS ought to collect this substantial donor information as it did for over 79 years. Though the collection of donor information may not be essential for groups such as social clubs, fraternities and sororities, and mutual ditch companies, the collection of this information non-publicly by the IRS is important in both enforcing tax-exempt requirements and in enforcing the tax law generally. Tax law prohibits the distribution of earnings from a nonprofit to those who control the organization. Substantial donors are classic suspects for seeking such improper receipts through their control. Thus, the information is key to IRS auditors. Considering the deficient budget of the IRS to ensure a properly enforced Code, the failure to collect that information puts the IRS in a disadvantaged position. While as a democratic matter, there may be some modest benefit from alleviating donors from the worry that the government will know about their political contributions, the harm to those who are not able to make use of these structures, the harm to those who are deprived of information regarding the biases associated with particular political activity, and the harm to the belief that the tax, campaign finance, and nonprofit law will be enforced equally upon all, is more significant. With these considerations in mind, the IRS and Treasury ought to rescind its most recent guidance on this matter. If not, Congress ought to require this information be disclosed by law.

Samuel D. Brunson

8th Circuit Remands Mayo Back to District Court

In a case deep in the weeds of tax-exempt law, the United States Eighth Circuit Court of Appeals remanded Mayo Clinic v. United States, No. 19-3189 back to the District Court. Though deep in the weeds, the case has some potential big importance to tax exempt law. 

Though it is technically about whether Mayo owes the unrelated business income tax associated with debt financed income, it has big importance because a loss here would potentially open up a simple way for charitable organizations to establish that they have a favored status of being a public charity rather than a private foundation by being an educational organization.

In order to be allowed an exemption under section 514 of the Code from the UBIT, Mayo claimed that it is a qualified organization under section 514(c)(9)(C)(i) because it is an "educational organization under section 170(b)(1)(A)(ii). That statute states: an educational organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on." Note that without the "primary test" a charity could normally maintain faculty and curriculum and normally have a regularly enrolled body or pupils, as something less than a primary part of the organization's activity. 

The IRS determined that Mayo was not such an educational organization based on its regulation interpreting the above language. The regulation Treas. Reg. 1.170A-9(c)(1) provides an organization is an educational organization "if its primary function is the presentation of formal instruction and it normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on."

Obviously Treasury and the IRS added the "primary function" test to what is provided for in the statute. The District Court held for Mayo on the basis that the primary function was not a part of the test Congress implemented. Mayo Clinic v. United States, 412 F. Supp. 3d 1038 1042 (D. Minn. 2019).

After applying the Chevron Two Step, the Appeals Court upheld the Treasury Regulation, but only in part, it says. It first finds that the District Court was right that the primary test added by Treasury was not reasonable. They find that the history and prior case law did not support this language. But then it suggests that the primary test should indeed apply but as to the idea of educational generally. Thus, the court determines that the test to apply is as follows: "The analysis normally unravels in three parts: (1) whether the taxpayer is “organized and operated exclusively” for one or more exempt purposes; (2) whether
the taxpayer is “organized and operated exclusively” for educational purposes; and (3) whether the taxpayer meets the statutory criteria of faculty, curriculum, students, and place."

One part of the history of charitable organizations that the Eighth Circuit fails to trace is the development of the idea of a publich charity under section 509 of the Code. There an organization is generally determined to be a private foundation unless it meets one of the requirements under (a)(1)-(4). Section 509(a)(1) includes these same educational organizations. 

I think what this all means is that there is an easier end run around obtaining public charity status for "educational organizations." A well funded advocacy organization by one individual that mainly educates the world about their point of view in order to influence political choices need only hire some faculty, have them establish curriculum, and then regularly educate some pupils. This would meet the above test and would circumvent the private foundation rules. I doubt this was intended by Congress, but that I think is the practical result of the Courts ruling. 

The Eighth Circuit remanded the case for further proceedings. It seems likely to me that Mayo will again win at the District Court. I would be surprised if the IRS appealed it further as they have lost the main issue on this one. Additionally, given the way they lost, I don't think the IRS can fix the regulation. The only way for the IRS to fight this one again would be to try to win in another Circuit. Given the trend of federal court cases going resoundingly against the IRS on interpretation issues like these lately, including most recently CIC Services at the Supreme Court, I suspect the only way to solve this mess is for Congress to take action. 

Philip Hackney

May 19, 2021

Amarante, States as Laboratories for Charitable Compliance: An Empirical Study

Eric Franklin Amarante (Tennessee) has posted States as Laboratories for Charitable Compliance: An Empirical Study, which will be published in the George Washington Law Review. Here is the abstract:

Each year, the IRS awards 501(c)(3) status to thousands of unworthy organizations. As a result, these undeserving organizations do not have to pay federal taxes and donations to these entities are tax-deductible. This is because the IRS, facing increasingly severe budget cuts, adopted a woefully inadequate application process that fails to identify even the most obvious of unworthy applicants. The result of this regulatory failure may prove to be catastrophic. As unworthy charities proliferate, the public will lose faith in the entire charitable regime. As trust dissipates, donations are certain to follow, and the charitable sector will lose a vital revenue stream. It is not an exaggeration to say that the loss of donations represents an existential threat to the entire charitable sector.

With a change in budgetary priorities unlikely in the foreseeable future, it would be unwise to wait for the IRS to curb this threat. Rather, it would be prudent to identify another way to increase regulatory compliance in the charitable sector. This article proposes a cost-efficient mechanism for states to fill the regulatory void left by the IRS. To identify this mechanism, this study reviewed 500 formation documents in five different states, identifying the state procedures that resulted in the highest level of regulatory compliance. By replicating the procedures identified in this article, individual states will not only ensure higher levels of regulatory compliance, but also help restore the public’s trust in the charitable sector.

Lloyd Mayer

Babenko, Bennett, Sen: Regulating CEO Pay: Evidence from the Nonprofit Revitalization Act

Ilona Babenko (Arizona State), Benjamin Bennett (Tulane), and Rik Sen (University of New South Wales) have posted Regulating CEO Pay: Evidence from the Nonprofit Revitalization Act. Here is the abstract:

Using compensation data for 14,765 nonprofit organizations during 2009-2017, we find that CEO pay dropped by 2-3% when new legislation adopted in New York reduced the ability of CEOs to influence their own pay. Despite cuts in pay, CEOs did not exert less effort. Further, nonprofit performance improved after the legislation, as reflected in larger donor contributions, more volunteers, and greater revenues. We show that these results are consistent with the predictions of a simple principal-agent model with compensation rigging. Overall, our results suggest that regulation that targets the pay-setting process can be effective at improving organizational outcomes at nonprofits.

Lloyd Mayer

Jay, Down the Rabbit Hole with the IRS' Challenge to Perpetual Conservation Easements, Part Two

Jessica Jay (Conservation Law, P.C.) has published Down the Rabbit Hole with the IRS' Challenge to Perpetual Conservation Easements, Part Two in the Environmental Law Reporter. Here is the abstract:

When the Internal Revenue Service began disallowing gifts of perpetual conservation easements for claimed failures of perpetuity requirements, it tumbled land trusts, landowners, and the U.S. Tax Court down the rabbit hole to a baffling land below. The Service’s drop into matters beyond valuation and into elements intended and necessary for easement durability and flexibility has caused a confusing array of Tax Court decisions.

Part One of this Article examined how the Service lures the land conservation community and the Tax Court into Wonderland distortions, and the precarious tower of cards upon which its legal theories rest. Part Two, here, identifies the fundamental elements of law and the process of law to topple the Service’s card construct, and awaken and return everyone to the world above ground.

Lloyd Mayer

Nwaeze, Public Benefit Corporations: There's No Public Benefit to Breaching Fiduciary Duties

Oderah C. Nwaeze (Faegre Drinker) has published Public Benefit Corporations: There's No Public Benefit to Breaching Fiduciary Duties in the Emory Corporate Governance and Accountability Review. Here is the abstract:

During the spring and summer of 2020, in the midst of the COVID-19 pandemic, the United States witnessed large, public protests and activism reminiscent of the 1950s and 60s. Following the death of George Floyd, a Black man, at the hands of Minneapolis police, the American public once again mobilized to fight the ills and inequities of racism and discrimination. A significant number of nonprofit organizations and government departments have been created to resolve the social and political issues that plague Americans. Even Corporate America has been called to act, given that seventy percent of consumers are interested in the social justice efforts taken by the corporations they patronize. By the third quarter of 2020, plenty of companies answered the call. For example, Bank of America and PNC Bank each have committed $1 billion to address economic and racial inequality. Google’s parent Alphabet pledged $12 million to further racial equality. Target Corp. has committed $10 million to civil rights organizations and 10,000 hours of consulting services to small businesses owned by people of color. Comcast Corp. also announced that it will allocate $75 million to organizations including the National Urban League, the Equal Justice Initiative, and the NAACP, along with $25 million in media over the next three years. Recognizing that corporate activism could be inconsistent with the duty of directors and officers to secure and retain value for the company, some commentators have suggested that corporations committed to activism should create or convert to a Public Benefit Corporation (“PBC”). While the core trait of a PBC is that it must pursue public benefit, that charge is not superior to directors’ and officers’ responsibility to generate and preserve value for the company’s stockholders. Thus, while PBCs provide legal cover for corporate activism, corporate management must weigh that interest against the obligation to satisfy traditional fiduciary duties of due care and loyalty, as well as the obligation to avoid waste. This balance is not difficult to strike; it simply requires that directors and officers carefully evaluate the anticipated conduct to ensure the action considered appears likely to provide corporate benefit, reasonable for the resources expended. As part of that due diligence process, directors and officers also must make certain any transaction that benefits a director or officer is entirely fair to the corporation. Furthermore, directors and officers must ensure that the resources committed to a social cause are reasonable given the company’s size and value, as well as the benefits of the philanthropy.

Lloyd Mayer

Papa, Not-For-Profit Hospitals and Managed Care Organizations: Why the 501c)(3) Tax-Exempt Status Should Be Revised

Andrew C. Papa (Young Conaway) has published Not-For-Profit Hospitals and Managed Care Organizations: Why the 501c)(3) Tax-Exempt Status Should Be Revised in the DePaul Journal of Health Care Law. Here is the abstract:

Healthcare organizations abuse the 501(c)(3) tax-exempt status—reaping tax benefits but failing to give back to their local communities in return. Congress created the 501(c)(3) tax-exempt status to benefit the poor and impoverished. Yet, not-for-profit hospitals and managed care organizations are neither required to offer services to the poor nor required to offer emergency care services to their local communities. Instead, they charge higher prices in their increasingly concentrated markets. Therefore, consumers subsidize the same not-for-profit healthcare systems that charge them higher prices.

This Article analyzes government-placed incentives under the 501(c)(3) tax-exempt status, demonstrating how not-for-profit hospitals unfairly compete with for-profit hospitals. Studies show that not-for-profit hospitals have larger profit spreads than their for-profit counterparts. This Article will also demonstrate how the government encourages not-for-profit healthcare entities to increase their market power and extract rents from consumers. Today, the out-patient care business model fractionalizes the healthcare industry. Subsequently, not-for-profit healthcare entities can now acquire assets or firms in a piecemeal fashion, resulting in highly concentrated markets.

The third-party payor system and the Affordable Care Act exacerbate the issue, destroying traditional market forces. The third-party payor system creates a disconnect between the true provider and true consumer of healthcare treatment. The Affordable Care Act imposed additional requirements on not-for-profit hospitals—intending to incentivize charitable giving. Instead, the Affordable Care Act’s additional requirements incentivize profit-maximizing behavior at the expense of charitable giving. Because the healthcare industry suffers from a misalignment of pecuniary incentives and public health needs, creating clout on who the actual winners and losers are, the tax-exempt status should be revisited.

Lloyd Mayer

DAFs Add a New Twist to Politicians & Nonprofits

Politicians have long taken advantage of close ties with nonprofits in a number of ways. For example, just in the past couple of weeks there have been news stories about a 501(c)(4) nonprofit chartering a flight on which the Michigan governor purchased a seat for a trip to see her father (see also this story), and "How a top New York mayoral candidate used a charity to boost his profile". But in a new twist, the L.A Times has now run two stories about how charities associated with California politicians have used donor advised funds to obscure the original sources of donations.

One story was titled "How a $1-million donation on behalf of Newsom was hidden in plain sight". As required by California law, California Governor Gavin Newson repotted the gift as given on his behalf. But he did not apparently have to report who arranged for the gift because it came from a donor advised fund at the Silicon Valley Community Foundation. This allowed the original source of the funds- and who advised that the gift be made - to be hidden even though according to the story "[u]nder California law, when an elected official or someone acting on their behalf asks that a donation of $5,000 or more in cash or services be directed to a nonprofit or government agency, that contribution is considered a behested payment and must be reported to the [California Fair Political Practices Commission]." 

And the L.A. Times also reported this week that "Donors gave millions to Garcetti nonprofit but kept their identities secret, Times analysis finds". The story focuses on a charity founded by Los Angeles Mayor Eric Garcetti that has raised over $60 million, including at least $3.8 million from donor advised funds. The Mayor is subject to the same law mentioned above, but has refused to reveal the original source of the funds or who advised that the various donations be made.

Lloyd Mayer

DAFs and Redirected Giving Report; The Role of State AGs in Regulating DAFs

Last week the Boston College Law School Forum on Philanthropy and the Public Good released a report by James Andreoni (U.C. San Diego) and Ray Madoff (Boston College ) titled Impact of the Rise of Commercial Donor-Advised Funds on the Charitable Landscape 1991-2019. Here is the conclusion:

This report has examined existing data about changes in the charitable landscape since the creation of the first commercial donor-advised fund. The following are the key findings of this analysis:

• There is no evidence that the proliferation of donor advised funds has resulted in an increase in individual charitable giving as individual giving has remained largely constant as a percentage of disposable income, and is currently at the low-end of the range.

• While individual giving has remained largely constant, there has been a substantial shift in this giving toward donations to private foundations and donor-advised funds and away from direct giving to charities. Combined giving to donor-advised funds and private foundations has increased from 5% in 1991 to 28% in 2019, an increase of 460%.

• The value of assets in donor advised funds and private foundations have increased
  significantly over the past thirty years.

• Though more funds are flowing into, and growing in, private foundations and donor advised funds, there is no evidence that charities have benefitted from this trend.

• In the five-year period prior to 1991, charities received on average 94.1% of all
  individual giving. By contrast in the years 2014-2018 (the most recent years for which data is available), total donations received by charities (including grants from private foundations and donor-advised funds as well as direct giving) equaled between 71-75% of total individual giving.

• If charities had received donations at the rate of 94.1% of individual giving (the average rate that they received in the 5-year period before commercial donor-advised funds), they would have received an additional $300 billion over those 5 years.

Coverage: Chronicle of Philanthropy. 

The Minnesota Council of Nonprofits also recently posted a paper presented at a conference a year ago titled Private Foundation Grants to DAFs: Attorney General Charitable Trust Oversight Calls for Disclosure of Use of Funds. Here is the abstract:

$3 billion was transferred from over 2,200 U.S. private foundations to five donor advised fund (DAF) sponsors between 2010 and 2018. Within this universe, a growing number of private foundations have made a single grant during a reporting year to a commercial DAF. Looking just at transfers to the top five commercial DAF sponsors, 35 foundations transferred the entirety of their annual grantmaking to DAFs between 2010 and 2018.

These transactions offered no tax benefit, but in effect excused private foundations from two legal requirements for U.S.-based private foundations derived from the Tax Reform Act of 1969: reporting grant recipients1 and the 5 percent annual payout requirement.2 Such grantmaking, while facially charitable and in-line with the requirements put forth in the 1969 legislation, not only risks breaches of restrictions established by the foundations’ founding documents but also obscures all aspects of the recipients of private foundation funding by providing no context for when or where the charitable dollars will be used.

Private foundation-to-DAF transfers frustrate state attorneys general’s ability to fulfill their supervisory duties to monitor and ensure that charitable dollars held by charitable trusts are used for their intended purpose.

This paper examines the governing authority and practices of state attorneys general offices as relating to a special problem of charitable trust enforcement: private foundation grantmaking to commercial DAFs. The authors examine the regulatory challenges based on interviews with both current and former attorneys from nine attorney general offices, as well as interviews with commercial DAF sponsors. Charities regulators’ ability to fulfill their supervisory duties related to private foundation-to-DAF grantmaking is blocked by the lack of transparency on the use of funds transferred to DAFs. Thus, charities regulators cannot ensure that private foundations’ grantmaking fulfills restrictions on their charitable giving, and the public is unable to see charitable activity ordinarily subject to public inspection.

In order to equip charity regulators to effectively enforce state charitable trust requirements, the paper concludes with two recommendations:

1. Charitable trusts should be required to report to state attorneys general all grants made or approved for future payment from DAF accounts to which they have transferred funds, subject to public inspection, and

2. Attorney General’s offices should respond to the growth of charitable funds held in trust by devoting increased resources to monitoring charitable trusts and donor advised funds.

Lloyd Mayer

Will the NRA's "Course Correction" Succeed?

The Bankruptcy Court trial and the resulting decision dismissing the National Rifle Association's bankruptcy case revealed some interesting information about the NRA and its governance and financial situation. First, and as media coverage highlighted, the decision to file the bankruptcy case was made with little involvement of the board or senior officers beyond chief executive officer Wayne LaPierre (formal title: executive vice president) and "not . . . in good faith but instead . . . as an effort to gain an unfair litigation advantage in the NY AG Enforcement Action and as an effort to avoid a regulatory scheme." Second, testimony during the trial revealed a host of facts relating to governance and financial misconduct that even the NRA's counsel acknowledged were cringeworthy. But what may prove to be most important in the long run even though it garnered much less coverage was the court found that what the NRA has labeled a "course correction" has resolved a number of governance and financial concerns, perhaps enough to save the NRA from dissolution in the NY AG proceeding and from the financial hole it has dug for itself.

On the first point, the court stated:

What concerns the Court most though is the surreptitious manner in which Mr. LaPierre obtained and exercised authority to file bankruptcy for the NRA. Excluding so many people from the process of deciding to file for bankruptcy, including the vast majority of the board of directors, the chief financial officer, and the general counsel, is nothing less than shocking.

As for the filing motivation, after lengthy consideration of the various reasons asserted and testimony on this point, including particularly from Mr. LaPierre, the court stated:

The Court finds, based on the totality of the circumstances, that the NRA’s bankruptcy petition was not filed in good faith but instead was filed as an effort to gain an unfair litigation advantage in the NYAG Enforcement Action and as an effort to avoid a regulatory scheme. This constitutes cause for dismissal under section 1112(b)(1) of the Bankruptcy Code.

On the second point, others have documented how trial testimony revealed numerous governance and financial failures. For a detailed if not unbiased summary, see this opinion piece from the Washington Post. These failures included details of LaPierre's personal and family expenses paid for by the NRA, and attempts to conceal those payments. 

But there is another point that may ultimately turn out to be the most significant, even though it has garnered the least coverage. In rejecting the appointment of a trustee or examiner, the court said the following (citations omitted):

While there is evidence of the NRA’s past and present misconduct, the NRA has made progress since 2017 with its course correction. Whether it is yet complete or not, there has been more disclosure and self-reporting since 2017. Both Ms. Rowling and Mr. Erstling, the NRA’s Director of Budget and Financial Analysis, testified that the concerns they expressed in the 2017 Whistleblower Memo are no longer concerns. Mr. Frazer testified regarding the compliance training program that the NRA now has for employees. Mr. Spray testified credibly that the change that has occurred within the NRA over the past few years could not have occurred without the active support of Mr. LaPierre. It is also an encouraging fact that Ms. Rowling has risen in the ranks of the NRA to become the acting chief financial officer, both because of her former status as a whistleblower and because of the Court’s impression of her from her testimony as a champion of compliance.

 

In short, the testimony of Ms. Rowling and several others suggests that the NRA now
understands the importance of compliance

Of course even if the NRA manages to eventually put its legal problems behind it, it will still have to deal with a slow burn financial crisis. As Brian Mittendorf detailed in 2019, the NRA has for years spent more than it brought in, creating a potential financial crisis. And that crisis is exacerbated by a point that came out during the trial and that Mittendorf highlighted on Twitter: of the NRA's approximately 5 million members, 2 million or 40% are life members who apparently have already paid all of the dues they will ever owe to the NRA. Whether course correction will be sufficient to right both the legal and financial aspects of the NRA remains to be seen.

Lloyd Mayer

Trump Supporters, Nonprofits, and the Law

In 2016, the rise of Donald J. Trump turned a spotlight on his purported charitable activities and made "self-dealing" and similar legal terms headline news. With his departure from office (and the dissolution of his family foundation in the face of a New York Attorney General lawsuit), it might be expected that such topics would once again return to news obscurity. But legal issues raised by the involvement of some of his supporters with nonprofits continue to garner new headlines.

Just in the past month, three prominent supporters have had that spotlight shine on them and their nonprofit-related activities. As reported by the Washington Post, federal authorities have indicated Brian Kolfage, who worked with Trump-advisor Stephen K. Bannon on the "We Build the Wall" crowdfunding campaign and then 501(c)(4) nonprofit, with filing a false tax return for allegedly failing to report hundreds of thousands of dollars he received from that effort and other sources.  And as reported by the Associated Press, former Trump campaign lawyer Sidney Powell now faces accusations in the lawsuit brought against her by Dominion Voting Systems that she used Defending the Republic, which claims to be a 501(c)(4) nonprofit, to pay for her personal legal expenses, an accusation she denies. And the fallout for Jerry Falwell, Jr. continues as Liberty University has now sued him for breach of contract and breach of fiduciary duties based on his alleged cover up of a personal scandal that led to his resignation as president and chancellor of the university.

Finally, congressional democrats continue to push for more information about possible tax-exempt nonprofit organization involvement in the January 6th attack on the Capital. As reported by Tax Analysts (subscription required), at this past week's ABA Tax Section virtual meeting a senior advisor to the Senate Finance Committee noted that Chair Ron Wyden remains interested in ensuring the IRS looks into which tax-exempt organizations helped plan the riots and whether any of them incited violence, thereby undermining their tax-exempt status.

Lloyd Mayer

A Thoughtful Consideration of Divorce (Yes, That One) and Philanthropy

Beth Breeze (University of Kent) and Genevieve Shaker (IUPUI Lilly Family School of Philanthropy) have a thoughtful post at The Conversation about the divorce of Bill and Melinda Gates and media speculation about its ramifications for philanthropy titled Bill and Melinda Gates: philanthropy caught in the crosshairs of society’s obsession with celebrity. It is worth reading the entire post, but the conclusion is particularly telling:

Clearly, Bill Gates and Melinda French Gates are extremely recognisable “people of interest”, but interest in, and reaction to, the end of their marriage says more about their celebrity status than the future of their philanthropy.

Lloyd Mayer

Eighth Circuit in Mayo Clinic Decision Partially Upholds Educational Organization Regulation and Remands Case

The U.S. Court of Appeals for the Eighth Circuit in Mayo Clinic v. United States partially upheld, and partially rejected, the "educational organization" regulation at the heart of the case. The result was the court found that the summary judgment record was insufficient to grant victory to either the Clinic or the government and so remanded the case for further proceedings. This result means that the government has avoided, for the most part, a major expansion of an exception not only to the unrelated business income tax debt-financed rules but also an exception to the definition of private foundation. 

The regulation at the heart of the case is 26 C.F.R. § 1.170A-9(c)(1), which provides:

An educational organization is described in section 170(b)(1)(A)(ii) if its primary function is the presentation of formal instruction and it normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on. The term includes institutions such as primary, secondary, preparatory, or high schools, and colleges and universities. It includes Federal, State, and other public-supported schools which otherwise come within the definition. It does not include organizations engaged in both educational and noneducational activities unless the latter are merely incidental to the educational activities. A recognized university which incidentally operates a museum or sponsors concerts is an educational organization within the meaning of section 170(b)(1)(A)(ii). However, the operation of a school by a museum does not necessarily qualify the museum as an educational organization within the meaning of this subparagraph.

The Clinic challenged the "primary function" and "merely incidental" requirements of the regulation, successfully asserting in federal District Court that these tests were inconsistent with this statutory definition of educational organization found in Internal Revenue Code § 170(b)(1)(A)(ii)):

an educational organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on

For the Clinic this issue was critical because if, as the District Court found in granting the Clinic's motion for summary judgment, it qualified as an educational organization it was exempt from unrelated business income tax on its debt-financed income to a tune of more than $11 million over the seven years at issue. But a larger ramification of the District Court's holding was that Internal Revenue Code § 501(c)(3) educational organizations are also not private foundations under IRC § 509(a)(1). So if the District Court's view prevailed, a charity that otherwise would be classified as a private foundation likely could have escaped that classification and the restrictions that come with it by simply operating a modest educational program.

However, based on a lengthy discussion of the legislative history of sections 170 and 501(c)(3), the appellate court concluded the District Court was only partially correct. The appellate court agreed that the regulation incorrectly added the "primary function [must be] the presentation of formal instruction" test. At the same time, it found that it was appropriate to interpret the statute as requiring an educational organization both to have being educational as its primary purpose and to limit its noneducational activities to being merely incidental to that primary purpose. It then found the summary judgement record to be insufficient to grant summary judgment to either the Clinic or the government under this interpretation, remanding the case for further proceedings (which presumably means a trial unless the parties settle).

Lloyd Mayer

Coverage: Law360 (sign-up required).

CRS Reports on Temporary Nonitemizer Deduction & Increased Contribution Limits

As part of a report on Temporary Individual Tax Provisions ("Tax Extenders") released a couple of weeks ago, the Congressional Research Service discussed the temporary nonitemizer charitable contribution deduction and temporary increased limits for charitable contributions. In that discussion, CRS made two interesting points.

With respect to the nonitemizer deduction, CRS noted (page 5):

The $300 nonitemizer deduction is likely to have a limited effect on charitable contributions because of its relatively small cap. One study estimated that the induced charitable giving from the nonitemizer deduction would be $100 million, a relatively negligible effect, because most taxpayers who donate are already contributing amounts in excess of $300. [citing “New Charitable Deduction in the CARES Act, Budgetary and Distributional Analysis,” blog post, Tax Policy Center, Penn-Wharton Budget Model, March 27, 2020, https://budgetmodel.wharton.upenn.edu/issues/2020/3/27/charitable-deduction-the-cares-act.]

With respect to the increased contribution limits, CRS noted (page 6; citations omitted):

Lifting caps on the deductions for both individuals and businesses can provide an incentive for additional charitable giving. Evidence on the response of charitable giving by individuals has been widely studied with mixed results. A review of this evidence suggests that an enhanced charitable deduction is likely to increase charitable giving by less than the associated revenue loss. Lifting the limits affects a relatively small share of charitable giving, and the revenue pattern suggests that much of the initial revenue loss (77%) can be attributed to an accelerated realization of carryovers.21 With charitable giving estimated at $427.4 billion in 2018, if all of the permanent revenue loss led to an increase in charitable giving by the same amount (i.e., approximately $1 billion), additional giving would be 0.3% of expected giving prior to the current economic slowdown.

Lloyd Mayer

Three New IRS EO-Related Compliance Initiatives

Last month the IRS issued a press release announcing eight new compliance initiatives for the Tax Exempt and Government Entities Division, which are now reflected on its Compliance Program and Priorities webpage. Of particular interest to exempt organizations are the following three new initiatives:

• Form 990-N Filers/Gross Receipts Model: The purpose of this strategy is to determine if an exempt organization was eligible to file Form 990-N where related filings indicate the $50,000 gross receipts threshold was not met.  The treatment stream for this strategy is examinations.

• Officers Treating EO as Schedule C Business: The purpose of this strategy is to determine if officers and insiders of exempt organizations are claiming expenses of exempt organizations as Schedule C business deductions. Issues of focus are potential private benefit and inurement related to the exempt organization and potential adjustments to Forms 1040. The treatment stream for this strategy is examinations.

• Small EOs that Sponsor Retirement Plans: The focus of this strategy is to review retirement plans of small exempt organizations to determine whether the plan investments are properly administered, whether there are any party-in-interest transactions in the plan trust and whether any participant loans violate Internal Revenue Code (IRC) Section 72(p). Improper transactions between the plan and its participants can result in prohibited transactions under IRC Section 4975, deeming distributions as taxable income, or result in IRC Section 72(t) early distribution penalties. The treatment stream for this strategy is examinations.

Hat tip: KPMG.

Lloyd Mayer

TIGTA: FY2019 Statistical Trends Review of the TEGE Division

The Treasury Inspector General for Tax Administration published earlier this month Fiscal Year 2019 Statistical Trends Review of the Tax Exempt and Government Entities Division. The report confirms that the Division has experienced both budget and staff reductions in recent years, although that trend started to reverse in fiscal year 2019. Here is the summary:

What TIGTA Found

The TE/GE Division is comprised of seven distinct functions: Employee Plans; Shared Services; Compliance Planning and Classification; and Exempt Organizations/Government Entities, which is comprised of the Exempt Organizations, Indian Tribal Governments, Tax-Exempt Bonds, and Federal, State, and Local (Governments)/Employment Tax functions. According to the IRS, the entities that the TE/GE Division serves employ almost 25 percent of the American workforce.

In May 2017, the TE/GE Division realigned the issue identification, planning, classification, and case delivery processes that were previously embedded within five functions into the consolidated Compliance Planning and Classification function. The reorganization has affected these five functions’ examinations units’ staffing, budget, and processes. In addition, in October 2018, the TE/GE Division established five new compliance groups, referred to as the TE/GE Compliance Unit, which in FY 2019 completed 4,863 compliance checks for three of the functions resulting in a 72 percent change rate.

New legislation often affects IRS operations and may require significant operational changes to implement it. Two new laws significantly affected the TE/GE Division’s operations during the years 2015 to 2019: the Tax Cuts and Jobs Act of 2017, and the Taxpayer First Act of 2019. In addition to legislative changes, the Federal Government had a lapse in appropriations from December 22, 2018, to January 25, 2019, that shut down most IRS operations for 35 days. As a result, the TE/GE Division experienced inventory backlogs in processing applications for tax-exempt status and timely completing compliance cases. However, IRS management stated that mitigation actions taken, such as allowing temporary overtime and detailing examination agents from one unit to another, addressed the backlogs of applications.

Over the FYs 2015 to 2019, the TE/GE Division’s budget decreased by more than $22.5 million (9 percent), although the FY 2019 budget increased by approximately $7.7 million (4 percent) over FY 2018’s appropriations. Along with the decrease in the budget, the TE/GE Division’s staffing level also decreased by 12 percent from FY 2015 to FY 2019, although hiring efforts in FY 2019 have started improving staffing levels. At the end of FY 2019, the TE/GE Division had approximately 1,500 employees, which was 2 percent of the IRS’s total staffing level of just over 78,000 employees.

What TIGTA Recommended

TIGTA made no recommendations in this report. IRS officials were provided an opportunity to review the draft report and did not provide a formal response

Lloyd Mayer

Failure to Prove Ownership or Exhibition of African Art Collection Results in Disqualification Under 501(c)(3)

In Tikar, Inc. v. Commissioner, the U.S. Tax Court upheld the IRS' revocation of recognition of tax-exempt status under Internal Revenue Code section 501(c)(3). The court found that the Texas nonprofit corporation failed to demonstrate that it operated exclusively for one or more exempt purposes set forth in section 501(c)(3) for two reasons. While it is reassuring to see there is some IRS audit activity still happening, it is also disconcerting to realize it took more than 15 years for the IRS to reexamine the initial recognition of exemption. 

The court's first reason for upholding the revocation was the court found the nonprofit failed to establish that it actually owned the collection of Tikar artifacts at issue. (As the court explained, "Tikar was one of the tribes in Cameroon when it was controlled by Belgium in the 19th and 20th centuries.")  This lack of ownership meant that the nonprofit's activities relating to the collection provided a private benefit to the actual owner of the collection and a foreign entity that he controlled. 

Sec0nd, the court found that even if it assumed the nonprofit had an ownership interest in the collection or other African artifacts, the nonprofit failed to establish that it actually had displayed any of the items or engaged in other activities relating to them that furthered an exempt purpose for many years. Its failure to do meant it was not operated exclusively to further an exempt purpose.

Based on the court's detailed findings regarding the failure of the nonprofit to provide evidence supporting its assertions regarding its activities, the court's conclusion is not surprising. It is also is somewhat reassuring to know the IRS is engaging in some audit activity - here specifically the audit that began in 2015 of the 2012 Form 990-PF filed by the nonprofit - which is what led to the revocation. But given that the nonprofit had received its favorable determination letter in 1999 and appears to have both failed to transfer the collection and to engage in required activities since then, it is a bit concerning that it took the IRS more than 15 years to select the nonprofit's return for audit. While there is no indication in the opinion regarding what triggered the audit, it may be that a 2007 lawsuit relating to the collection drew the IRS' attention. If that was the case, who knows if and when the IRS would have audited one of the nonprofit's returns absent that litigation.

Lloyd Mayer

NRA Bankruptcy Case Dismissal Quick Takes & Media Coverage

Here is a round up of quick takes on the dismissal of the National Rifle Association's bankruptcy case and what it means for the ongoing lawsuit by New York Attorney General Letitia James seeking dissolution of the NRA:

• NY AG Press Release
• Law & Crime
• The Trace
• Vox

And here is a sampling of the extensive media coverage:

• AP
• Bloomberg
• CNN
• MSN
• NPR
• N.Y. Times
• Politico
• Reuters
• Washington Post
• WSJ

Lloyd Mayer