Baylor Law SchoolBaylor Law SchoolNonprofit OrganizationsNonprofit Organizations

Spring 2005 CourseSpring 2005 CourseFederal Standard of Care; Charitable

Purpose; Social Welfare Organizations

Prepared By:

Darren B. MooreBourland, Wall & Wenzel,

A Professional Corporation

Attorneys and Counselors

City Center Tower II

301 Commerce Street, Suite 1500

Fort Worth, Texas 76102

(817) 877-1088

(817) 877-1636 (facsimile)

E-mail: dmoore@bwwlaw.com

©Bourland, Wall & Wenzel, P.C.

Federal Standard of Conduct

Self-Dealing

Excess Benefit Transactions

Private Foundation

• Per § 509(a): Organization described in § 501(c)(3) other than the following:– Traditional public charities– Publicly supported charities– Supporting organizations– Public safety testing organizations

(i.e. § 501(c)(3) is a private foundation if it fails to qualify as a public charity)

Public Charity

• Traditional charities (hospitals, churches, etc.)

• Publicly supported (aka gross receipts) charities (receive substantial amount of support from public or governmental agencies)

• Supporting Organizations (take status from supported organization)

Self-Dealing (PF)

• § 4941 – Any conflict of interest transaction between an insider (disqualified person) and the organization– Fairness to organization irrelevant– Awareness by person involved that the acts

constituted self-dealing irrelevant– Consequence is excise tax

Self-Dealing (Insiders)

1. Foundation Managers (officers, directors, trustees)

2. Substantial contributors (greater of 2% of total contributions for tax year or $5000)

3. 20% Owners (owner of 20%+ power of organization that is a substantial contributor)

4. Family Member of (1), (2) or (3) (spouses, ancestors, children, grandchildren, great grandchildren)

5. 35% owned entities (organizations more than 35% controlled by any of the above)

Self-Dealing Transactions

1. Sale, exchange or leasing of property (unless leased to PF free of rent)

2. Lending of $$ or extension of credit (unless lent to PF interest free)

3. Furnishing of goods, services or facilities (unless provided on same basis as to general public)

4. Payment of compensation or reimbursement of expenses that are not reasonable and necessary to accomplish an exempt purpose

5. Transfer to or use by or for the benefit of a DQP of any of the income or assets of PF

6. Certain agreements to pay a government official

Self-Dealing Consequences

• Two tier excise tax on DQP1. 5% of amount involved for each year (2.5%

on foundation manager participating unless unaware act was self-dealing and not willful)

- a DQP who is also a Foundation Manager can be subject to both

2. If not corrected in a timely manner, second-tier tax of 200% on DQP and 50% on foundation manager)

Self-Dealing Consequences

• “Amount involved”: the greater of the amount of money and the fair market value of the property given or the amount of money and fair market value of the other property received (§ 4941(e)(2))

• First tier tax cannot be abated by IRS even for reasonable cause (§ 4962(b))

Self-Dealing (Estate of Reis)

• Courts have consistently held that statutory scheme of excise taxes is a valid legislative response to perceived abuse in use of PF’s

• Interest of PF in property of an estate (as a beneficiary of the estate) is an asset of the PF for self-dealing purposes (prohibits indirect self-dealing)

• Benefit to the DQP doesn’t have to be pecuniary but must be significant as opposed to tenuous

Excess Benefit Transactions

• Applies intermediate sanctions (excise taxes) on DQP’s who benefit improperly and on organization managers who participate in such transaction

• Applies to public charities and social welfare organizations

• Overlaps concepts of private inurement discussed later in course

Excess Benefit Transactions

§ 4958(c)(1): Any transaction in which an economic benefit is provided by an applicable tax-exempt organization directly or indirectly to or for the use of any DQP if the value of the economic benefit provided exceeds the value of the consideration (including the performance of services) received for providing such benefit.

EBT: Disqualified Persons

1. Any person who was in a position to exercise substantial influence over the affairs of the TE organization at any time during a 5 year period ending on the date of the transaction

2. A family member of a person of substantial influence

3. An entity that is 35% controlled by (1) or (2)

**Beware: this is a different definition from PF DQP’s.**

Substantial Influence

• President, CEO, COO

• Treasurer, CFO

• Voting member of the governing body

• Persons with a material financial interest in a provider-sponsored organization (e.g. nonprofit hospitals)

Persons Deemed Not to Have Substantial Influence

• § 501(c)(3) organizations

• Certain § 501(c)(4) organizations

• Employees receiving economic benefits of less than a specified amount in a taxable year

Facts & Circumstances Tending to Show Substantial Influence

• Founder of organization• Substantial contributor• Compensation primarily based on revenues

derived from activities of the organization• Has or shares authority to control/determine

substantial portion of the organization’s capital expenditures

• Managerial authority or key advisor to person with managerial authority

• Has controlling interest in a corporation, partnership or trust that is a DQP

Facts and Circumstances Tending to Show No Substantial Influence

• Person is an independent contractor

• Person has taken a vow of poverty

• Preferential treatment offered to all making comparable donations

• Direct supervisor of the person is not a DQP

Excess Benefit Transaction Consequences

• Two tier excise tax on DQP

1. First tier tax of 25% of the excess benefit- can be abated under certain circumstances

2. If not corrected in a timely manner, second-tier tax of 200% of the excess benefit

• Organization manager who knowingly participates pays a tax of 10% of the excess benefit not to exceed $10,000 <can be subject to both if the organization manager receives the excess benefit>

Correcting an Excess Benefit Transaction

An excess benefit transaction is corrected by undoing the excess benefit to the extent possible, and taking any additional measures necessary to place the applicable tax-exempt organization involved in the excess benefit transaction in a financial position not worse than that in which it would be if the DQP had been dealing under the highest fiduciary standards. (Treas. Reg. § 53.4958-7(a))

Practical Correction

1. Return the “correction amount” (the excess benefit plus interest)

2. Return the specific property where excess benefit was transfer of property (organization must agree)

- DQP (and family members) cannot vote on whether to accept the property as correction

Caracci v. Commissioner

Ouch!!!Ouch!!!

Unreasonable Compensation as an Excess Benefit

• Compensation must be reasonable in relationship to the value of the services rendered – Compensation paid by similarly situated

organizations for comparable positions– Availability of similar services in geographic

area– Current compensation surveys by

independents firms– Written offers from competitors for the

employee

EBT: Compensation

• Organization must clearly indicate intent to treat the economic benefit as compensation when the benefit is paid– Written contemporaneous substantiation

• Employment contract• W-2, 1099, 990• DQP reports on 1040• Exception: amounts excluded from gross income

(e.g. employer-provided health benefits)

EBT Compensation: Rebuttable Presumption of Reasonableness

• Transaction approved by an authorized body of the organization composed of non-conflicted individuals

• Prior to making determination, authorized body obtained and relied upon appropriate comparability data

• Authorized body adequately documents basis for determination concurrently with making decision

Excess Benefit Transactions (Misc)

• Applies to churches (although IRS must still follow church audit act)

• Applies only to post-September-1995 transactions

• Does not replace revocation of exemption – Has organization been involved in repeated excess

benefit transactions?– Size and scope of excess benefit transaction– Safeguards implemented following transaction– Compliance with other applicable laws

Registered Nonprofit Organizations by IRC Subsection (National)(2003)

(c)(1)(c)(2)(c)(3)(c)(4)(c)(5)(c)(6)(c)(7)(c)(8)(c)(9)(c)(10)(c)(11)(c)(12)(c)(13)(c)(14)(c)(15)(c)(16)(c)(17)(c)(18)(c)(19)(c)(20)(c)(40)(c)(50)Other

Source: National Center for Charitable Statistics, Urban InstituteDoesn’t include most religious congregations.

Charitable Organizations § 501(c)(3)

• Why choose to be a 501(c)(3)?– Not required to pay income taxes– May elect not to pay federal unemployment

taxes– Ability to attract deductible contributions– State tax exemptions

§ 501(c)(3) Elements

1. Proper organizational structure

2. Organized exclusively for charitable purposes

3. Operated exclusively for charitable purposes

4. No part of net earnings inures to benefit of private individual

5. Not an action organization

6. <<case law>> - not violative of public policy

Entitlement to Tax Exemption

• Should the government subsidize certain activities?– If so, what types? All types?

• Should the government provide a double subsidy for charitable, religious, educational organizations?

• Should there be limits on an organization’s ability to qualify as charitable, religious, educational?– What should the standard be for each?– Who should determine if the standard is met?

Organizational/Operational Tests

Organizational• Look to enabling

documents• Must be organized

exclusively for charitable purpose(s)

• May be general or specific

Operational• Look at actual activities of

organization• Must be operated

exclusively for charitable purpose(s)

• May not engage in substantial activities that fail to further charitable purposes

• More often the basis for revocation

Charitable Purpose

• “Primary” purpose must be charitable (“exclusive” doesn’t mean “sole”)

• Charitable purposes:– Relief of poverty– Advancement of education & religion– Promotion of health– Governmental purpose– Social welfare

• BBB v. United States

Social Welfare Organizations

• “[c]ivic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare . . .”

• “exclusively” again means “primarily”

Social Welfare Organizations: Can qualify as exempt under § 501(c)(3) or (c)(4) with purposes to

further common good and benefit community

§ 501(c)(3)– Contributions are

deductible– Cannot be involved in

political campaigns– Cannot have a primary

purpose of lobbying

§ 501(c)(4)– Contributions not

deductible– Can have some

involvement in political campaigns (not a primary purpose)

– Can have as a primary purpose lobbying

Regan v. Taxation with Representation

Social Welfare Organizations

1. Commensurate with the “common good and general welfare” of the community

2. Doesn’t include activities that primarily constitute “carrying on business with the general public in a manner similar to organizations operated for profit”

3. Must benefit community as a whole rather than merely benefiting the organization’s membership or other select group of individuals or organizations

What is community???

Advocacy Groups

• Attempts to influence legislation

• May operate to inform public on controversial subjects even though advocating a particular viewpoint

Q: Why is this beneficial to the community?

• Cannot have as a primary purpose intervention on behalf of or in opposition to a candidate for public office.

Next Week

Federal Tax Exempt Status

Read pp. 196-265