Nonprofit Law Prof Blog

Hemel on The State-Charity Disparity Under the 2017 Tax Law

David Hemel (Chicago) has posted The State-Charity Disparity Under the 2017 Tax Law, Washington University Journal of Law and Policy (forthcoming). Here is the abstract:

Since December 2017, several states have enacted laws granting state tax credits for charitable contributions that go toward public education or public health. One purpose of these laws is to allow individuals to claim federal charitable contribution deductions for payments that simultaneously serve to reduce those individuals’ state tax liabilities and to support programs that state governments would otherwise fund. The strategy adopted by these states — if effective — would mitigate the impact of the $10,000 cap on individual state and local tax deductions imposed by the December 2017 tax law. The U.S. Treasury Department and the Internal Revenue Service (“IRS”) have proposed, but not yet finalized, regulations aimed at shutting down that strategy.

The ongoing debate regarding state charitable credit programs and the proposed Treasury regulations raise a number of interesting legal questions — some of which may be addressed at subsequent stages of the rulemaking process, others of which will likely be resolved by litigation. Rather than trying to answer any of those questions, this Essay — an edited transcript of remarks at the Washington University Journal of Law & Policy-Missouri Department of Revenue 2018 Symposium on State & Local Taxation — focuses instead on a separate, though related, question, a question that is implicated by the charitable credit debate but that will linger long after any litigation is resolved. That is: Why should federal tax law allow more favorable treatment to charitable contributions than to state and local tax payments? What are the essential differences between non-governmental charities and sub-national governments, or between contributions and tax payments, that justify this lack of parity?

Ultimately, this Essay concludes that there is little justification for allowing a virtually unlimited charitable contribution deduction while capping the deduction for SALT. That conclusion gives rise to a critique of the December 2017 tax law, but also to a critique of presidential candidate Hillary Clinton’s tax plan, which would have capped the rate at which state and local tax payments could be deducted without applying the same cap to charitable contributions. The Essay ends with reflections on the long-term implications of the state charitable credit programs for tax policy and politics.

Hat tip: TaxProf Blog

Lloyd Mayer

NBER Working Paper on Corporate Philanthropy and Strategic Advocacy

Marianne Bertrand (Booth School of Business, University of Chicago), Matilde Bombardini (Vancouver School of Economics, University of British Columbia), Raymond Fisman (Economics, Boston University), Bradley Hackinen (University of British Columbia), and Francesco Trebbi (University of British Columbia) have posted a National Bureau of Economic Research working paper titled Hall of Mirrors: Corporate Philanthropy and Strategic Advocacy. Here is the abstract:

Politicians and regulators rely on feedback from the public when setting policies. For-profit corporations and non-pro t entities are active in this process and are arguably expected to provide independent viewpoints. Policymakers (and the public at large), however, may be unaware of the financial ties between some firms and non-profits - ties that are legal and tax-exempt, but difficult to trace. We identify these ties using IRS forms submitted by the charitable arms of large U.S. corporations, which list all grants awarded to non-profits. We document three patterns in a comprehensive sample of public commentary made by firms and non-profits within U.S. federal rulemaking between 2003 and 2015. First, we show that, shortly after a firm donates to a non-profit, the grantee is more likely to comment on rules for which the firm has also provided a comment. Second, when a firm comments on a rule, the comments by non-profits that recently received grants from the firm's foundation are systematically closer in content similarity to the firm's own comments than to those submitted by other non-profits commenting on that rule. This content similarity does not result from similarly-worded comments that express divergent sentiment. Third, when a firm comments on a new rule, the discussion of the final rule is more similar to the firm's comments when the firm's recent grantees also comment on that rule. These patterns, taken together, suggest that corporations strategically deploy charitable grants to induce non-pro fit grantees to make comments that favor their benefactors, and that this translates into regulatory discussion that is closer to the firm's own comments.

Lloyd Mayer

Boris & Cordes on How the TCJA's New UBIT Provisions Will Affect Nonprofits

Elizabeth Boris and Joseph J. Cordes at the Urban Institute's Center on Nonprofits and Philanthropy have published How the TCJA's New UBIT Provisions Will Affect Nonprofits. Here is the abstract:

Changes in Unrelated Business Income Taxes (UBIT) mandated by the Tax Cuts and Jobs Act (TCJA) of 2017 will have significant costs for some nonprofit organizations. A survey of Independent Sector members and partner organizations in November 2018 reveals the costs and other implications of those changes.

Costs of New Transportation Benefits UBIT Taxes: Over 200 nonprofit organizations estimate it will cost them more than $2.1 million dollars in unrelated business income taxes (UBIT) on transportation fringe benefits they provide to employees, and for organizations that will report UBIT for the first time under that requirement, there will be estimated associated administrative expenses for filing IRS tax forms (Form 990T) of more than $200,000.

Costs of New Reporting Rules for UBIT: Required separate reporting of multiple revenue streams for purposes of UBIT is estimated to cost an additional $376,150 for affected organizations.

Lloyd Mayer

Identifying and Navigating Impermissible Private Benefit in Practice

John Tyler (Ewing Marion Kauffman Foundation), Hillary Bounds, and Edward Diener posted to SSRN an article published in the September/October 2018 edition of Taxation of Exempts entitled Identifying and Navigating Impermissible Private Benefit in Practice.  Here is the abstract:

Organizations and people from within the charitable sector are increasingly engaging in historically non-traditional activities and with other than 501(c)(3) organizations in their efforts to generate revenue and investment/donations and to more aggressively pursue their charitable mission objectives. Examples include ventures with or from other than charitable-oriented businesses and investors, combined public-private fund arrangements, pay-for-success, impact investing, opportunity zones, micro-lending for business, and other finance-oriented relationships. These efforts are changing the ways in which 501(c)(3) organizations must identify and manage against impermissible private benefit.

One aspect of many of these activities is intentional awareness that the brand and reputation of many 501(c)(3) organizations can have independent value on which others might want to trade, with or without providing commensurate value. Another area in which private benefit problems arise is within more garden-variety, day-to-day operations. Consider operation-oriented pursuits such as contracting for delivery of goods and services, which might require increased attention to the financial and non-monetary values of data collected and the tools used to collect, store, secure, and analyze that data. Finally, “new” philanthropists and social change actors are engaging in historically non-traditional activities by structuring these activities without regard to (or at least with much less regard for) the incentives of tax deductions and exemptions. 

All of these implicate and require thoughtful consideration of and management to protect against impermissible private benefit while still allowing for enthusiastic pursuit of mission objectives.

Nicholas Mirkay

 

Denying Tax-Exempt Status to Discriminatory Private Adoption Agencies

Allison M. Whelan (Covington & Burling, Washington D.C), Denying Tax-Exempt Status to Discriminatory Private Adoption Agencies, 8 UC Irvine L. Rev. 711 (2018):

This Article ... argues that the established public policy at issue here is the best interests of the child, which includes the importance of ensuring that children have safe, permanent homes. In light of this established public policy, which all three branches of the federal government have recognized and support, this Article ultimately argues that, consistent with the holding in Bob Jones, private adoption agencies that refuse to facilitate adoptions by same-sex parents, thereby narrowing the pool of qualified prospective parents and reducing the number of children who are adopted, act contrary to the established public policy of acting in the best interests of the child.

This Article proceeds in five Parts. Part I first provides general information about the child welfare system, adoption, private adoption agencies, and the “best interests of the child” standard. Part II describes the emergence of state laws that allow private agencies to refuse to facilitate adoption by same-sex couples. Part III provides an overview of federal income tax exemptions and then summarizes the Supreme Court’s decision in Bob Jones University v. United States. Part IV applies the analysis and holdings of Bob Jones to private adoption agencies that discriminate against same-sex couples, and ultimately argues that such policies are contrary to the established public policy of the best interests of the child. As a result, this Article argues that the IRS should conclude that these agencies do not qualify for exemption from federal income tax. Part V concludes by offering a potential compromise and additional policies the government should consider.

(Hat tip:  TaxProfBlog )

Nicholas Mirkay

Hemel posts "Tangled Up in Tax: The Nonprofit Sector and the Federal Tax System"

Daniel Hemel has posted "Tangled Up in Tax: The Nonprofit Sector and the Federal Tax System," to SSRN. From the abstract:

If the relationship between the federal tax system and the nonprofit sector is to be summed up in a single word, “entanglement” rather than “exemption” would be the appropriate term. Nonprofit organizations in the United States are caught in a complex web of nonprofit-specific tax provisions, and even seemingly unrelated tax statutes often tie back to the nonprofit sector in winding ways. This chapter seeks to understand how the federal tax laws lead to and limit the nonprofit sector’s entanglement with the public and for-profit sectors. It distinguishes among three types of entanglement—administrative entanglement, political entanglement, and market entanglement—and goes on to explain how society’s decisions to support the nonprofit sector through tax exemptions and tax deductions both respond to and result in entanglement of all three types. It then evaluates the specific strategies of entanglement management that the federal tax system employs. The chapter concludes with thoughts on the future of entanglement in light of the December 2017 tax law, which creates new sources of friction between the federal tax system and nonprofit organizations while at the same time withdrawing some of the tax system’s support for the nonprofit sector. 

 

Aprill Adds More Light to IRC 4960

Following up on my post regarding [Questionable] Strategies to Avoid IRC 4960.  Professor Ellen Aprill's excellent article earlier this year provides needed clarity:

New section 4960 imposes a 21% excise tax on certain organizations not subject to income tax, including organizations exempt under section 501(c)(3) and those for which income is excluded from taxation under section 115(1), if any of their five highest paid employees have annual compensation above $1 million. (It also imposes the tax on “excess parachute payments,” as defined in the statute.) In December, 2017, I wrote a blog post on “Medium: Whatever Source Derived,” arguing that, whatever the Congressional intent, the language of the statute did not reach states, their political subdivisions or integral parts of either.

In particular, the post contrasted the basis of income tax exemption for states and their political subdivision to entities that fall under section 115(1). Section 115(1) excludes from gross income “income derived from...the exercise of essential governmental function and accruing to a state or any political subdivision thereof.” This provision, however, is not the basis for exempting from income tax the income of states and their political subdivisions. The IRS has long exempted states and their political subdivisions from income tax under a doctrine of implied statutory immunity, not under section 115(1). For many decades, the IRS has interpreted section 115(1) not refer to states and their political subdivisions, but only to organizations that are organized separately from a state or political subdivision and meet certain other requirements. The blog post is reprinted here as Part I of this piece.

Professor Douglas Kahn of University of Michigan took issue with my position on the basis that the new section does apply to section 501(c)(3) organizations and that state universities are educational institutions. I responded to him in an article originally published in Tax Notes that constitutes Part II of this piece. It corrects an error in my earlier piece by acknowledging that some state universities have indeed received recognition under section 501(c)(3) from the IRS. Not all, however, have done so. Thus, I assert again my position that new section 4960 does not by its terms apply to entities free of income tax by virtue of their status as a state, political subdivision, or an integral part of either. Moreover, as the piece explains, those state universities that have received a section 501(c)(3) determination can, if they choose, relinquish their section 501(c)(3) status. The piece discusses the various options available to tax authorities and public universities confronting this new excise tax.

Since publication of these pieces, Treasury and the Joint Committee of Taxation have acknowledged that a technical correction is need in order for section 4960 to apply to all governmental entities, as Congress intended. Technical corrections, however, are not anticipated any time soon. Even though not all public universities and other governmental entities are subject to the strictures of section 4960, guidance could specify that its excise tax applies to those that have sought section 501(c)(3) status. On the other hand, until there is a technical correction, out of considerations of federal-state comity and to avoid differential treatment of various state universities and other governmental entities, Treasury and the IRS could decide that such governmental entities with 501(c)(3) status are to be treated as exempt from this excise tax, on the model of the special treatment they currently receive in being exempt from the Form 990 filing requirement and from the intermediate sanctions excise tax regime. I do not envy Treasury and the IRS in having to make this difficult choice.

I think state universities still have a problem because most of their football coaches' compensation is typically paid not by the University itself, but through related foundations that are exempt under 501(c)(3).   See  https://www.wsj.com/articles/SB122853304793584959.  

dkj

Pomeroy, On Job's Defense (and the Duty of Charity, not Business, by Houses of Worship)

Chad J. Pomeroy has just published "Let My Arm Be Broken Off at the Elbow" (Job 31:22) in the Oklahoma Law Review.  Here is the introduction (sans footnotes):

 

The largest producer of nuts in the United States. A multi-billion dollar insurance and financial services company. The fourteenth largest radio chain in the country. “A catering company, a major television channel, an internet marketing company.” And real estate! Enormous real estate holdings in Hawaii, Montana, Nebraska, Oklahoma, Texas, Washington, and Wyoming. Probably more land in both Utah and Florida than any other private actor. Internationally, there are major investments in Argentina, Australia, Brazil, Canada, and Mexico, and about as much land in Britain as the Crown Estate.  Take these assets, add billions in stocks and bonds and other securities, and include another $6-$8 billion per year of donated funds. To most of us, such a collection of assets and income probably seems appropriate for a large, public corporation.

However, as the preceding footnotes make clear, the entity described is not a titan of industry but is instead a church. And that is the starting point for this Article: though the American legal system is deferential toward religion and churches, it is undeniable that the Church of Latter-day Saints--and other like organizations--are not just churches. They are, instead, important participants in the market economy, some of them global business enterprises of major proportions. This twinning of profit and spirit is seamless for many religions, with numerous modern churches preaching a “prosperity gospel” that promises spiritual and temporal blessings in return for donations. Still other churches--such as the Church of Scientology--directly charge for religious services that are “necessary” for spiritual improvement and advancement in the church hierarchy. And still others accumulate their own reserves of property and wealth. This asset assemblage leads, ineluctably, to enormous income and wealth concentrated in the hands of religious organizations across America.

While there is nothing inherently wrong with religious organizations amassing wealth, it is troubling that they do so while enjoying informational and tax advantages not afforded to other entities. However, these benefits are not “tax advantages”; these are “tax advantages that are expressly made unavailable to other, competing, profit-seeking entities that suffer greatly due to their comparative disadvantage.” Indeed, this Article’s foundational claim is these advantages are so significant that they have come to shape the aims and actions of many religions, effectively bending the nature of many organizations away from traditionally religious and charitable work and toward profit-seeking. This state is both unintended and inequitable. As such, these advantages should be eliminated.

Before describing any recommended changes to these tax benefits, it is critical to first understand how the American tax system treats churches. As explained in Part I, our legal and tax system is laced with a series of benefits and exemptions that favor churches over virtually every other kind of entity. These benefits permit churches to bring in funds under the auspices of a non-profit entity and then direct those funds to for-profit endeavors. Indeed, not only are churches permitted to do this, they are incentivized to do so. Because these organizations are uniquely permitted to build up networks of interlocking entities of non-profit and for-profit subsidiaries and freely funnel funds from one to the other, churches are effectively permitted to own profit-seeking entities that have an intrinsically lower cost of capital than their competitors. This system ensures that church-affiliated companies will always enjoy a superior market position. In the face of such economic opportunity, how could any entity not do what these churches have done? It is difficult to blame churches for taking advantage of a U.S. system of religious tax exemption that effectively guarantees them preferential returns on church-sourced funds when those funds are directed to profit-seeking instead of charity.

Blameworthy or not, this tax structure is problematic. Such a market-oriented incentive discourages churches from expending funds in pursuit of charitable goals. The American economy is a capitalistic one, rewarding capital, among other things. Permitting churches, with their lower cost of capital, to access markets that reward capital means that every dollar devoted to the needy is not being devoted to its highest and best use--from an internal rate-of-return perspective. That, of course, will lead to “under-spending” on charity, which is deleterious to the public policy underlying the relevant sections of the Internal Revenue Code.

The United States was clear in its reasoning when it made the decision that churches should enjoy special tax status: the government explicitly decided to forego the substantial tax revenues associated with funds raised and expended by churches because it believed that these entities--of all entities--would use those funds to do the “good works” that would otherwise be the responsibility of government. Taxing a church on funds that it could use to set up an orphanage makes no sense, for example, if such taxation would force the church to abandon its plans for the orphanage and leave the government to ultimately clean up the remains itself. Indeed, the U.S. government--through Congress, the judiciary, and the IRS--has been extraordinarily generous in its treatment of churches in connection with tax law, both in terms of how it has interpreted and applied tax laws and rules to churches and in terms of how much tax money the government has foregone. But that attempt to generate private party charity is defeated, at great expense to the American taxpayer, when churches invest instead of help.

Even more troubling than the undercutting of U.S. tax policy is when churches use their tax exempt funds to engage in massive business operations instead of directing funds toward charity. This does actual damage to the broader market economy. As discussed in Part II below, when non-taxed organizations compete against ordinary business entities in the market, they operate under different economic constraints and disrupt the normal functioning of capital supply and demand, fundamentally distorting the market place. By tapping into untaxed capital, these non-taxed businesses put downward pressure on the rates of return that would otherwise be available in an equally constructed market place, which burdens other economic actors. Accordingly, it is not simply that charitable entities undermine the intent of the IRC when they engage in profit-seeking activities--it is that by doing so, they distort the economy and introduce inherent market inefficiencies.

Part III makes recommendations intended to resolve this problem as it manifests itself in the context of churches. These suggestions largely revolve around increased transparency and the potential imposition of a tax on funds that are not spent on charitable endeavors. Laying bare the finances of these organizations will enable all stakeholders in charitable giving-- including, importantly, U.S. taxpayers--to see how their investments are being spent. Furthermore, taxing non-charitable funds would ensure that our tax system functions the way it is intended--without favor or distortion.

dkj

Delany and Steckel on the Private Benefit Doctrine and Pay for Success Programs

Sean Delany and Jeremy Steckel have published "Balancing Public and Private Interests In Pay for Success Programs:  Should we Care About the Private Benefit Doctrine?" in the New York University Journal of Law & Business.  Here is the abstract:

In the rapidly expanding world of social impact finance, “pay for success” or “PFS” programs are increasingly popular vehicles for attracting private resources to address historically intractable social problems. Also known as “social impact bonds,” these programs are designed to encourage private investors to advance capital to fund social services and receive a return from the government only if predetermined “success metrics” for the target populations are met. As well as private investors and government agencies, participants include social service providers, technical advisors, and other entities that have been recognized as tax-exempt under section 501(c)(3) of the Internal Revenue Code.  This Article is an effort to understand how the private benefit doctrine might affect the structures of PFS programs in the United States, and might limit or encourage their expansion in the future. The doctrine prohibits charitable entities from being operated more than incidentally for the benefit of private interests. The boundaries that tax-exempt organizations must observe when engaging with profit-making entities—whether through transactional relationships or joint ventures—to achieve their charitable missions are far from clear, because the private benefit doctrine has evolved in piecemeal fashion without a coherent conceptual framework. As PFS programs evolve and relationships between participating exempt organizations and profit-making investors are designed, how will the exempt organizations ensure they are not violating the private benefit doctrine? Despite the inconsistent jurisprudence surrounding the private benefit doctrine, applying it to PFS programs demonstrates that it protects against valid concerns not addressed elsewhere in the Code, and offers a cost-benefit framework which we use to draw conclusions about the desirability of funding social services through PFS programs.

dkj

 

Prentice, "Misreporting Nonprofit Lobbying Engagement and Expenses: Charitable Regulation and Managerial Discretion"

 

ARNOVA's (Association for Research on Nonprofits and Voluntary Action) Nonprofit Policy Forum (Volume 9 (2018) (I think your law library has to have an electronic subscription) has an interesting article by Christopher Prentice on how nonprofits [mis]report lobbying activities and expenses.  Here is the abstract:

Abstract:

On the one hand, nonprofits are expected to protect values, promote ideals, and effect change, and on the other hand, they are normatively and legally discouraged from engaging in advocacy and lobbying. These countervailing forces produce a tension that nonprofit managers must navigate. Although previous research suggests that normative boundaries and legal implications constrain lobbying efforts, it is possible that these factors merely influence how some charities report their lobbying activities to authorities. Indeed, incentives to misreport lobbying engagement exist at the federal level where regulatory oversight is lax. This article compares state data obtained for a sample of charities to contemporaneous federal data regarding the lobbying engagement, payments, and expenses of these organizations and their registered lobbyists. Findings demonstrate that roughly half of the charities sampled engage in more lobbying than they report to federal authorities, lending support to the premise that managerial discretion influences nonprofit reporting. 

Other articles in Volume 9 include:

• Barbetta, Canino, Cima and Verracchia, Entry and Exit of Nonprofit Organizations  [in Italy]
• Andersson, Necessity Nonprofit Entrepreneurship:  A Study of Extrinsically Motivated Nascent Nonprofit Entrepreneurs
• Bryan and Isett, Philanthropic Foundation Strategies to Advance Systems Reform:  Perceptions from Frontline Change Implementers

ARNOVA also has a page containing forthcoming articles.  The most recent forthcoming issue contains several articles regarding nonprofit health care.  I recommend the website for anyone writing or thinking about how tax policy impacts nonprofits. 

dkj 

Tax Policy Center Brief on Reforming Charitable Tax Incentives: Assessing Evidence and Policy Options

Joseph Rosenberg and  C. Eugene Steuerle of the Tax Policy Center published Reforming Charitable Tax Incentives: Assessing Evidence and Policy Options.  Below is the brief's abstract:

The federal tax treatment of charitable giving and the nonprofit sector is at an inflection point. Following enactment of the Tax Cuts and Jobs Act in 2017, the number of taxpayers who will claim a charitable deduction will decline substantially. What does that mean for charitable giving and the nonprofit sector? What principles should guide tax policies affecting the nonprofit sector, and what are the policy options going forward? This brief summarizes these and other questions discussed at a recent roundtable—comprised of national experts on the issues of tax policy and charitable giving, including researchers, academics, government administrators, and charitable organizations—cohosted by the Tax Policy Center and Independent Sector.

-- TLH

 

Toussaint Publishes The New Gospel of Wealth: On Social Impact Bonds and the Privatization of Public Good

Professor Etienne C. Toussaint (UDC David A. Clarke School of Law) published The New Gospel of Wealth: On Social Impact Bonds and the Privatization of Public Good, 56 Hous. L. Rev. 153 (2018).  Below is the article's abstract:

Since Andrew Carnegie penned his famous Gospel of Wealth in 1889, corporate philanthropists have championed considerable public good around the world, investing in a wide range of social programs addressing a diversity of public issues, from poverty to healthcare to criminal justice. Nevertheless, the problem of “the Rich and the Poor,” as termed by Andrew Carnegie in his famous essay, remains unsolved. Socially conscious investors have recently called for America to reimagine a new “gospel of wealth”, one that not only grapples with the what of social injustice, but also explores the how and the why of systemic social and economic inequality. An emerging social finance tool, the social impact bond (“SIB”), has been praised as a promising platform that can help solve many of our social challenges by targeting impact investments toward traditionally underfunded social welfare programs.

This Article sets forth a critical examination of the new SIB model, highlighting some of the opportunities for the social finance tool to promote social impact, while also revealing several of its challenges that may hinder its broader adoption in communities across America. In the process, this Article exposes key flaws inherent in the design of the SIB model, including its neoliberal emphasis on market-based economic development strategies and its disregard for the primary role of government in the protection and advancement of the public good. It concludes by calling for a more progressive economic development framework to guide the implementation of the SIB model, one that can help development practitioners, philanthropists, and impact investors wrestle with the deficiencies of our global capitalist economic system and overcome the entrenched systemic barriers to economic justice in America.

-- TLH

Riley: Catholic Dioceses in Bankruptcy

Marie T. Reilly (Penn State) has posted Catholic Dioceses in Bankruptcy on SSRN. Here is the abstract:

The Catholic Church is coping with mass tort liability for sexual abuse of children by priests. Since 2004, eighteen Catholic organizations have filed for relief in bankruptcy. Fifteen debtors emerged from bankruptcy after settling with sexual abuse claimants and insurers. During settlement negotiations, sexual abuse claimants and debtors clashed over the extent of the debtors’ property and ability to pay claims. Although such disputes are common in chapter 11 plan negotiations, the Catholic cases required the parties and bankruptcy courts to account for unique religious attributes of Catholic debtors. This article reviews the arguments and outcomes on property issues based on reported decisions, pleadings, plans, and disclosure statements. It explains the key characteristics of Catholic dioceses under canon and secular organization law and the bankruptcy contexts in which these characteristics became hot button issues. It offers an analysis of the legacy of the Catholic cases for bankruptcy law, religious liberty, and for the relationships among entities within a Catholic diocese.

Lloyd Mayer

Grewal: The Proposed SALT Regulations May Be Doomed

As discussed in a previous post, the Treasury and IRS issued proposed regulations to address the attempts by states to create a way for their residents to get around the recently enacted cap on the state and local tax (SALT) deductions by facilitating charitable contributions that would qualify the donors for state tax credits. The proposed regulations would treat the state tax credits as return benefits, thereby requiring a reduction in any otherwise available charitable contribution deduction.  Andy Grewal (Iowa), who has been at the center of this debate, has published another article on this topic in the Iowa Law Review Online (103 Iowa Law Review Online 75 (2018)) entitled The Proposed SALT Regulations May Be Doomed.  Here is a description of the article:

The IRS recently followed through on its promise to address state strategies designed to avoid the new state & local tax deduction limits. Although programs adopted by blue states sparked the IRS’s interest, the proposed regulations address both blue and red state programs. This has, predictably, led to IRS criticism from all sides. But the IRS was right to step in here. Revenue and policy concerns easily justify administrative guidance on the state strategies.

Unfortunately, the proposed regulations suffer from some significant technical and conceptual flaws. Those flaws, if left unaddressed, may jeopardize the validity of any final regulations, especially as they apply to red state programs. This essay discusses the flaws in the proposed regulations and offers recommendations for improvement.

 

NMirkay

Local Regulation of Charitable Solicitation in the US's Largest Cities

Following up on yesterday's post on local land use controls of nonprofits, I want to briefly share some findings from a forthcoming article on local regulation of charitable solicitation. As you probably know, states often nonprofits that solicit donations from residents of their state to register with the state. Many cities have similar requirements -- in fact, cities were often the first to act in the regulation of charitable solicitation. And yet, we almost never hear about (or study) local requirements (outside of, perhaps, laws about panhandling and begging), so I was curious how common they were. Turns out, they're pretty common.

I looked at the laws of the largest 50 cities in the United States by population. Every single one of them had a law that specifically targeted charitable solicitation in some way.  Most cities had sidewalk solicitation ordinances, designed to deter panhandlers, which have been subject to numerous constitutional challenges in recent years. Several cities also had severe restrictions about roadside solicitation, allowing it only a few days a year, and requiring costly insurance and CPR training. About a quarter of the cities had restrictions about the location and maintenance of donation bins. 

Most interesting, at least to me, are the cities that broadly require registration of any nonprofit soliciting in the city by any means, including phone, mail, email, internet, television, radio, etc. (See the table, but note Houston's ordinance only applies to telephone and face to face solicitation.) Additional cities (not listed) had special registration requirements for public solicitation, paid solicitors, or other particular situations. Some of the registration requirements are specific, demanding information about social security numbers of all solicitors, requiring that the registration be completed at least 10, 15, or 30 days prior to the onset of any solicitation, or, in the case of Oakland, California, a pretty clearly unconstitutional requirement that no more than 16% of direct gifts will be used on costs. 

Although many of these rules appear to be holdovers form an earlier era, they remain on the books and cities continue to update them (and process the registrations required). In fact, 3 of the cities with these registration requirements revisited them last year, made minor adjustments, but chose to leave them in full force. While I doubt many organizations face any serious legal jeopardy for overlooking these local laws -- and they are regularly overlooked! -- their existence adds an additional cost to nonprofits attempting to follow all of the laws that might apply to their solicitation campaigns.

-Joseph Mead

Charitable Contributions, State Tax Credits, and Return Benefits: IRS Proposed Regs, IRS Announcement, and Much Commentary

The Treasury and IRS proposed regulations to address the attempts by states to create a way for their residents to get around the cap on the state and local tax (SALT) deductions by facilitating charitable contributions that would qualify the donors for state tax credits. The proposed regulations would treat the state tax credits as return benefits, thereby requiring a reduction in any otherwise available charitable contribution deduction. The proposed regaultions raise a range of issues, including:

• whether this approach should apply more broadly to all third-party-provide benefits not just state tax credits (see comments of Lawrence Zelenak (Duke); hat tip: TaxProf Blog);

• whether a substance-over-form approach would have been better (see a pre-proposed regs article by Joseph Bankman (UCLA) and Darien Shanske (UC Davis); Zelenak also flagged this issue);

• how to treat the state tax credits if they are later sold or expire (see comments by Andy Grewal (Iowa));

• administrative concerns (see a pre-proposed regs article by David Gamage (Indiana University)),  which are partially addressed by a de minimis exception for both state tax credits of up to 15% and state tax deductions resulting from charitable contributions; and

• political issues, in that the proposed regulations do not differentiate the recent SALT cap workaround efforts from the 100 or more pre-tax legislation state programs that provided state tax credits in exchange for contributions to certain types of charities (see a pre-proposed regs State Tax Notes article (subscription required) by eight tax academics that includes an appendix listing those existing programs).

Earlier articles raising these and other issues include: Joseph Bankman et al., Caveat IRS: Problems with Abandoning the Full Deduction Rule, State Tax Notes (2018); Roger Colinvaux (Catholic), Failed Charity: Taking State Tax Benefits Into Account for Purposes of the Charitable Deduction, 66 Buffalo Law Review 779 (2018); and Andy Grewal, The Charitable Contribution Strategy: An Ineffective Salt Substitute, Virginia Tax Review (2018).

An added wrinkle is that shortly after the issuance of the proposed regulations the IRS issued an announcement stating that "[b]usiness taxpayers who make business-related payments to charities or government entities for which the taxpayers receive state or local tax credits can generally deduct the payments as business expenses." While meant as a clarification, this announcement may not in fact have clarified very much or may indeed have created a significant loophole, as Andy Grewal has noted.

Lloyd Mayer

 

More About 501(c)(4)s Than You Ever Wanted to Know

Last fall the NYU Law School's National Center on Philanthropy and the Law focused its annual conference on section 501(c)(4) social welfare organizations. The conference papers will be published in the NYU Journal of Legislation & Public Policy, but for those who can't wait the following papers are now available on SSRN (in the order they were presented at the conference):

Ellen P. Aprill, Examining the Landscape of Section 501(c)(4) Social Welfare Organizations

David S. Miller, Advice for Jeff Bezos: Social Welfare Organizations as Grantmakers

Lloyd Hitoshi Mayer, A (Partial) Defense of Section 501(c)(4)'s "Catchall" Nature

Roger Colinvaux, Social Welfare and Political Organizations: Ending the Plague of Inconsistency

For those particularly interested in the use of 501(c)(4)s as part of a group of affiliated organizations engaged in advocacy and other political activity, the Alliance for Justice has recently released the 4th edition of The Connection: Strategies for Creating and Operating 501(c)(3)s, 501(c)(4)s, and Political Organizations (written by B. Holly Schadler).

Lloyd Mayer

SALT Workarounds and Return Benefits for Charitable Contributions

The much discussed attempts by high-tax states to find a way for their residents to continue to contribute to state and local coffers without running smack into the new $10,000 limit on deducting state and local taxes (SALT) raises an important issue relating to the charitable contribution deduction - when, if ever, is a SALT reduction a return benefit that reduces or eliminates the deduction for the "charitable" contribution that triggered the SALT reduction? While the Treasury Department has expressed its disapproval of such workarounds, its task is complicated by the fact that there were more than a 100 state charitable tax credit provisions in place across 33 states before the recent federal tax legislation.

For the arguments in favor of permitting the charitable contribution deduction under these circumstances (and a list of the previously existing state charitable tax credits), see Joseph Bankman et al., State Responses to Federal Tax Reform: Charitable Tax Credits, published in Tax Notes, April 30, 2018. Here is the abstract:

This paper summarizes the current federal income tax treatment of charitable contributions where the gift entitles the donor to a state tax credit. Such credits are very common and are used by the states to encourage private donations to a wide range of activities, including natural resource preservation through conservation easements, private school tuition scholarship programs, financial aid for college-bound children from low-income households, shelters for victims of domestic violence, and numerous other state-supported programs. Under these programs, taxpayers receive tax credits for donations to governments, government-created funds, and nonprofits.

A central federal income tax question raised by these donations is whether the donor must reduce the amount of the charitable contribution deduction claimed on her federal income tax return by the value of state tax benefits generated by the gift. Under current law, expressed through both court opinions and rulings from the Internal Revenue Service, the amount of the donor’s charitable contribution deduction is not reduced by the value of state tax benefits. The effect of this "Full Deduction Rule" is that a taxpayer can reduce her state tax liability by making a charitable contribution that is deductible on her federal income tax return. 

In a tax system where both charitable contributions and state/local taxes are deductible, the ability to reduce state tax liabilities via charitable contributions confers no particular federal tax advantage. However, in a tax system where charitable contributions are deductible but state/local taxes are not, it may be possible for states to provide their residents a means of preserving the effects of a state/local tax deduction, at least in part, by granting a charitable tax credit for federally deductible gifts, including gifts to the state or one of its political subdivisions. In light of recent federal legislation further limiting the deductibility of state and local taxes, states may expand their use of charitable tax credits in this manner, focusing new attention on the legal underpinnings of the Full Deduction Rule. 

The Full Deduction Rule has been applied to credits that completely offset the pre-tax cost of the contribution. In most cases, however, the state credits offset less than 100% of the cost. We believe that, at least in this latter and more typical set of cases, the Full Deduction Rule represents a correct and long-standing trans-substantive principle of federal tax law. According to judicial and administrative pronouncements issued over several decades, nonrefundable state tax credits are treated as a reduction or potential reduction of the credit recipient’s state tax liability rather than as a receipt of money, property, contribution to capital, or other item of gross income. The Full Deduction Rule is also supported by a host of policy considerations, including federal respect for state initiatives and allocation of tax liabilities, and near-insuperable administrative burdens posed by alternative rules.

It is possible to devise alternatives to the Full Deduction Rule that would require donors to reduce the amount of their charitable contribution deductions by some or all of the federal, state, or local tax benefits generated by making a gift. Whether those alternatives could be accomplished administratively or would require legislation depends on the details of any such proposal. We believe that Congress is best situated to balance the many competing interests that changes to current law would necessarily implicate. We also caution Congress that a legislative override of the Full Deduction Rule would raise significant administrability concerns and would implicate important federalism values. Congress should tread carefully if it seeks to alter the Full Deduction Rule by statute.

For a contrary view, see Roger Colinvaux, Failed Charity, Taking State Tax Benefits into Account for Purposes of the Charitable Deduction, Buffalo Law Review (forthcoming). Here is the abstract:

The Tax Cuts and Jobs Act (TCJA) substantially limited the ability of individuals to deduct state and local taxes (SALT) on their federal income tax returns. Some states are advancing schemes (CILOTs) to allow taxpayers a state tax credit for contributions to a 501(c)(3) organization controlled by the state. The issue is whether CILOTs are deductible as charitable contributions on federal returns. Under a general rule of prior law – the full deduction rule – state tax benefits were ignored for purposes of the charitable deduction. If the full deduction rule is applied to CILOTs, then the SALT limitation can successfully be avoided. This article explains that after the TCJA, state tax benefits are more valuable and it no longer makes sense to ignore them for purposes of determining whether a taxpayer has made a charitable contribution. To allow a charitable deduction for payments that make a taxpayer better off would undermine a fundamental purpose of the charitable deduction: that it is meant to encourage personal sacrifice, not tax avoidance. Thus, CILOTs likely fail as charitable contributions. Further, by changing the economics of state tax benefits, Congress inadvertently has called into question the deductibility of a variety of other payments that trigger state tax benefits and that previously have been deducted as charitable contributions. 

Lloyd Mayer

College and University Endowments in an Investment Income Tax World

The recently enacted federal excise tax on private college and university endowments may not be the last congressional word relating to such endowments. Research relating to such endowments, including a recent Congressional Research Service report and a recent report out of the Federal Reserve Bank of Cleveland therefore may have important policy implications.

The CRS report is titled College and University Endowments: Overview and Tax Policy Options. Here is the Summary:

Colleges and universities maintain endowments to directly support their activities as institutions of higher education. Endowments are typically investment funds, but may also consist of cash or property. Current tax law benefits endowments and the accumulation of endowment assets. Generally, endowment fund earnings are exempt from federal income tax. The 2017 tax revision (P.L. 115-97), however, imposes a new 1.4% excise tax on the net investment earnings of certain college and university endowments. Taxpayers making contributions to college and university endowment funds may be able to deduct the value of their contribution from income subject to tax. The purpose of this report is to provide background information on college and university endowments, and discuss various options for changing their tax treatment.

This report uses data from the U.S. Department of Education, the National Association of College and University Business Officers (NACUBO) and Commonfund Institute, and the Internal Revenue Service to provide background information on college and university endowments. Key statistics, as discussed further within, include the following:

 In 2017, college and university endowment assets were $566.8 billion. Endowment assets have been growing, in real terms, since 2009. Endowment asset values fell during the 2007-2008 financial crisis, and took several years to fully recover.

 Endowment assets are concentrated, with 12% of institutions holding 75% of all endowment assets in 2017. Institutions with the largest endowments (Yale, Princeton, Harvard, and Stanford) each hold more than 4% of total endowment assets.

 The average spending (payout) rate from endowments in 2017 was 4.4%. Between 1998 and 2017, average payout rates have fluctuated between 4.2% and 5.1%. In recent years, institutions with larger endowments have tended to have higher payout rates.

 In 2017, endowment assets earned a rate of return of 12.2%, on average. Larger institutions tended to earn higher returns. Larger institutions also tended to have a larger share of assets invested in alternative strategies, including hedge funds and private equity.

Changing the tax treatment of college and university endowments could be used to further various policy objectives. Current-law tax treatment could be modified to increase federal revenues. The tax treatment of college and university endowments could also be changed to encourage additional spending from endowments on specific purposes (tuition assistance, for example).

Policy options discussed in this report include (1) a payout requirement, possibly similar to that imposed on private foundations, requiring a certain percentage of funds be paid out annually in support of charitable activities; (2) modifying the excise tax on endowment investment earnings; (3) a limitation on the charitable deduction for certain gifts to endowments; and (4) a change to the tax treatment of certain debt-financed investments in strategies often employed by endowments.

The Federal Reserve Bank report is authored by one the Bank's Senior Research Economists and titled simply College Endowments. Here are the first three paragraphs (footnotes omitted):

The Tax Cuts and Jobs Act (Public Law 115-97) was signed into law by President Trump on December 22, 2017. Among the law’s numerous provisions is a new 1.4 percent tax on the investment income of private colleges and universities enrolling at least 500 students and with assets of at least $500,000 per student.

Opinions on this “endowment tax” vary. Some commentators argue that it makes it more difficult for colleges and universities to fulfill their educational missions, while others feel that it rightly incentivizes them to spend endowment funds on beneficial research and teaching rather than receiving tax advantages to invest their endowments in risky assets.

No matter what the case may be, now is an opportune time to take a deeper look at college endowments. What are endowments, and what is their purpose? How have the values of endowments at US colleges fluctuated over time, and what is their distribution currently? How many colleges will be affected by the new law? I consider these questions using data on college endowments from the National Center for Education Statistics’ Integrated Postsecondary Education Data System.

Lloyd Mayer

Charitable Giving Trends and Federal Tax Law

Two important recent reports provide information regarding trends in charitable giving, the annual Giving USA report and a report from the American Enterprise Institute on the likely effects of the recent federal tax legislation on charitable giving.

The Giving USA 2018 report shows continued growth in charitable giving, by 5.2 percent (3.0 percent adjusted for inflation) over 2016 to an estimated $410.02 billion in 2017. Individuals continue to provide most of the giving (70 percent), although foundation giving has increased by an annualized average of 7.6 percent over the past five years. Religious organizations continue to receive the largest proportion (31 percent) of giving among types of charities. These numbers mask at least two interesting trends, however. One is the well-known growth in donor-advised funds (see, e.g., this Atlantic article and this ThinkAdvisor article, both gathering data about such growth). The other is a decline in the number of donors, even as the total amount of donations has increased, as documented in data collected by the Indiana University's Lilly School of Philanthropy showing that from 2000 to 2014 the share of Americans donating dropped from 66.2 percent to 55.5 percent. See Chronicle of Philanthropy article.

The Giving USA report almost certainly does not reflect much impact from the recent federal tax legislation, given its passage in December 2017, but the AEI report fills that gap by trying to predict how the legislation as enacted will affect charitable giving. It concludes that the tax law changes will reduce charitable giving by 4.0 percent or $17.2 billion in 2018 under a static model and by $16.3 billion if the changes also provide a modest boost to growth. Four-fifths of this effect is driven by the increased number of taxpayers who will claim the enhanced standard deduction and so will no longer benefit from the itemized charitable contribution deduction.

Lloyd Mayer