Nonprofit Law Prof Blog

Charity Scandals Serious Enough for the Feds to Get Involved

News reports of thefts from charities and other improper diversions of charitable funds are unfortunately somewhat common, often reflecting the all too common combination of greed and lack of sufficient internal controls in many volunteer-run or under-staffed organizations. Usually these matters are handled by local authorities or state attorney general offices. But sometimes they rise to a level that the DOJ and FBI get involved. In the past month there have been a couple reported situations where this occurred:

The Kansas City Star reported that "Feds shut down Missouri Christian nonprofit that was supposed to cover medical bills".  According to the article, the FBI and DOJ are alleging that section 501(c)(3) Medical Cost Sharing Inc. was "an elaborate fraud scheme that spanned the better part of a decade" operated by two individuals to enrich themselves. Additional coverage: Forbes. ProPublica has a related story about issues with several medical cost sharing ministries, including Medical Cost Sharing, Inc.

And the St. Louis Post-Dispatch reported that "Feds probe St. Louis-area church, nonprofit that claimed millions in federal food aid". According to the article, the U.S. Attorney's Office for the Eastern District of Missouri has issued subpoenas relating to Influence Church and section 501(c)(3) New Heights Community Resource Center in the wake of earlier investigative reports by the paper. The investigation is focusing on federally funded child nutrition programs, under which millions of dollars were paid to the Church and Center.

Lloyd Mayer 

National Taxpayer Advocate: Congress Should Remove the Contemporaneous Aspect of Written Acknowledgements for Charitable Contributions

One nightmare of donors and tax advisors alike is having a sizeable charitable contribution deduction disallowed for failure to meet the substantiation requirements imposed by Congress, which the IRS and the courts strictly construe. Often these errors arise for complex reasons, such as a failure to obtain a an required appraisal that is "qualified" (see, for example, the recent U.S. Tax Court memorandum opinion in Lim v. Commissioner). But these errors also sometimes arise for a simple failure to obtain the  Code section 170(f)(8) "contemporaneous written acknowledgement" (CWA) from the recipient charity that both has the required information and is obtained by the taxpayer by the earlier of the date they file the relevant return or the due date of that return.

Now the National Taxpayer Advocate is urging Congress to relax the contemporaneous aspect of the CWA requirement in her 2023 Purple Book: Compilation of Legislative Recommendations to Strengthen Taxpayer Rights and Improve Tax Administration. Legislative Recommendation #58 recommends that Congress "[e]liminate the 'contemporaneous written acknowledgment' requirement and replace it with an 'adequate written documentation' requirement." The new AWD requirement would be the same as the CWA requirement with respect to the information required, but the timing aspect would be removed. This would allow a charity to issue the required acknowledgement, or correct a defective acknowledgement, at any time, including presumably after the IRS on audit identified the absence or deficiency.

Hat tip: EO Tax Journal.

Lloyd Mayer

Conservation Easements Update: Cert. Denial; Hearing on Proposed Regs; New Articles

The long legal grind relating to conservation easements continues, with no end in sight. Setting aside the periodic issuance of dispositive and procedural decisions in the many pending cases - about half-a-dozen such decisions over the past three or so months by my count - there have been two significant developments and two new articles of interest.

First, the Supreme Court of the United States denied certiorari in Oakbrook Land Holdings, LLC v. Commissioner, one of two federal appellate court decisions that had created a circuit split over the validity of a conservation easement regulation. The Court apparently took to heart Professor Michael Kane's recommendation that it not take up this issue.

Second, the Treasury Department held its public hearing earlier this month on proposed regulations designed to address court decisions holding syndicated conservation easement listing Notice 2017-10 to be invalid under the Administrative Procedure Act. According to a Thompson Reuters article, many commentators urged Treasury to retain a carveout for donee organizations. According to a Law360 article, some of the commentators also questioned whether the proposed regulations are needed now that Congress has enacted a new charitable deduction disallowance rule for certain conservation easement contributions. 

As for the articles, Vanderbilt Law Review has published a note authored by Molly Teague and titled Conservation Options: Conservation Easements, Flexibility, and the “In Perpetuity” Requirement of IRC § 170(h). And the Wildlife Society Bulletin published a short article by several scholars titled Conservation Easements: A Tool for Preserving Wildlife Habitat on Private Lands and proposing "a shift from primarily negative clauses and restrictive language to a more affirmative approach, developing language to proactively improve management of properties under conservation easement in order to maximize benefits to wildlife and ecosystems."

Lloyd Mayer 

 

The Mormon Church v. the SEC

About a week and a half ago, the SEC announced that it had charged Ensign Peak Advisors and the Church of Jesus Christ of Latter-day Saints (the Mormon church) with violating Section 13(f) of the '34 Act and Rule 13f-1. Ensign Peak agreed to settle and pay a $4 million fine for failing to file Form 13F for about 22 years, while the Mormon church agreed to settle the allegation that Ensign Peak acted with its knowledge and direction and pay the SEC $1 million. On this blog we're usually more focused on tax (and, on occasion, state nonprofit) issues than we are securities regulation, but this is a big deal securities reg story involving nonprofits, so it's worth a little time to dig into and understand.

But before we dig into the story, it's worth laying some groundwork:

The Players:

The Mormon church is organized as a Utah corporation sole and, unsurprisingly, is exempt from tax under section 501(c)(3). (In fact, I'm putting the finishing touches on a book about the Mormon church and taxes, which will probably be published at the end of this year or sometime in 2024.) The church has a strong preference for centralization and hierarchy; in the U.S., the Utah corporation owns basically all of its property (unlike other denominations, which often incorporate different regions or congregations separately). The Mormon church is tremendously wealthy; just before the pandemic, a whistleblower alleged that it had $100 billion of invested assets (an amount that presumably didn't include, for instance, land it uses for church buildings).

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Joint Venture Private Inurement

In joint venture private inurement, insider sets up a for-profit entity, obtains an exclusive contract with the insider's non-profit and then pays himself fat salaries derived from the not unreasonable fees paid by the nonprofit to the for profit.  

 

In my very first scholarly piece as professor  -- a piece for which I was wrongly, rudely, and unjustifiably denied a Pulitzer -- I wrote about private inurement.  My goal was to describe the underlying theory that made private inurement and excess benefit broader than the disguised distribution of dividends.  I thanked David and Evelyn in the footnotes, neither of whom probably remember reading early drafts.  I came up with catchy new labels for the "protean" ways private inurement manifested.  "Strict accounting" private inurement happens when the organization pays too much or realizes too little.  "Incorporated pocketbook private inurement" is when an insider uses the organization's revenues for personal consumption, reaching into the organization's assets like his own pocketbook whenever or wherever.  And then "joint venture" private inurement.  There was the coup de grace.  I was convinced the Supreme Court would soon be quoting and citing my article in a monumental landmark case that would forever be defined by "The Scintilla of Individual Profit."  So I released the article into the stream of intellectual commerce and waited for Bill Clinton's phone call and invitations to speak at lighted venues around the world.  "Ich bin ein Berliner!"  or "Mr. Gorbachev, tear down this wall!" I would be quoted as saying.  And Harvard and Yale would be sorry for not pursuing me with greater vigor [or at all, actually] during the meat market.  But all I got were crickets.  My senior mentors at Pitt Law hardly even looked up from writing their own masterpieces to ask "now what are you working on?"

But a letter ruling released last week finally vindicates me.  It involves revocation of an organization's exempt status for joint venture private inurement.  All the personally identifiable information is redacted and that makes reading the letter somewhat difficult; I am pretty sure I have the essential details correct:

The exempt organization operates youth homes.  Husband and Wife were the executives and apparently comprised the entire board, if not just a voting majority.  They had at least three youth homes in different cities and money -- primarily from contracts with state agencies to which children were remanded -- and revenues were increasing.  One day, they got the idea to open a management company to operate the homes.  They incorporated a for-profit management company; they were majority owners, but its not clear whether there were other investors in the entity.  Then, without bids or other shopping around, the nonprofit entity entered into an exclusive contract with the for profit for management services.  Consistent with industry practice, the for profit would be paid a percentage of revenues from the nonprofit youth home operation for its services.  The Service stipulates that the management fees were within industry practice; there is no assertion that the management company charged unreasonable rates.  But the monies paid to the management company are distributed to its  owners by way of salaries and other payments for services to the management company.  

So no strict account private or incorporated pocketbook private inurement.  But something still doesn't seem right.  Here is what I said about joint venture private inurement too many years ago:

Strict accounting private inurement, representing the literal form, is closest to the statutory language, and even incorporated pocketbook private inurement can be made to fit within the literal prohibition if one thinks of unrelated transactions benefiting insiders as distributions of earnings in kind, rather than of cash. Those two forms of private inurement seem to exhaust the means by which an insider might violate the prohibition. The universe, though, includes a third form of private inurement not contingent upon an unfair or unnecessary transaction. This final category, which I call "joint venture private inurement," can occur even though the entity pays or charges an appropriate amount and even though the transactions are entirely appropriate and necessary to the accomplishment of the tax-exempt purpose. Instead, the violation occurs because the operations of the tax-exempt entity and an insider-controlled taxable entity are so closely related that the insider, by virtue of his interest in the taxable entity, financially benefits from the exempt entity's invariable consumer power. The taxable and tax-exempt entities are engaged in an implicit joint venture.  As such, the exempt entity purchases all of its necessary commodities solely from the insider's for-profit entities or otherwise conducts its affairs through an insider's profit-making apparatus.' Although serving an exempt purpose, the entity necessarily subsidizes individual profit making.'

The private letter ruling concludes that the organization's revenues inured to the benefit of insiders, even though the amounts paid to the management company were within reasonable industry standards and without any evidence that the compensation formula incentivized the management company to cut back on charitable services:  

6.  Organization pays management company a substantial amount of money for management services, the vast majority of which management company pays out to husband and wife in the form of salaries and distributions to themselves and their trusts. 

The operational test is not satisfied where any part of the organization's earnings inure to the benefit of private shareholders or individuals, and where the organization serves a private benefit rather than public interests.  (Regulations § 1.501(c)(3)-1(c)(2)) As in People of God, Youth Home fails to qualify for exemption under section 501(c) (3) . 

 7. Youth Home is the main client of  Management Company.  Management Company benefits substantially from the operation of  Youth Home.

Note that the management company became an "insider" (a requirement to find private inurement) by virtue of its ownership and control by the charitable fiduciaries.  Nice teaching points in this ruling once you get beyond the redactions.  

So yes, there is something called joint venture private inurement after all.  President Biden and the Supremes should be calling me any minute now.  I'll just wait right here.

 

darryll jones

Tax Exemption for Clinical Traphouses Becomes A Closer Reality

We reported about Safehouse, Inc four years ago.  And more than four years have passed since Safehouse obtained tax exempt status to provide a "range of overdose prevention services," including operation of "safe injection sites." Those sites, where addicted people can use drugs under supervision designed to prevent overdoses, are included in a range of medically recognized substance abuse "harm reduction" strategies.  As we reported,  Safehouse was stopped in its tracks when the Trump DOJ sued for a declaration that Safehouse's primary mission -- operation of a safe injection site -- would violate federal law against the maintenance of traphouses.  A traphouse, by the way, is typically an abandoned or otherwise derelict former residence in an urban, and often underserved and neglected community where dealers set up shop; consumers come, buy, use, and are often "trapped" in that retail place for days turning tricks or robbing and stealing in adjacent neighborhoods to feed their addiction indefinitely.  Cars, people on bikes, kids in their dad's car, and professionals from all professions "come thru" at all hours of day and night.

A traphouse in Columbus Ohio near Ohio State University

Here is how Wikipedia describes traphouses:

Abandoned buildings ravaged by arson or neglect are utilized by drug dealers since they are free, obscure, secluded and there is no paper trail in the form of rent receipts. The sale of illegal drugs often draws violent crime to afflicted neighborhoods, sometimes exacerbating the exodus of residents.  In some cases, enraged citizens have burned crack houses to the ground, in hopes that by destroying the sites for drug operations they would also drive the illegal industries from their neighborhoods.

Now, after litigation all the way up to the Supreme Court, leaving intact the 3rd Circuit's declaration that safe injection sites violate federal law, the Biden Justice Department has signaled a reversal, according to the Associated Press. The declaration of illegality would permanently end tax exemption for safe injection sites under the illegality doctrine.  But let's be clear, a traphouse is something entirely different from a safe injection site. It was the description above that prompted dogged opposition by the Trump administration.  They thought drug dealers were seeking income and property tax exemption, I guess.  Safe injection sites are not the horrible places described in several senators letter to Biden:

It has been reported that the Department of Justice (DOJ) is considering supporting the use of supervised injection sites. Supervised injection sites are public facilities for drug users to consume illicit drugs like fentanyl, methamphetamine, or heroin, under the supervision of medical staff. This reported position by your Justice Department is concerning for a number of reasons.

Beyond this, recent government reports show that supervised injection sites do not reduce overall overdose deaths or opioid-related emergency calls. Additionally, supervised injection sites have led to an increase in crime, discarded needles, and social disorder in the surrounding neighborhoods. Advocates in favor of supervised injection sites assert that they provide connections for those with substance use disorders to find housing and treatment options. However, these sites have a poor record of moving drug users into treatment and recovery, with some referral rates as low as 1%. Supporting those with substance use disorders is critically important; however, supervised injection sites’ goals of limiting the spread of diseases pale in comparison to the grave consequences of enabling and normalizing the consumption of illicit drugs.

Senator Grassley is a primary author and signatory, so we might expect he will continue resisting efforts to allow tax exemption for nonprofit organizations operating safe injection sites.  But a Cato Institute policy analysis discusses the benefits of safe injection sites -- thereby distinguishing them from traphouses -- as well as the emerging medical and sociological consensus that safe injection sites are preferable to the interminable and unwinnable (is there any debate about that?) war on drugs.  Fault or personal moral failings aside, some people can't "just say no."  Cato issued an update upon hearing the news from DOJ:

When a private, self‐​funded organization in Philadelphia sought, with the City Council’s endorsement, to open Safehouse in the city’s Kensington District, it was thwarted by the Trump administration’s Justice Department. After losing in the Court of Appeals, the U.S. Supreme Court refused to hear the case. The harm reduction project is now in legal limbo.

Defying federal law, last summer the Governor of Rhode Island signed a bill permitting privately‐​funded safe consumption sites beginning this spring. New York City opened two safe consumption sites last November and plans to open two more in coming weeks. San Francisco plans to officially open a site in the coming weeks. In the meantime, a de facto site is working under the radar in a Tenderloin District Linkage Center. The state legislature is entertaining a bill to legalize safe consumption sites statewide starting in 2023.

Since 2014 a safe consumption site has been secretly saving lives in the U.S. while being monitored by researchers at an independent non‐​profit research institute based in North Carolina. The researchers provide data in the peer‐​reviewed medical literature which they update regularly, while keeping the name and location of the site confidential. To avoid interdiction, the site is only able to operate part‐​time.

In July 2020 the researchers provided five years (2014–2019) of data in the New England Journal of Medicine. There were 10,514 injections through 2019, with 33 overdoses over the 5‑year period—all of which were reversed. They reported that the types of drugs changed over that period, with combinations of opioids and stimulants comprising 5 percent of injections in 2014 and 60 percent of injections in 2019.

Last month these researchers reported in the Journal of General Internal Medicine that facility users were 27 percent less likely to visit emergency departments, had 54 percent fewer emergency department visits, and were 32 percent less likely to be hospitalized. Those who were hospitalized spent 50 percent fewer nights in the hospital. Therefore, in addition to saving the lives of people who inject drugs, safe consumption sites can reduce stress on the health care system.

Addiction is a public health issue.    

darryll jones

EO Updates TG 58 Excise Taxes on Self-Dealing under IRC 4941

Last week, the Service released recently updated Technical Guide 58, regarding IRC 4941 excise taxes on self-dealing.  I was particularly tickled to see the announcement in the IRS email update to which I subscribe because the update is based on Chief Counsel Advisory 202243008.  The Advisory was written to Casey Lothamer, Area Counsel (Tax Exempt and Government Entities), Mid-Atlantic Region.  Casey is one of my former students from my days at Pitt.  It makes me wanna hitch up my pants and brag when I see one of my former students out in the trenches.   "Yeap.  I taught that boy dang near ere'thang he knows about exempt organizations!" 

 

Campaign Legal Center Files FEC Complaint re: George Santos

Call me bleeding heart, but I worry about the human being known as George Santos and hope he understands that this too shall pass.  Maybe like a very painful gallstone, but it will pass if he doesn't let it kill him first.  I mean, just think if every one of us had all of our boneheadness displayed in headlines and bright lights.  Granted this was a whole lot more than the average boneheadedness, but watching him sitting all alone in the House Chamber last week and knowing that prosecutorial sharks are circling makes me worry about his mental state.  He will inevitably lose his seat in Congress.  I hope he lives through it and finds peace when all is said and done. 

But meanwhile the nonprofit Campaign Legal Center has filed a complaint with the FEC alleging all sorts of malfeasance, including "straw donor contributions."  Here are a few allegations from the complaint:" 

2. Santos purported to loan his campaign $705,000 during the 2022 election.3 But it is far from clear how he could have done so with his own funds, because financial disclosure reports indicate that Santos had only $55,000 to his name in 2020,4 and his claims of having earned millions of dollars in 2021 and 2022 from a supposed consulting business that he started in May 2021, Devolder Organization LLC (“Devolder LLC”), are vague, uncorroborated, and non-credible in light of his many previous lies.5 As set forth below, the overall circumstances instead indicate that unknown individuals or corporations may have illegally funneled money to Santos’s campaign through the newly formed Devolder LLC. 

3. In addition, Santos’s campaign appears to have routinely falsified its disclosure of disbursements. The campaign reported an astounding 40 disbursements between $199 and $200, including 37 disbursements of exactly $199.99.6 The sheer number of these just-under-$200 disbursements is implausible, and some payments appear to be impossible given the nature of the item or service covered. Accordingly, there is reason to believe Santos’s campaign deliberately falsified its disbursement reporting, among numerous other reporting violations. Moreover, some of the reported disbursements made by Santos’s campaign appear to violate federal laws prohibiting the conversion of campaign funds to personal use, including disbursements to pay rent on a candidate’s personal residence. This complaint is filed pursuant to 52 U.S.C. § 30109(a)(1) and is based on information and belief that respondents violated the Federal Election Campaign Act (“FECA”), 52 U.S.C. § 30101, et seq. “If the Commission, upon receiving a complaint . . . has reason to believe that a person has committed, or is about to commit, a violation of [FECA] . . . [t]he Commission shall make an investigation of such alleged violation.”

21.  FECA provides that “[n]o person shall make a contribution in the name of another person or knowingly permit his name to be used to effect such a contribution, and no person shall knowingly accept a contribution made by one person in the name of another person.”

22.  The Commission regulation implementing the statutory prohibition provides the following examples of contributions in the name of another: a. “Giving money or anything of value, all or part of which was provided to the contributor by another person (the true contributor) without disclosing the source of money or the thing of value to the recipient candidate or committee at the time the contribution is made.” b. “Making a contribution of money or anything of value and attributing as the source of the money or thing of value another person when in fact the contributor is the source.”

23.  The requirement that a contribution be made in the name of its true source promotes Congress’s objective of ensuring the complete and accurate disclosure by candidates and committees of the political contributions they receive,35 and ensures that the public and complainants are fully informed about the true sources of political contributions and expenditures. Such transparency also enables voters, including complainant Wieand, to have the information necessary to evaluate candidates for office, “make informed decisions[,] and give proper weight to different speakers and messages.”

25. Straw donor contributions like those alleged here are serious violations of federal campaign finance law that have led to criminal indictments and convictions in recent years.39 As explained in one such indictment, the straw donor ban works in tandem with other campaign finance laws to protect the integrity of our electoral system and to ensure that all candidates, campaign committees, federal regulators, and the public are informed of the true sources of money spent to influence federal elections.40 Another recent indictment highlighted how straw donor schemes have been used to skirt FECA’s source prohibitions, such as the ban on contributions by government contractors.

26. Even for contributions that would otherwise be legal — i.e., contributions that would not be prohibited or excessive, if made in the true contributor’s own name — the prohibition of contributions in the name of another serves FECA’s core transparency purposes by ensuring that voters have access to complete and accurate information regarding the sources of electoral contributions. 

Here is a brief primer on dark money and nonprofits.

 

darryll jones

 

Stranger Things With Syndicated Conservation Easements

 

My college-aged daughter is home for the holidays and she is a Netflix junky.  Some of the things she recommends are pretty good.  Like Stranger Things -- I tried to explain that it was just a jazzed up version of Scooby-Doo and "those meddling kids" but she wasn't impressed that old folks could possibly recognize anything new and IT related.  You gotta be a person of  a certain age to understand the reference, I guess.  Anyway, I thought of the show -- Stranger Things -- as I was scouring the internet looking for something interesting to say about nonprofit law.  Its a slow news day, I think, in Independent Sectorville but I did run across this  U.S. Attorney's press release from earlier this year.  The PR announces an indictment against tax shelter promoters.  More on that below.  As near as I can tell, though, Stranger Things is about someone having let loose some kind of monster on the earth, and the meddling kids are involuntarily drafted into the effort to put the monster back into his confinement somewhere but neither in the real nor the virtual world.  I guess that leaves the spiritual world but I really can't figure out what seems easy and normal to my daughter. 

Stranger Things' basic plot, describes the on-going battle against Syndicated Conservation Easements (SCE).  A monster has been loosed upon the tax landscape and those fearless government kids have been working feverishly to trap the monster back into its netherworld.  Isn't that how most tax shelter battles go? Every time we smash the monster, it reincarnates for another tax season and here we are on Season 5, I think, of Stranger Things.   We have previously blogged about SCEs here and here.   The only recent thing I found was a district court's denial a few days ago of a motion to dismiss in United States Fischer, et. al.   But I worked backwards and happened upon the indictment in that case.  I swear I don't know how I made it through law school back in the stone ages.  It was all theory and argument, cost benefit, utilitarianism and all that jazz, usually too divorced from facts to be of interest except as required to pass the class.  All with chalk and blackboards, if the Professor was really feeling the topic that day.  I also walked ten miles in the snow with no shoes to make it to class, but kids these days have it so easy and interesting.  They can find real life examples of pretty much every dry legal theory ever IRAC'd.   Anyway, the indictment is informative because it almost puts the reader in the room while the nefarious conspirators -- in short sleeve shirts and ties, glasses, number 2 pencil and pencils pocket in place, no doubt -- plan out the monster's release upon the tax landscape.  I find these real life examples make students look up from their laptops more often than one of my dry old Dad jokes.  I have cut and pasted liberally from the indictment below the fold but you can only really get the "in the room" otherworldly feel for how syndicated conservation easements are hatched and loosed by reading the whole indictment.  The indictment describes what seems like an unbelievable plot that nevertheless persisted long enough to wreak havoc in some quarters of the tax landscape.  

dkj

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IRS Continues to Issue Audit Technique Guides & Technical Guides to Replace IRM Sections

The IRS is replacing entire sections of the Internal Revenue Manual with new Audit Technique Guides (ATGs) and Technical Guides (TGs). Most recently it announced publication online of the following three TGs:

• TG 0 Technical Guide Overview
• TG 3-4 Exempt Purpose, Scientific Organizations 501(c)(3)
• TG 17 Supplemental Unemployment Benefit Trusts

The first TG listed above explains that the IRS initially promulgated internal Technical Resource Guides (TRGs) to replace previous IRM sections 7.25, 7.26, and 7.27, and ATGs to replace previous IRM section 4.76. The IRS is now creating publicly available TGs based on the TRGs and ATGs, and retiring the related TRGs and ATGs as the TGs become available. The full  set of TGs and at least some of the ATGs (but not any of the TRGs) can be found at this IRS webpage.

I first noticed this change when I attempted to located the IRM section addressing a particular topic, only to discover it was no longer available. Unfortunately it appears the topic I was interested in is still stuck in TRG limbo, available internally at the IRS but not to the public. Hopefully it, and the rest of the topics still only in TRGs, will soon become publicly available again.

Lloyd Mayer

NASCO Asks For Timely Availability of Form 990 Data and Revisiting Use of Form 1023-EZ

Responding to the IRS' request for comments on tax-exempt organization forms, the National Association of State Charity Officials (NASCO) submitted a letter late last month with two requests that highlight the extent to which state officials rely on the IRS in policing charities.

First, NASCO stated its members had noticed significant lags between when charities file Forms 990 and they become publicly available. It therefore asked the IRS to address delays in the timely availability of these forms.

Second, NASCO repeated its concerns about the Form 1023-EZ and continued to call for elimination or at least revision of this form.  The letter stated that among their concerns NASCO members "continue to be concerned that the ability to use Form 1023-EZ in place of Form 1023 has made it easier for 'scam' charities to obtain 501(c)(3) status," citing the recent Treasury Inspector General for Tax Administration report on this topic.

Lloyd Mayer

Conservation Easements Update: Proposed Listed Transactions Regs; Kane on Circuit Split

Last month the U.S. Tax Court held that the syndicated conservation easement listing notice was invalid for failure to follow Administrative Procedure Act requirements. Without agreeing with the Tax Court's decision, the Treasury Department has now issued proposed regulations that would identify these transactions as listed transactions. Here is the Federal Register summary:

This document contains proposed regulations that identify certain syndicated conservation easement transactions and substantially similar transactions as listed transactions, a type of reportable transaction. Material advisors and certain participants in these listed transactions are required to file disclosures with the IRS and are subject to penalties for failure to disclose. The proposed regulations affect participants in these transactions as well as material advisors. In addition, while the proposed regulations exclude qualified organizations from being treated as participants or parties to a prohibited tax shelter transaction subject to excise tax, this notice of proposed rulemaking requests comments on whether the final regulations should remove the exclusion from the application of the excise tax for qualified organizations that facilitate syndicated conservation easement transactions. Finally, this document provides notice of a public hearing on the proposed regulations.

Comments are due by February 6, 2023. For additional coverage of the Tax Court's decision, see Peter J. Reilly's Forbes article.

I also previously noted the circuit split relating to a conservation easement regulation. Now Mitchell Kane (NYU) has published The Dispute Over Perpetual Conservation Easements Just Got Worse in Tax Notes, arguing that Supreme Court should not grant certiorari to resolve that split. Here is a paragraph from the introduction:

In Section I, I explain why certiorari is not warranted in Oakbrook. Further, the stakes transcend conservation easements and the proceeds regulation: A grant of certiorari in this case could lead down a path that would destabilize tax regulations generally and greatly hinder effective tax code enforcement. To argue against cert grant is not to say that the status quo is optimal. IRS challenges to easements under the proceeds regulation seem to have involved instances with suspiciously high valuations. There is nothing wrong with that strategy from a litigation standpoint; we should expect the IRS to focus its scarce resources on high-value cases, and the agency has won cases bringing challenges under the proceeds regulation. Even so, this litigation at least raises the prospect of casting a cloud over existing, or future, easement transactions that are not abusive and are within the set of transactions that Congress plausibly wanted to encourage. The status quo is thus not obviously the best outcome in terms of the law applicable to the tax treatment of conservation easements under section 170. For this reason, in Section II, I will consider alternatives to the status quo.

For previous coverage of the circuit split, see Kristin E. Hickman (Minnesota), The Federal Tax System's Administrative Law Woes Grow, ABA Tax Times, May 26, 2022.

Lloyd Mayer

Politics Update: More Coverage of Mega-501(c)(4)s; Senator Whitehouse Criticizes 501(c)(3) CPI

I previously reported on commentary stimulated by recent reports of multi-billion dollar donations to 501(c)(4)s. Bloomberg Law (subscription required) has now published Ray Dalio, Koch Family Wield Powerful Tool to Give Fortunes Away highlighting additional instances of mega-501(c)(4)s controlling billions of dollars.  Here are the opening paragraphs for the story:

Ray Dalio , founder of the world’s largest hedge fund, has one. The Koch family, sitting atop a $137 billion fortune, has at least two. Still another entity, with unknown backers, owns a big stake in one of Wall Street’s fastest-growing financial technology startups.

The vehicle, long deemed a dumping ground for nonprofits like low-income housing developers, Rotary International and even the AARP, drew controversy in the past decade as a “dark money” political giving tool. Now it’s attracting billionaires who realize it offers far more.

The most important quality of the so-called 501(c)(4) organization boils down to one word: control.

Control over their business. Control over political influence. Control over disclosure. Control over taxes. And, of course, control over the crucial soft power of charitable giving.

All in one place.

In other politics and nonprofits news, U.S. Senator Sheldon Whitehouse, Chairman of the Senate Finance Taxation and IRS Oversight Subcommittee, publicly criticized the section 501(c)(3) Conservative Partnership Institute for possible political campaign intervention and private benefit. This follows an NPR report on CPI's activities (full disclosure: I am quoted in this report as saying CPI's reported activities raise yellow flags). It also comes at the same time as a Daily Signal report that Senator Whitehouse pressured the IRS and DOJ to investigate conservative groups.

Lloyd Mayer

An Understandably Modest IRS Agenda for Fiscal Year 2023

This month saw three updates on IRS (and Treasury) tax-exempt organization plans or possible plans for fiscal year 2023, and those plans are (understandably) modest. The highlights from the 2022-2023 Priority Guidance Plan, the TE/GE FY2023 Program Letter, and the annual IRSAC report are:

• Six of the ten Priority Guidance Plan exempt organizations items are repeats from last year (group exemptions, supporting organization final regs, section 512 allocation regs, section 4941 partnership investment guidance, section 6104(c) final regulations, and section 7611 appropriate high-level official final regs). The section 6104(c) item is listed only to say it was completed (T.D. 9964), and the section 7611 issue may be moot as the IRS has identified the Commissioner, TE/GE and the Deputy Commissioner for Services and Enforcement as the appropriate officials in IRM 4.76.39.1.1.

• The other four Priority Guidance Plan EO items are an expansion of the single donor advised fund item from last year. The expanded items identify specifically donor advised fund regulations under sections 4966, 4967, and 4958, as well as guidance regarding the public-support computation with respect to DAF distributions.

• The Priority Guidance Plan drops guidance relating to LLCs and section 501(c)(3), apparently because the IRS has decided not to issue any additional guidance in response to comments on Notice 2021-56, as Paul Streckfus reported today.

• Other exempt organizations related Priority Guidance Plan items include section 170 general guidance and also specific guidance relating to conservation easements, section 414(e) definition of a church plan regulations, section 501(c)(9) voluntary employees' beneficiary associations regulations and other guidance, and section 514(c)(9)(E) fractions rule final regulations.

• The TE/GE Program Letter focuses on high-level, relatively vague goals (Service, Enforcement, People, Transformation) as has been typical in recent years. That said, it does report that TE/GE hired 187 new employees in FY2022 and anticipates hiring a greater number in FY2023.

• The IRS Advisory Council Public Report only contains two recommendations of tax-exempt organization interest, one relating to tax-exempt bonds and the other to the tax-exempt organization data. The former has to do with form revisions, and the latter with ensuring functionality of data sharing in compliance with section 6104.

Lloyd Mayer

IRS Commissioner Nominee Evokes Memories of Alleged IRS Bias Against Conservative Nonprofits

The Washington Post reports that the White House announced on Thursday that President Biden will nominate Daniel Werfel to lead the Internal Revenue Service, tapping a former budget official to spearhead implementation of key parts of the administration’s economic agenda. 

Mr. Werfel served in the George W. Bush and Obama administrations, working at senior levels of the White House Office of Management and Budget and at the IRS. He was acting IRS commissioner in 2013, taking over after top officials resigned over a controversy involving the agency’s scrutiny of nonprofit groups.

What was the controversy about? 

NPR provides the answer. In an October 5, 2017, report, NPR revealed that in 2013, IRS official Lois Lerner revealed that conservative groups seeking tax-exempt status had been getting extra scrutiny, based on words such as "tea party" or "patriots" in their names. For conservatives, Ms. Lerner's statement confirmed their darkest suspicions: in the Tea Party heyday years of 2009 and 2010, hundreds of groups affiliated with the party had sought tax-exempt status as 501(c)(4) "social welfare" organizations. IRS demands for documents left many of them in bureaucratic limbo for a year or more.

The NPR report revealed that an audit by the Treasury Inspector General overseeing the IRS had found that the agency had targeted not just conservatives but also scores of groups with words like "progressive" in their names. The Treasury Inspector General for Tax Administration, or TIGTA, did the report at the request of a bipartisan group of senators.

The report did not satisfy everyone, particularly supporters of the conservative groups who had sought tax-exempt status during that period. Conservative lawyer Cleta Mitchell, who represented eight groups that were given the extra scrutiny, said at the time that the approval process took far too long. In one case, she said, "the IRS wanted every communication that this organization had made about Obamacare," as the Affordable Care Act is commonly called. 

Mitchell opined that even if progressive groups were targeted, "they didn't get subjected to the kinds of follow-up the Tea Party groups did." Meanwhile, in June 2013, Rep. Hal Rogers, R-Ky., told Fox News the IRS had an "enemies list out of the White House." Also, at a Tea Party rally on Capitol Hill, Sen. Rand Paul said an out-of-control government was "persecuting people for their religious and their political beliefs."

According to the NPR report, 

Then-President Obama quickly cleaned house in the upper echelons of the IRS, but congressional hearings ran more than three years before they spun off into secondary issues, which inevitably included missing emails. Lerner became a target for conservative attacks when she took the Fifth Amendment at a House investigative hearing.

In cleaning house, President Obama appointed Mr. Werfel acting IRS Commissioner. According to the Washington Post, current Treasury Secretary Janet Yellen reacted positively to Mr. Werfel's pending nomination:

Danny’s prior service under both Democratic and Republican administrations, his deep management experience, and his work directing significant transformation efforts, make him uniquely qualified to lead the agency at this critical juncture. Danny’s deep commitment to fairness and making sure government works for all will also be invaluable as we improve the taxpayer experience and eliminate a two-tiered tax system.

John Koskinen, who served as IRS commissioner after being nominated by President Obama, also had words of praise for Mr. Werfel. According to Mr. Koskinen, Mr. Werfel worked effectively with the GOP at the height of the anger over accusations that the tax agency had targeted tea party groups for additional scrutiny. He continued: "Werfel was dropped into the middle of a maelstrom [yet] did a good job of responding positively to congressional inquiries.”

But not everyone is sold on the idea that Mr. Werfel is the best person for the job. The Post reports that at least one leading House Republican on Thursday criticized Mr. Werfel’s performance during that period. According to Rep. Kevin Brady (R-Tex.), the top Republican on the House Ways and Means Committee, "Daniel Werfel was named acting IRS commissioner in 2013 with the goal of restoring credibility and confidence in the IRS after the agency’s shameful targeting of conservative groups. He didn’t succeed in 2013 and I’m concerned about whether he can succeed in 2023 and beyond."

We shall have to wait to find out. If the Senate confirms Mr. Werfel's appointment as IRS Commissioner, he will face many challenges, including the challenge of improving IRS customer service, which struggled amid the pandemic after years of budget cuts. The IRS taxpayer watchdog reported over this summer that the agency had a backlog of 21.3 million returns, and call response rates have plummeted. Only 1 in 10 of the 73 million taxpayer calls for help reached an employee in the last filing season. 

Whatever he does, though, it would be wise for Mr. Werfel to ensure that the IRS does not unnecessarily target nonprofit organizations for extra scrutiny. 

Prof. Vaughn E. James, Texas Tech University School of Law

 

    

Texas Tribune & ProPublica Investigate Churches Politicking

The Texas Tribune and Propublica published an investigation into churches, politicking and lack of IRS enforcement and quote a couple members, including myself, of this blog. From the article:

"At one point, churches fretted over losing their tax-exempt status for even unintentional missteps. But the IRS has largely abdicated its enforcement responsibilities as churches have become more brazen. In fact, the number of apparent violations found by ProPublica and the Tribune, and confirmed by three nonprofit tax law experts, are greater than the total number of churches the federal agency has investigated for intervening in political campaigns over the past decade, according to records obtained by the news organizations." . . . 

"Among the violations the newsrooms identified: In January, an Alaska pastor told his congregation that he was voting for a GOP candidate who is aiming to unseat Republican U.S. Sen. Lisa Murkowski, saying the challenger was the “only candidate for Senate that can flat-out preach.” During a May 15 sermon, a pastor in Rocklin, California, asked voters to get behind “a Christian conservative candidate” challenging Gov. Gavin Newsom. And in July, a New Mexico pastor called Democratic Gov. Michelle Lujan Grisham “beyond evil” and “demonic” for supporting abortion access. He urged congregants to “vote her behind right out of office” and challenged the media to call him out for violating the Johnson Amendment."

Though the story is perhaps not news to those who follow this topic closely, it's a good piece, documenting pretty clear violations of the prohibition on charities from intervening in a political campaign. It has some nice history on the adoption of the amendment that I found useful alone. It also gives nice context for the PACI project where the IRS actually began actively looking at political activities in general, where many of the charities were indeed churches.

Though it is true that the IRS has barely enforced this provision over the years, the fact that there is a large effort among some churches to vigorously move into the politicking space today that is documented in this story is of concern. The biggest policy reason to focus in on this issue is summarized pretty well by the following quote by Andrew Seidel, vice president of strategic communications for the advocacy group Americans United for Separation of Church and State: “If you pair the ability to wade into partisan politics with a total absence of financial oversight and transparency, you’re essentially creating super PACs that are black holes.” 

Philip Hackney

 

Nonprofits In the News (Not in a Good Way): Brett Favre; J.D. Vance; Hershel Walker; Indictments in Minnesota

Sometimes it seems every scandal has a nonprofit involved, and every politician has a questionable nonprofit connection.

For example, the continuing revelations about Brett Favre and alleged misuse of government welfare funds include both a nonprofit that was in the middle of that misuse and also new allegations about Favre's own foundation and its grants to support college athletes (and possibly the volleyball facility at the heart of the welfare funds scandal), even given the foundation's purported purposes being limited to helping children and cancer patients. (Favre's foundation is, despite the name, a public charity that appears to receive much of its contributions from people other than the former NFL football player.)

As for politicians, the N.Y. Times published an article over the weekend titled "J.D. Vance’s First Attempt to Renew Ohio Crumbled Quickly. In 2017, the Republican candidate for Senate started a nonprofit group to tackle the social ills he had written about in his 'Hillbilly Elegy' memoir. It fell apart within two years." And it earlier published an article titled "Herschel Walker’s Company Said It Donated Profits, but Evidence Is Scant," reporting that of the four charities that supposedly received 15 percent of the profits from Walker's company, "one declined to comment and the other three said they had no record or recollection of any gifts from the company in the last decade."

And in Minnesota, the other shoe dropped for the Feeding Our Future scandal, with a U.S. Department of Justice press release stating "U.S. Attorney Announces Federal Charges Against 47 Defendants in $250 Million Feeding Our Future Fraud Scheme." In addition, a federal court has denied the request of another nonprofit, Partners in Nutrition, to be reinstated to the child nutrition program given its ties to some of the alleged participants in the fraud.

Lloyd Mayer

California Governor Vetoes Tax Exemption & Insurrection Bill

Late last month, California Governor Gavin Newsom vetoed a bill (SB 834) that would have revoked the tax-exempt status of nonprofit in California that the state Attorney General determined engaged in treason, insurrection, conspiracy, government overthrow, or mutiny by members of the military as defined under federal law. Here is the governor's explanation for the veto:

Without question, extremist groups that participate in anti-government acts such as those that took place during the insurrection on January 6, 2021 should be renounced and investigated for their participation. However, these are issues that should be evaluated through the judicial system with due process and a right to a hearing.

The legislature has 60 days (excluding joint recess days) to override the veto by a two-thirds vote in both houses. And in the unlikely event that occurs (the best information I could find states there has not been an override for over 40 years), the law would almost certainly face constitutional challenge.

Coverage: CBS News/Bay City News Service; California Globe;  Law360.

TIGTA: More Information Is Needed to Make Informed Decisions on Streamlined Applications for Tax Exemption

The Treasury Inspector General for Tax Administration (TIGTA) this week issued a report titled More Information Is Needed to Make Informed Decisions on Streamlined Applications for Tax Exemption. Here are the highlights (emphasis added):

What TIGTA Found

On July 1, 2014, the IRS released Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, a simplified electronic application for smaller organizations to request and obtain exemption from Federal income tax as an organization described in I.R.C. § 501(c)(3) tax-exempt status. Form 1023-EZ requires applicants to attest, rather than demonstrate, that they meet the requirements for I.R.C. § 501(c)(3) status. For example, Form 1023-EZ applicants are not required to submit their organizing documents to the IRS; they instead attest that they meet organizational requirements.

Based on our assessment of internal and external stakeholder opinions, States’ reporting requirements, comparison with the information required on the long application form, our testing of the application process, and limited examination compliance efforts, we determined that the information provided on the Form 1023-EZ is insufficient to make an informed determination about tax-exempt status and does not educate applicants about eligibility requirements for tax exemption. TIGTA obtained I.R.C. § 501(c)(3) status for four of five nonexistent organizations. The IRS correctly identified one of our fictitious applications as potentially ineligible and sent a request for additional documentation. Our undercover testing illustrates vulnerabilities in the IRS’s tax-exempt status determination process.

The IRS relies on a Form 1023-EZ examination strategy to detect noncompliance after organizations are approved; however, less than 1 percent of tax-exempt organizations are examined each year. In addition, online guidance for the Form 1023-EZ is inaccurate. The online web page used to apply for tax-exempt status includes educational links to assist Form 1023-EZ applicants. However, one of the educational links takes the applicant to a web page containing inaccurate information for applicants using the Form 1023-EZ.

What TIGTA Recommended

TIGTA recommended that the IRS: 1) revise the activities description narrative on Form 1023-EZ, 2) assess the feasibility of requiring applicants to submit their organizing documents as an attachment to Form 1023-EZ, 3) notify applicants when additional time is needed to process their Form 1023-EZ applications, and 4) update online guidance with accurate information on the application process for Form 1023-EZ filers.

IRS management agreed with the second and fourth recommendations. In addition, the IRS will consider notifying applicants when their submissions need additional time to process. However, the IRS believes that requiring detailed activity descriptions is unnecessary to make determination decisions.

Lloyd Mayer

TIGTA, Review of the IRS’s Enforcement Program for Tax-Exempt Organizations That Participate in Illegal or Nonexempt Activities

The Treasury Inspector General for Tax Administration (TIGTA) last week issued a report titled Review of the IRS’s Enforcement Program for Tax-Exempt Organizations That Participate in Illegal or Nonexempt Activities. Here are the highlights:

What TIGTA Found

TIGTA found that both the IRS and State charity regulators are limited by their respective laws and procedures for coordinating with each other as a means to identity tax-exempt organizations potentially engaging in illegal or other nonexempt activities. Currently, no State Attorneys General Offices have formal disclosure agreements with the IRS.

TIGTA identified 3,726 closed EO function referrals alleging potential fraudulent or illegal activities during Fiscal Years 2018 through 2020. For these referrals, classifiers inaccurately recorded the results for 42 cases on the referral database. In addition, for the 15,522 unique referral cases closed during Fiscal Years 2018 through 2020, our analysis identified 980 closed cases for which two referral database fields included conflicting information about the final dispositions of the referrals. TIGTA also determined that 2,934 data fields were missing required information because referral database system controls do not require these fields to be completed prior to the case closing.

TIGTA reviewed two judgmental samples consisting of 46 referral cases closed between Fiscal Years 2018 and 2020 that alleged potentially fraudulent or illegal activities to determine whether the IRS’s assessments of the referrals were sufficiently researched and properly documented. All 46 referral cases sampled were sufficiently researched. However, five of the 46 referrals did not have sufficient documentation to justify the decision to not pursue an examination.

Finally, during this review and as in prior reviews, TIGTA found that the IRS has processes in place to identify whether a tax-exempt organization engages in substantial activities that do not further their tax-exempt purpose.

What TIGTA Recommended

TIGTA recommended that the IRS should: 1) ensure that Classification managers periodically emphasize to classifiers the importance of including supporting documentation in the case files for selecting or not selecting referrals for examination; 2) implement referral database system controls to ensure that complete and accurate data is input into the database; and 3) review the fields on the referral database and determine if any may be eliminated to avoid confusion, conflicting information in similar fields, and redundancy.

The IRS agreed with our recommendations and plans to take corrective actions.

Lloyd Mayer