Thursday, August 17, 2023
Last Saturday, Forbes reported on the indictment of Michael Meyer for the promotion of his allegedly fraudulent charitable-donation tax shelter, the Ultimate Tax Plan. Meyer and his associates and the charities he created have been the subject of federal law enforcement interest for more than a decade, and the indictment recounts numerous acts of fraud and deception. Additional information can be found in the Tax Court petition filed in July by the Family Office Foundation, a charitable entity created by Meyer, to contest its denial of tax-exempt status. The appendix includes the adverse determination letter from the IRS, which provides a detailed description of the Ultimate Tax Plan and how it was supposed to work.
The acts described in the indictment are clearly fraudulent. As the Forbes article points out, many of the transactions involved backdating transaction documents to a previous year, and “[a]nything that involves backdating is bad.” Backdated transactions reflect clear deception, and “[j]uries can … easily understand that one cannot take a deduction for 2016 for something that didn’t happen until 2017.” Furthermore, “if a tax strategy has a name, then it probably doesn’t work.”
However, the strategy includes at least one component that the IRS appears to view as impermissible that I would love to learn more about, partially because it is facilitated by donor-advised funds. The Ultimate Tax Plan involves the following structure. First, a donor-advised fund sponsoring organization (let’s call it “Charity”) is created. Second, each client creates an LLC with controlling interests and noncontrolling interests. The client retains the controlling interest and donates the noncontrolling interest to the Charity. The client then takes a charitable tax deduction for fair market value of the noncontrolling LLC interest. In the actual Ultimate Tax Plan, this transaction (allegedly) includes all sorts of shenanigans like the aforementioned backdating, transactions that appear on paper but were never executed, dramatic mis-valuations of the donated noncontrolling LLC interest, an explicit promise that the Charity would sell back the LLC interest to the “donor” at a fraction of the value taken as a tax deduction, and many others. But more interesting to me than all the shenanigans is the fact that the IRS appears to take the position in the adverse determination letter that the donation of noncontrolling LLC interests to the Charity inherently fails to qualify as a charitable contribution because “the Bogus Charities never had dominion or control over any of the purported contributions.” By permitting the donor to transfer a noncontrolling interest in the LLC that the donor continues to control, “the donor can take a tax deduction for a ‘charitable contribution’ while maintaining the economic benefit and control of the donated asset.”
Again, the (alleged) shenanigans clearly make Meyer’s scheme fraudulent and cause the Family Office Foundation to fail to qualify as a tax-exempt organization. But I’m not sure the IRS is on such firm legal grounds if it wants to argue that a donation of a noncontrolling interest in an LLC that continues to be controlled by the donor automatically fails as a charitable contribution because the charity never obtains dominion and control. (I’m sure some readers know this law better than me, and would love help if I’m just wrong about this). Obviously, any time a charity receives a donation of corporate stock, it does not thereby receive the right to obtain any distribution from the stock or demand that the company repurchase it. Generally, at least for publicly-traded stock, that’s not a problem for the charity because it can sell the stock and use the proceeds to pursue its charitable activities (or not, at its discretion). My understanding is that the general principle is true for donations of illiquid property as well: the fact that there is not a ready market for a donated asset may affect the valuation of that asset (a so-called liquidity or marketability discount), but it does not render the donation void. A charity that receives a donation of an illiquid asset, like a noncontrolling interest in a closely held firm, is considered to have sufficient dominion and control over the asset to treat the transaction as a completed donation. The fact that the charity doesn’t have the power to compel the firm to make distributions or convert the ownership interest into cash does not negate the fact of the donation. The fact that the charity has expressly agreed to sell the property back to the donor at a fraction of its reported value of course would negate the substance of the transaction, but not the mere fact that it is a noncontrolling interest in a firm that the donor continues to control.
It is true that there is a poorly defined body of law that holds that a charity has to undertake at least some actual charitable activities in order to qualify for exemption, and so the charity has to actually receive some cash from somewhere that it can spend on pursuing its charitable activities. The IRS determination letter calls this the “substantial present economic benefit test.” But for the purposes of our hypothetical, let’s assume that the Charity manages to get its hands on enough cash to satisfy the substantial present economic benefits test.
The reason I’m interested in this structure, if it could be pursued without all the shenanigans that make it obviously illegal, is because it appears to be substantially facilitated by the current legal treatment of Donor Advised Funds. If the Charity had to be a Private Foundation because it was receiving donations from a single person or family, current law would prevent it from continuing to own a substantial interest in the donated LLC, taking a deduction for the fair-market value (rather than basis) of the donated LLC interest, and from spending less than 5% of its assets every year, etc. In other words, the Family Office Foundation case might be an example of a structure that (if dramatically cleaned up) still illustrates an abusive but currently legal use of Donor Advised Funds. The big commercial DAF sponsoring organizations, like those created by Fidelity and Vanguard, would never permit such an abusive use even if legal. I think the IRS and Congress should focus on relatively low-hanging fruit of closing these DAF loopholes rather than getting tied up deciding whether to make dramatic changes to the DAF laws.
-Benjamin M. Leff
Thursday, August 10, 2023
In a post I made earlier this week on the Streamlining Federal Grants Act of 2023, I discussed the Act's peculiar definition of "nonprofit." As a reminder, the Act's definition of nonprofit is as follows:
any corporation, trust, association, cooperative, or other organization that—
(A) is operated primarily for scientific, educational, service, charitable, or similar purposes in the public interest;
(B) is not organized primarily for profit;
(C) uses net proceeds to maintain, improve, or expand the operations of the organization; and
(D) is not an institution of higher education.
While the definition reverberates with the echoes of Section 501(c)(3), it is clearly not the same. So in my original post, I posed a question to the universe about the origins of this language.
And the universe answered!
David Thompson, the Vice President of Public Policy at the National Council of Nonprofits (the source of the article I linked in the original post) wrote me with the following information:
The definition of nonprofit organization in the legislation actually tracks ... the definition in the OMB Uniform Guidance, 2 CFR Sec. 200.1 Nonprofit Organization. Since the bill deals with the grantmaking process, it makes sense to use the definition upon which the federal grantmaking agencies rely. This also explains why Institution of Higher Education is defined separately too – the Uniform Guidance has distinct rules for Eds that are different from the ones governing grants to nonprofits.
So many thanks to David for that assist!
It does leave me to wonder, however, if this isn't a place where we could have some streamlining, which is ostensibly the purpose of the Act (I mean, just look at the title, friends!). The committee hearing testimony of all of the participants highlighted the capacity issues facing organizations applying for grants - cost, expertise, training, just having enough warm bodies, etc. For nonprofits, having to deal with two definitions certainly makes life more (and IMHO, unnecessarily) complicated. I'd certainly advocate for using the 501(c)(3) definition, something that nonprofit grantees are already going to be pretty used to dealing with on a regular basis.
I can see, however, two issues: (1) this definition may already be so embedded in Federal contracting lingo that changing it could have collateral impacts, and (2) the definition seems broader than just Section 501(c)(3). So here's my compromise, Senate Homeland Security Committee: what about a safe harbor? Can we just say, explicitly, that any organization holding a current 501(c)(3) determination letter automatically meets the contracting definition - assuming that doesn't exists already somewhere in the Federal contracting guidelines. That keeps your original contracting definition in play, makes life easier for your 501(c)(3) grantees, and preserves the ability of non-501(c)(3)s to qualify under the Federal contracting definition, if it is in fact broader? You might have to deal with churches separately, as some have their determination letter but others do not... but we deal with churches separate all the time for this reason.
Anyway, thanks again to David for his good work and the work of the Council, and thanks for participating in this conversation.
Tuesday, August 8, 2023
The National Council of Nonprofits reports that the Senate Homeland Security and Governmental Affairs Committee approved Senate Bill 2286, the Streamlining Federal Grants Act of 2023. According to the Council,
the legislation seeks to improve the effectiveness and performance of federal grants and cooperative agreements, simplify the application and reporting requirements, and facilitate greater coordination among federal agencies responsible for delivering services to the public. Notably, the bill mandates consultation with charitable nonprofits and governments and calls for improving services delivered to communities and organizations that historically have not received federal grants or cooperative agreements.
In summary, the Act requires each federal agency to appoint a senior official to oversee federal grant administration for that agency. In addition, the Office of Management and Budget (OMB) must establish a Grants Council, made up of the Controller of OMB as the chair, the senior grants officials from the various agencies, and others as determined by the chair. The Grants Council is charged to “consistently and regularly solicit input and collect feedback and user experience information with respect to the application, administration, and reporting of grants and cooperative agreements, including from non-Federal entities” (emphasis added). The Director of OMB, in consultation with Grants Council, must develop plans for improving grants administration, including streamlining application and reporting processes, simplifying grant opportunity notices, and increasing opportunities for training and education in federal grants administration.
As indicated, the Grants Council is supposed to work with “non-Federal entities” in developing these grant procedure improvement plans. A “non-Federal entity” is defined as a “State, local government, Indian Tribe, institution of higher education, or nonprofit organization.” In turn, the term “nonprofit organization” is defined as follows:
any corporation, trust, association, cooperative, or other organization that—
(A) is operated primarily for scientific, educational, service, charitable, or similar purposes in the public interest;
(B) is not organized primarily for profit;
(C) uses net proceeds to maintain, improve, or expand the operations of the organization; and
(D) is not an institution of higher education.
I’m struck by the definition of a nonprofit organization for these purposes. It clearly is not co-terminus with the requirements of Code Section 501(c)(3). For example, it includes “service” purposes…” and contains an odd variation on the nonprofit distribution constraint. Confusingly, it uses terms that do not seem to exclude for-profit entities, as the organization only need be “not organized primarily for profit” – would this include, for example, an L3C? A for-profit traditional (not next gen) cooperative?
In a concededly brief effort to find more information on the definition of “nonprofit” in the bill, I took a very quick look at some of the hearing testimony. The Senate Committee held a hearing on May 2, information about which can be found here. I didn’t find a great deal of information on that specific issue – in fact, most of the testimony revolves around state and local government capacity challenges and it barely mentions private entities. I’d be curious if anyone out in Nonprofit Land recognizes this definition from another Federal grant statute or otherwise has any background on from whence it came.
Tuesday, August 1, 2023
Representative Bryan Steil, Chairman of the Committee on House Administration, introduced the American Confidence in Elections Act, touting it as "the most conservative election integrity bill to be seriously considered in the House in over 20 years." While most of its provisions relate to election law, several provisions relate directly to tax-exempt organizations:
- Section 131 would amend section 501(c)(3) to prohibit organizations described in that section from providing "direct funding to any State or unit of local government for the purpose of the administration of elections for public office or any funding to any State or unit of local government in a case in which it is reasonable to expect such funding will be used for the purpose of the administration of elections for public office (except with respect to the donation of space to a State or unit of local government to be used as a polling 10 place in an election for public office)."
- Section 163 would prohibit donations by foreign nationals to section 501(c) organizations that make or expect to make contributions to a political committee.
- Section 308 would prohibit the collection of identifying information for any donor to a 501(c) organization, except as permitted under section 6033 and certain non-tax laws, and section 309(d) would amend section 6033 to codify the current administrative position that reporting of such information is not required for 501(c) organizations other than 501(c)(3)s.
- Section 309 would also increase the section 6033 annual gross receipts filing threshold for an annual return (i.e., Form 990 series) from $5,000 to $50,000.
- Section 310 would prohibit Treasury from issuing any guidance under section 501(c)(4) (other than guidance limited to a particular taxpayer) relating to whether an organization is operated exclusively for the promotion of social welfare and lock in the standard and definitions relating to this requirement that were used as of January 1, 2010.
The congressional outrage over the announced merger of the PGA Tour and the Saudi Arabian backed LIV Golf continues. Last week Senator Ron Wyden, Chairman of the Senate Finance Committee, introduced two bills in response. One - The Sports League Tax-Exempt Status Limitation Act - would go after the PGA Tour's tax-exempt status under 501(c)(6) by stripping that status from any sports organizations with assets exceeding $500 million. The other - The Ending Tax Breaks for Massive Sovereign Wealth Funds Act - would end the exemption from withholding for sovereign wealth funds with over $100 billion invested, with an exception for countries that have either a free trade agreement or a tax treaty with the U.S. and are not deemed by the State Department to be a "foreign country of concern." This would limit the bill's effect to about half-a-dozen countries, including not only Saudi Arabia but also Russia, China, Qatar, the United Arab Emirates, and Kuwait.
Tuesday, June 27, 2023
Everything in this post is “old news,” but last month I posted a largely positive account of donor-advised funds (DAFs). In that post, I mentioned “specific abusive uses of DAFs,” but didn’t elaborate. So, today I want to describe one DAF “loophole” that really should be closed as soon as is practical. The Treasury proposed closing this loophole in a notice in 2017, but has never released regulations to actually do so. I sometimes worry that efforts to prevent DAFs from delaying the use of charitable funds (which are relatively controversial) are getting in the way of acting to prevent specific abusive uses of DAFs. At the top of my list of DAF loopholes that should be closed is the way that recipient organizations treat distributions from DAFs for the purposes of the public support tests.
To understand what I mean, imagine that Mrs. Smith wants to give $1 million to a charity she controls called the Mrs. Smith Foundation. If she gives the money directly to the Foundation (and no one else does), then that charity is a private foundation, subject to a number of important legal restrictions. However, if she gives that money to a DAF and then advises the sponsoring organization to distribute the money to the Mrs. Smith Foundation, then the Foundation is a public charity under current law. It’s a public charity instead of a private foundation even if Mrs. Smith controls the Foundation, and even if it never receives any funds from anyone but her (through her DAF). In effect, by using a DAF as an “intermediary,” Mrs. Smith has managed to create an organization that provides all the benefit of a private foundation, but which is not subject to any private foundation restrictions. Way back in 2017, the IRS pointed out this problem and announced that they “are considering” fixing the problem by requiring the “distributee charity” to treat distributions from DAF sponsoring organizations as coming from the DAF donor rather than the organization solely for the purposes of the public support tests.
Why does it matter that Mrs. Smith can create a fully-controlled charity that avoids private foundation status? First, under current law, DAF sponsoring organizations are not allowed to pay Mrs. Smith or her children “compensation” out of DAF funds, but the Mrs. Smith Foundation would be able to pay her and her children compensation (just like she could if it was a private foundation), as well as reimburse travel expenses associated with the Foundation’s activities. Second, under current law, private foundations and DAF sponsoring organizations must exercise “expenditure responsibility” if they make a grant to anyone other than a public charity. But the Mrs. Smith Foundation, as a public charity, doesn’t have that obligation. Expenditure responsibility is a series of actions that federal law requires private foundations and DAF sponsors to take to make sure that their grants are used for proper charitable purposes. Just to give one example, imagine that Mrs. Smith wanted to give funds to support a presidential candidate. She’s not supposed to use charitable dollars (which are tax deductible) to do that. If she created a private foundation, it would be prohibited from making any expenditures to support a candidate or lobby, but it could probably make a grant to a 501(c)(4) organization to support that organization’s charitable activities, as long as the private foundation exercised expenditure responsibility to make sure that none of the grant was used for political purposes. But if instead Mrs. Smith used a DAF as an intermediary to permit the Mrs. Smith Foundation to avoid private foundations status, then the Foundation could make the grant to the 501(c)(4) organization without exercising expenditure responsibility. Even better, if Mrs. Smith already had funds in a private foundation, that foundation could use the DAF as an intermediary to get the funds to the Mrs. Smith Foundation, which could in turn distribute the funds to the 501(c)(4) organization without being bound by expenditure responsibility. The DAF acts as a blocker for the original foundation’s need to exercise expenditure responsibility, and the fact that the Mrs. Smith Foundation qualifies as a public charity relieves it from the requirement to exercise expenditure responsibility. Surely that isn’t the way the law is intended to work.
Finally, here’s the irony: when DAFs are used as “intermediaries” in this way, they are not themselves delaying the expenditure of charitable dollars, which so many commentators are worried about. Instead, the DAF sponsor’s statistics about expenditures would show distributions to controlled charities as current expenditures. Once those distributions were made to the Mrs. Smith Foundation, there would be no need for the Foundation to spend them on charitable purposes on any particular timeline. The Foundation isn’t even be subject to the 5% payout requirement of private foundations. Again, if Mrs. Smith already had a private foundation, she could satisfy the 5% payout requirement of the private foundation by using a DAF as an intermediary to distribute funds to the Mrs. Smith Foundation, which qualifies as a public charity. The Mrs. Smith Foundation could then sit on those assets for pretty much as long as it wants, just the same as other public charities. Basically, the fact that charities can use DAF funds as “public support” to avoid private foundation status means that unless that rule is changed, all other rules regulating private foundations or DAFs will be easy to avoid. The Treasury should make the change proposed in 2017 as soon as possible.
Thursday, May 11, 2023
The books I posted about yesterday and Tuesday are both quite critical of donor-advised funds (DAFs), and I hear a lot of criticism of DAFs these days. I am persuaded that current law permits some specific abusive uses of DAFs, but I am not (yet?) persuaded that among those abuses is the fact that DAFs avoid the 5% payout requirement of private foundations. The argument that I attributed to Rob Reich yesterday – that DAFs are like kudzu, crowding out donations to operating charities and so delaying the benefits of philanthropy – is well represented in the literature. So, I’d just like to share a single anecdote today about the benefits of a DAF for one real person.
Let’s call this person Mrs. Smith to protect her privacy. Mrs. Smith spent her life as a relatively frugal middle class woman, and found in her eighties that she had amassed a greater fortune, worth several millions of dollars, than she ever thought she would. She knew that she should be increasing her charitable giving, but felt somewhat overwhelmed by the multiple solicitations she received and so ironically gave less than she thought she should. She was persuaded to open a DAF at her city’s community foundation, largely because it would enable her to choose an amount that she intended to give for the year and give it, without agonizing about each specific charity.
The DAF has several additional benefits that she likes. First, it makes her donations of appreciated securities much easier than it would be if she tried to make them to individual charities. Because she is elderly, a significant portion of her wealth is in highly appreciated securities, and the tax benefit of using them for charitable contributions is well known. But because she still makes many charitable contributions of a few hundred dollars, it is quite complicated to try to make donations of appreciated securities to individual charities, many of which would much prefer to get a cash donation from a DAF than a donation of a few shares of stock from an individual. Second, because she feels overwhelmed by charitable solicitations (which are extremely costly to the charities), she would prefer to donate anonymously. The DAF permits her donations to individual charities to be anonymous and the DAF sponsor has assured her that it keeps private its own information about her. Third, because her DAF sponsor is a community foundation in her city, she appreciates the work that it does to recommend worthy charities and she reads its annual report diligently. She has said that she feels good about the (quite small) fees that the community foundation collects because she supports the work it does in turn supporting charities in her community. Fourth, as she ages she is quite anxious about charitable fraud, and feels comforted by knowing she can conduct her charitable giving and only have to interact directly with one trusted institution. Finally, the fact that she can track all her charitable giving on the community foundation’s website both helps her feel organized about her charitable activities and helps her act on her internal commitment to be more charitable. In her personal experience, investing through a DAF has enabled her to increase her charitable donations very significantly, even when measuring only donations that actually get transferred to active charities. Looking back over the past three years she has had the DAF, about 70% of her contributions into the DAF have already been transferred out to individual charities.
Interestingly, more than a decade ago, Mrs. Smith opened a different DAF at a major financial institution. She had converted a traditional IRA to a Roth IRA and for a single year was in a higher tax bracket than normal. She was advised to use that opportunity to make a significant charitable contribution into a DAF, which she could then distribute gradually in the following years. She also thought that having the DAF would facilitate discussions with her grandchildren about charitable giving as they chose recipients together. Because of where she was in her life, that just didn’t happen, and the balance sat in the DAF paying fees to the financial institution for seven years. Perhaps surprisingly, she continued to make the small charitable contributions she had always been making out of her regular checking account, but did not use the DAF at all. Finally, she decided to liquidate the DAF by making a (very large for her) single contribution to an active charity in her community.
One could imagine changing the law to require all DAFs to function more like Mrs. Smith's current experience and to prohibit the experience she had previously. But it's not at all clear that those changes to the law are necessary. It just depends on the relative benefits and burdens imposed on donors and charities by the law.
Saturday, March 11, 2023
Anyone who tracks legal developments relating to the involvement of nonprofits in politics would be forgiven if they felt they were in a particularly drawn out version of the movie Groundhog Day. That is because it appears everything that is new is something we have seen before. Here are some recent examples:
- DISCLOSE Act Introduced (again): U.S. Senator Sheldon Whitehouse (D-RI) and Representative David Cicilline (D-RI), along with 162 colleagues, reintroduced the Democracy Is Strengthened by Casting Light On Spending in Elections (DISCLOSE) Act in the new Congress. As noted in the press release, "Senate Majority Leader Chuck Schumer first introduced the DISCLOSE Act in the wake of the disastrous Citizens United decision in 2010, and Whitehouse has led the introduction of the legislation in every subsequent Congress."
- Treasury/IRS Barred From Issuing 501(c)(4) Guidance (again): The Consolidated Appropriations Act, 2023 (Pub. L. No. 117-328) continues the now longstanding prohibition on the Treasury Department, including the Internal Revenue Service, using any funds to develop guidance "relating to the standard which is used to determine whether an organization is operated exclusively for the promotion of social welfare for purposes of section 501(c)(4)" (Division E, Title I, Section 123, under Administrative Provisions - Department of the Treasury). The Act also continues now longstanding prohibitions on the IRS using any funds "to target citizens of the United States for exercising any right guaranteed under the First Amendment" or "to target groups for regulatory scrutiny based on their ideological beliefs." (Division E, Title I, Sections 106 & 107, under Administrative Provisions - Internal Revenue Service).
- A Politician Benefitting from a Friendly 501(c)(4) (again): Politico reports that "A new nonprofit group is helping DeSantis go national." The new nonprofit, named And to the Republic, is reportedly a section 501(c)(4) organization that "is supporting Ron DeSantis’ national political activity."
- A Politician Accused of Misusing a Nonprofit (again): The Arizona Republic reports that a former Democratic primary candidate for Secretary of State Reginald Bolding is facing allegations of wrongdoing relating to a nonprofit he founded and helped lead ("Bolding, his nonprofit, referred to AG for investigation of connections, donations"). The referral from Arizona Secretary of State Katie Hobbs states there "is reasonable cause to believe [Bolding] violated campaign finance law" based on a complaint filed by a Phoenix resident. The nonprofit is named Our Voice Our Vote, and according to IRS records it is a section 501(c)(4) organization.
Friday, March 10, 2023
Last month three U.S. Senators focused their attention on tax-exempt hospitals. Two of them, Senator Elizabeth Warren (D-Mass.) and Senator Ron Wyden (D-Ore.) directed their ire toward McKinsey & Company, asking it to explain its role in helping nonprofit hospitals "take financial advantage of low-income patients." The other, Senator Tammy Baldwin (D-Wisc.) focused on the Ascension Health system, asking its CEO to explain activities at some of its hospitals that recent press reports highlighted , including patient safety concerns, the closure of a labor and delivery unit, and sizeable for-profit investment activities.
And a recent article by Brian D. Cadman and Elena Patel (both at the University of Utah, the former in the School of Business and the latter in the Department of Finance) focuses on nonprofit hospital finances. It is titled Nonprofit Regulation and Earnings Distribution: Nonprofit Hospital. Here is the abstract:
Organizing as a nonprofit amplifies agency problems through limited ownership and restricted earnings distribution. We examine how these agency problems influence the distribution of economic profits by nonprofit hospitals, which dominate the population of tax-exempt organizations and account for a large fraction of the US economy. Using detailed hospital-level financial data, we find that nonprofit hospitals earn large economic profit. We also show that these hospitals hold five times more cash and 85% more retained earnings than for-profit hospitals. In addition, we document that general and administrative labor expenses are 60% larger, physician labor expenses are 32% larger, and expenses for drugs provided to patients are 31% larger for nonprofit hospitals. Finally, we find that nonprofit hospitals invest more in land improvements and buildings. The evidence suggests that nonprofit hospitals distribute economic profits through wages and capital expenditures.
The past couple of months have seen several commentators questioning whether the federal tax benefits for charities should continue to exist, either in their current form or at all. Here are some examples:
- As reported by Peter J. Reilly in Forbes, in December EO Tax Journal editor Paul Streckfus floated the idea that calling for repeal of Code section 170 in its entirety could be used by a presidential candidate to help separate themselves in what may be a crowded field. Reilly further reports that Streckfus made it clear in response to a follow-up inquiry that he supports this proposal, given that the deduction in its current form primarily if not almost exclusively benefits the wealthy who tend to give to the organizations that the wealthy themselves are interested in, such as their alma maters and, if they are very wealthy, their own foundations.
- Shortly thereafter, Peter Coy wrote an Opinion for the N.Y. Times titled The Thorny Questions Raised by Charitable Giving (subscription may be required). He flagged important issues, including the relative roles of government and philanthropy, whether to give locally or globally, and the balancing of giving fish with trying to teach someone to fish. He also noted that philanthropic priorities tend to be set by people with money, citing the effective altruism approach championed by Sam Bankman-Fried as an example, and the fact that the charitable contribution deduction is no longer available to most people of moderate means.
- Then in the Chronicle of Philanthropy, Jeff Cain wrote an Opinion titled End the Charitable Tax Exemption and Remove the Conflict of Interest Baked Into Big Philanthropy. He highlights the bipartisan opposition to the Accelerating Charitable Efforts Act among private foundations, and argues that "philanthropists can use their tax-advantaged funds to advocate for greater tax-incentivized charitable laws through the tax-exempt nonprofits they support. And they do." He refers to this trend as "Big Philanthropy" and argues that the way to address it is "ending charitable tax exemptions and deductions of every kind."
- Finally, Business Insider published an article titled How the Rich Have Their Cake and Eat It Too by Using Trusts to Give to Charity, Collect Cash, and Save on Taxes at the Same Time (subscription required), critically highlighting the tax advantages provided for donors to charitable remainder trusts.
An interesting recent example of how philanthropy favors the wealthy, including through tax benefits, is the Bloomberg News article Billionaire Donates $1.9 Billion to Art Museum Where He Lives (subscription required). The story notes the tax benefits that come with a donation along these lines, although often creating a legacy is more important to the donors.
Thursday, March 9, 2023
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.
Tuesday, January 31, 2023
I am glad student athletes can be paid for their game, but I swear, the whole NIL infection has pretty much ruined everything from a fan standpoint. Before NCAA v. Alston, when everybody made money except players, and players were locked into their team (economically, if not legally) like indentured servants or baseball players before free agency, you could watch a kid for at least three years. You kinda felt like you "knew" the kid and the team, and that feeling contributed to your rabid affinity for your team. But the market is amoral and doesn't care about your stinking feelings! So I guess we better get used to student athletes acting just like the head coaches who condemn NIL money have been acting for years. Go where the money is, forget team loyalty.
Anyway, here is an excerpt from an interesting Forbes article regarding NIL money being funneled through nonprofit organizations:
Across the country, groups known as collectives have sprung up to channel money to high school and transfer-willing superstars looking to finally get their cut of the multibillion-dollar enterprise that is college athletics. Some of the groups — at least five by Forbes’ count — do so as IRS-approved, tax-exempt organizations. Rather than stuffing paper bags with cash in the hopes of luring a can’t-miss prospect to campus, donors can make “charitable” gifts that, after a bit of transmogrification, are every bit as tax deductible as a check sent to St. Jude. Think of it. For decades, college football’s legions of followers have shown they’re not only willing to pay for game tickets and jerseys, they’ll fork over cash just for the remote possibility their team might beat State, or whomever their rival is, with no other return on investment expected.
That’s where non-profit collectives come into play. “The primary purpose for the tax-exempt collectives was to enable individuals to make tax-deductible charitable contributions,” Larry Mohr, a tax partner at Baker Tilly, told Forbes. “The key with the tax-exempt organizations is making sure they have a charitable mission.” Rather than raising money from the local car dealership or fireworks store, it’s coming from donors. But there’s a rub. For a collective to be a nonprofit, contributions can’t go directly to players.
The workaround involves a bit of theater. Donations to the nonprofit collective are said to be a gift to a charitable organization (which may or may not be directly affiliated with the collective itself). But rather than, you know, give the money to the charity to do its good deeds, the money is earmarked to pay players to, at least on paper, serve as fundraisers. The arrangement leads to a whole host of other questions. Unlike a business, charities can’t pay people whatever they feel like. To keep their tax-free privileges, charities must pay compensation considered “fair value.” And if players are essentially being paid to do charitable work, is it even charity? Stepping afoul of either guideline could put the player and the charity in jeopardy with the IRS.
“A commonly cited example of an appropriate payment is the payment of a ‘fair market value’ appearance fee at a fundraiser for a nonprofit organization,” attorneys Tom Molins and Ethan Sanders from Stinson LLP told Forbes in an email. “On the other hand, just paying a student-athlete a large sum to sign autographs may not be viewed as fulfilling a collective's charitable purpose. Similarly, paying student-athletes to donate their time working at a soup kitchen or homeless shelter probably will also not suffice. While those are clearly charitable endeavors, paying a student-athlete to do volunteer work is really not serving a public good that justifies payment.”
Something stinks, alright, but I think both points made in the article are incorrect and I sent a note to the author about it. Here is the email I sent:
I just finished reading your interesting article “Looking for A Tax Break? Buy Your Alma Mater Its Next Football Star.” A few important quibbles: (1) Actually, charities can indeed pay employees whatever they want. That is, charities can pay “going rate,” and they are allowed to use for-profit business to determine going rate. That’s why the head of Red Cross or some big nonprofit hospital can earn as much as the head of American Airlines or a for profit hospital. So if the going rate for celebrity endorsements – broadly defined – is $13 million, a charity hiring a college football or basketball player to endorse it can pay whatever for-profits would have to pay for the same endorsement from a pro football or basketball player. (2) People who work for charities – even just to appear at a “volunteer event” – are entitled to be paid the “going rate.”
Once these two issues are understood, the only real (and real big) issue in your article is whether the charitable collectives are operating for a “public” rather than “private” purpose. Clearly, there is a strong legitimate question whether these organizations deserve or qualify for tax exempt status. I don’t think the article makes this point strong enough though it does quote a practitioner who says “charitable mission is key.” And even that is a bit imprecise. A hospital, for example, that dispenses health care might be deemed charitable, but if it does not distribute its beneficial impact to a broad swath of people, without regard to ability to pay in some instances, it is operating for a private purpose (that of those who can pay) rather than a public purpose. It’s all right there in the easily accessible, fun to read (oh boy, oh boy!) tax regulations. The collectives are likely operating for private benefit and therefore not entitled to charitable tax exemption.
Besides, donors can get a trade or business expense deduction for the amount paid for NIL licenses, easy enough, and with a little creative or not so creative planning (form an LLC that does "something" business, and pay the kid to use his or her pic on a billboard or mailer!) I am not quite clear what benefits are derived from funneling the money through a nonprofit but there must be something there because according to the article, two senators -- a Democrat and a Republican -- have sponsored a bill that would deny the charitable contribution deduction for NIL payments. Here is how the bill was described in the Senators' press release:
“In this new NIL era, we want to ensure that the opportunities available for student athletes to benefit from their own name, image and likeness are protected,” said Senator Cardin. “We also have an obligation to protect taxpayer funds, which means that charitable deductions should be reserved for charitable activities. Purposefully blurring the line between private expenses and charitable contributions dilutes both these efforts.”
“College athletes have the ability to benefit from opportunities related to their own name, image, and likeness, but outside organizations and collectives should not be able to write contributions off their taxes that are used to compensate athletes,” said Senator Thune. “This common-sense legislation would prohibit these entities from inappropriately using NIL agreements to reduce their own tax obligations. These basic taxpayer guardrails would protect athletes, strengthen NIL, and uphold the responsible stewardship of taxpayer dollars.”
The bill proposes a new IRC 170(p). Here is the gist of it:
(p) CONTRIBUTIONS FOR CERTAIN PURPOSES RELATING TO COLLEGE ATHLETICS.—
‘(1) IN GENERAL.—No deduction shall be allowed for any contribution any portion of which is used by the donee to compensate 1 or more secondary or post-secondary school athletes for the use of their name, image, or likeness by reason of their status as athletes.
(2) EXCEPTION.—Paragraph (1) shall not apply to any contribution made directly to an organization which is an eligible educational institution (as defined in section 25A(f) (2)).’’
I suppose a nonprofit can be structured to work, as suggested in this interesting On3 NIL article on the topic:
Winter says there is a way collectives can operate within the 501(c)(3) world, especially if the groups are paying the student-athletes for work that is serving a charitable purpose. For example, Winter said paying a student-athlete fair-market value to make an appearance on behalf of the charity at a fundraiser would probably “pass muster.” “But if you’re just paying guys for serving soup, I don’t see how that necessarily aligns with the charitable mission of the collective,” Winter said. “How does that serve the public good by paying to do volunteer work?”
Sure it works, even if you pay a celebrity to serve soup. The celebrity is paid for the association of her name, image and likeness with the charity while serving soup. Not for serving soup! The celebrity endorsement need only be reasonably conducive to the accomplishment of the charitable purpose, it seems to me. A celebrity endorsement -- like a commercial or billboard featuring a college athlete asking for donations to Save the Children or Ronald McDonald House -- seems reasonably conducive. Maybe the issue is whether exempt organizations should even be paying for celebrity endorsements, particularly when the payment for the endorser is millions more than the cost of the soup. Ahh, yes, now we have the private benefit issue cornered. Read Judge Posner's opinion in United Cancer Council for an explanation of the private benefit issue when we suspect that the costs of charitable operations outweighs the charitable benefits derived by several multiples. Anyway, all of this gnashing of teeth makes me ask the question, why? What is the benefit derived from using a nonprofit?
Tuesday, January 24, 2023
Monday, January 23, 2023
Last week, House Democrats proposed a constitutional amendment (reprinted below) that would overrule Citizens United v. Federal Elections Commission. In other news, scientists have discovered the theoretical possibility that Hell might freeze over.
Wednesday, December 14, 2022
Does the Respect for Marriage Act create "clearly defined public policy" under Bob Jones University?
Bob Jones University stands for the proposition that every organization exempted under IRC 501(c)(3) must be charitable, in the legal sense, and that racial discrimination is not charitable. The Supreme Court found that racial discrimination violated a "clearly defined," "fundamental," "established," super duper, holy grail type public policy. But we all know that the holding is sui generis, resulting in no real precedential value outside of its factual context. The case has not been relied upon since to revoke or deny exemption. Still, there was enough concern that Congress specifically disclaimed the establishment of a fundamental public policy sufficient to deny tax exemption to religious organizations that refuse to recognize same-sex marriage or perform same-sex marriage ceremonies. Here is a brief PSA discussing (its a free video only if you agree to sit through a 30 second sales pitch -- and BTW, never accept free lodging or meals from a time-share company or you will sit through more than a 30 second commercial):
Tuesday, December 13, 2022
I can't believe how old and fatter I am getting. I was reminded of my age while reading a sports story about Deion Sanders' contract with Jackson State University. The contract is, of course, terminated because Coach Prime has moved up to big time college football, having recently accepted the Head Coaching gig at Colorado. What caught my attention was clause 4(g) of the Jackson State University Contract. I should note, first, that JSU is a 501(c)(3) charity according to Publication 78, Guidestar and Charity Navigator. This is an important preliminary fact because the excess benefit prohibition of IRC 4958 applies only to charities recognized under IRC 501(c)(3). There are many state universities that have not applied for 501(c)(3) recognition and thus are not subject to the excise tax for excess benefit transactions. State colleges and universities are generally exempt under the "intergovernmental tax immunity doctrine" and IRC 115 (gross income does not include income derived from the exercise of any essential governmental function and accruing to a state or political subdivision) and do not need to apply for exemption under 501(c)(3). Some public institutions nevertheless apply, typically to give potential big donors greater assurance that their donations will be deductible (though I hardly see that as necessary but some universities do so anyway just to avoid having to explain to big donors who want to see their beneficiary's name in Publication 78 before writing the check). Anyway, a public university that has applied and received IRC 501(c)(3) recognition, like JSU, becomes an "applicable" organization for purposes of IRC 4958. And while revocation of exempt status for an excess benefit transaction would change little (because the public institution would still be entitled to exemption under IRC 115 and intergovernmental immunity), being an applicable exempt organization subjects disqualified persons and managers to two tiered excise taxes. Thus, Coach Prime and the JSU officials could potentially be hit with excise taxes even if JSU's tax exempt status is safe. Why? Take a look at clause 4(g) of Prime's contract with JSU:
Eds Update: Rep. Pascrell on College Coaching Salaries; Grand Canyon University Not a Nonprofit (for DOE purposes)
I previously noted the interest of Representative Bill Pascrell (D-NJ) in salaries paid by colleges to sports coaches, as demonstrated by the letters he sent to several of them. He has now released an official House Ways and Means Committee Subcommittee on Oversight report on this topic, including both the text of his letter and the responses of the nine addressees. In releasing the report, he stated:
Universities’ tax-exempt status is an important pillar of our higher education system, but it is not a blank check from taxpayers to dole out gargantuan coaching contracts with lavish benefits. The committee should consider reforming the excise tax on salaries over one million to apply to all colleges and universities. This would close a loophole that may enable some state universities to avoid the tax. It is also worth exploring whether profitable, multimillion dollar college athletics programs should be subject to the Unrelated Business Income Tax. We must consider whether tax-exempt educational activities and lucrative athletics programs should be treated differently. Certainly we can see that American students and American taxpayers deserve better
The report also includes as an Appendix a four and a-half page memo from the Congressional Research Service providing "Information on the Tax-Exempt Status of Colleges and Universities and Sections 4960 and 4958 of the Internal Revenue Code." It is uncertain whether his yet-to-be-determined Republican successor as Oversight Subcommittee Chair will have any interest in this topic or the proposed reforms.
In other news, the U.S. District Court for the District of Arizona upheld the decision by the U.S. Department of Education refusing to recognize Grand Canyon University as a nonprofit. As posted previously, the Department decided the University, which had legally converted from for-profit to nonprofit status under state law and obtained tax exemption under section 501(c)(3), did not qualify as a nonprofit for purposes of Title IV funding. The basis for the decision is reported to be that the University has an agreement that continues to generate revenue for its former owner. (I have not been able to find a publicly available copy of the court's decision; if any reader identifies one, please let me know and I will add a link to it.)
Monday, December 12, 2022
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.
Tuesday, November 1, 2022
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.”
Friday, October 28, 2022
In light of the recent changes to the AGI limitations for charitable contributions, it is interesting to explore charitable giving in the S Corporation context. In 2019, a CPA Journal article noted that unique planning opportunities exist for charitably minded S corporation shareholders. For example, the rule that limits the pass-through deduction to the shareholder’s basis in S corporation stock and debt is not applicable when the S corporation donates appreciated property to a charity. Thus, even if a shareholder has a zero basis in his/her S corporation stock, appreciated property donated to a charity would pass through as a charitable contribution. In effect, the deduction becomes the portion limited by (and reducing) basis, plus the appreciation in the donated property. This interesting article addresses the incentives Congress has provided since 2006, which are still applicable under the TCJA.
Hoffman Fuller Associate Professor of Tax Law
Tulane Law School