The IRS recently issued Technical Advice Memorandum 200435020 in connection with the proposed application of the intermediate sanctions. Any guidance issued by the IRS under Section 4958 should be of interest given the current lack of precedents applying 4958 to actual facts....
| The Desktop Guide is Quickly Becoming the Must Have Guide for Nonprofit Executives Jack Siegel's new book, A Desktop Guide for Nonprofit Directors, Officers, and Advisors: Avoiding Trouble While Doing Good, has quickly become the go to guide for nonprofit executives and advisors. So what are people saying about the Guide? When our Jack Siegel introduced himself to one of the leading authorities on the law of federal tax exemption after she had made a presentation at a recent conference, the speaker said, "You're the 'Jack' in the Guide! We are fighting over your Guide in our office." A second speaker held the book up to two people who were asking questions after her presentation, exclaiming "I love this book. I tell everyone at conferences to buy it." One state charity regulator has indicated that the Guide is great and has recommended it to her fellow regulators. Some of our readers have followed the link to the Amazon.com Web site, but apparently have not bought the Guide. If they were turned off by the price, they should reconsider. One prominent attorney in the exempt organization field grabbed a review copy of the Guide and couldn't put it down. She has instructed a number of her clients to buy it, pointing out to them that for less than 1/2 hour of her billable time, they receive a lesson (and resource) that tells it like she would like it told. If you are starting a new charity, the Guide could save you thousands of dollars in legal fees by teaching you how to better utilize your legal counsel and framing the issues so you don't spin your wheels at $400 an hour. Buy your copy today at Amazon.com. Barnes & Noble, or John Wiley (the publisher). |
The organization in question (Charity X) is a relatively new one, receiving its tax-exempt status sometime during the last three or four years. It qualified as a church under Section 170(b)(1)(A)(i) and as a public charity (as opposed to a private foundation) under Section 509(a)(1). However, at this point you should drop any preconceived notions of what a charity looks like. There is a heavy “family” aspect to this charity, as we will soon see.
Charity X’s by-laws are revealing. Article III, Section 1 of the by-laws identifies the founder of Charity X to be A. Directors are appointed by A and serve until their death, disability, resignation or removal by A. We are already suspicious about Charity X’s claim that it is a charity. The governing documents are not focused on mission, but on granting extraordinary control to A.
A has always been Charity X's president and a director. B, A's wife, is secretary treasurer and a director. Their sons, C and D, are directors of Charity X. C also serves as Charity X's vice president. E, who is not an employee of Charity X, is A and B's son in law.
The first issue discussed in the ruling is whether Property J (apparently owned by Charity X) was used by A and his family as a personal residence. The TAM described the audit and the house as follows:
On March 4, 2002, the agent toured the property, and found that it appeared to be a personal residence by all indications. Personal items such as clothing in the closets, family pictures of children and grandchildren, bathrobe and toiletry items were found in the house.
Furnishings purchased for the house included, but are not limited to, sofa, loveseat, ottoman, end tables, chairs, bath towels, table lamps and patio furniture. The utilities, security system, cable TV and landscaping expenses were paid for by [Charity] X….
[Charity X] paid for utilities, security, cable TV, landscaping, and furnishing for the house
Interestingly, the TAM notes that Charity X applied for property tax exemption for the residence, but was initially denied exemption. The assessor eventually granted an exemption for the 11% of the property that was used for the storage of books.
The ruling then goes on to describe a second house that was occupied for six months by A’s two sons. This house was sold before the audit.
The ruling next examines credit card statements and charges. The agent found charges for meals, gasoline and miscellaneous items that appeared to be unrelated to Charity X’s charitable activities. The agent focused on charges incurred at about the same time as seminars sponsored by Charity X. While the TAM does not provide relative magnitudes, the tone suggests that charges that could not be traced to Charity X seminars were material.
The ruling then goes on to describe a number of vehicles owned by Charity X. The tone of the ruling suggests that the vehicles were used for personal rather than business purposes. We wonder why a church needs a vehicle referred to as a “roadster.”
The agent asked for policy statements regarding personal use of cars, as well as policy statements on reimbursement to Charity X of personal expenditures incurred by employees and paid for by Charity X. There does not appear to have been formal written policy statements, but Charity X responded by saying that there were policies in place that assured that Charity X only funded charitable expenditures.
The IRS concluded that Section 4958 applied to the transactions in questions. However, the IRS did not place a great deal of emphasis on whether the payments were excessive compensation, stating:
In the instant case, A and his relatives expended funds of [Charity] X, and used[Charity] X assets, in a variety of ways described below and in separate technical advice memoranda issued to his wife, sons, and son in law. A does not contend that these expenditures and uses were intended as compensation to himself or his relatives. In any event, there is no evidence in the record that would satisfy the contemporaneous substantiation rules of section 53.4958 4(c)(3) of the regulations.
The IRS focused on whether these properly reimbursable business expenditures, concluding that:
It follows that unless A can satisfy the accountable plan requirements of section 1.62 2 of the regulations, or the requirements of sections 162 and (to the extent relevant) 274 and the regulations thereunder for ordinary and necessary business expenses, the expenditures and use of [Charity] X funds described below must qualify as automatic excess benefits.
After providing additional details regarding the excess benefits and how it computed the value of these benefits, the IRS imposed the 25% Tier 1 tax under Section 4958 on A, stating:
An excise tax, as provided by section 4958(a)(1) of the Code, equal to 25 percent of the excess benefit amount, should be imposed on A. A was the founder, president, and chief executive of [Charity] X. As a practical matter, he had total control of all [Charity] X expenditures. He either approved of the excess benefit transactions by his wife, his two sons, and his son in law, or he at least acquiesced in them. If A had withdrawn funds from [Charity] X and given them to his family members, there would have been no question that such gifts would be taxable excess benefits to him. By authorizing or allowing his relatives the natural objects of his bounty to make unlimited expenditures of [Charity] X funds for personal purposes, without any substantiation or evidence of an [Charity] X business purpose, he in effect improperly removed charitable assets from [Charity] X and gave them to his relatives. Accordingly, A not only is liable for the excess benefit transactions from which he personally benefited, but also is jointly and severally liable for all of the excess benefits outlined in the technical advice memoranda of today regarding B, C, D, and E. See John Marshall Law School v. United States, supra; Code Section 4958(d)(1).
The IRS then goes on to propose that the 200% Tier 2 tax under Section 4958 also be imposed. That is the end of the TAM.
THE $64,000 QUESTION
Technical Advice Memorandum 200435020 is fine as far as it goes. The facts portray what appears to be a clearly abusive situation. The ruling provides a nice roadmap showing how the IRS will apply the intermediate sanctions, particularly where ostensible business expenses are at issue. However, the ruling doesn’t provide much insight as to how charities with more defined accounting systems can protect themselves.
Where this technical advice memorandum strikes us as misleading is its exclusive focus on intermediate sanctions. Section 4958 may contain “intermediate” sanctions, but these are not the only sanctions available to the IRS.
Technical Advice Memorandum 200435020 gives short shrift to the prohibition against private inurement. And it doesn’t even discuss the basic requirement that the charity be “operated” for charitable purposes. While we don’t have enough facts, we do have some trouble believing that Charity X even qualifies as a “charitable” organization for tax purposes. In our view, anytime the IRS raises the intermediate sanctions, it should also discuss why it isn’t “yanking” exempt status. In many cases, there will be good reason for stopping short. After all, that was why Congress provided the IRS with tools under the intermediate sanctions. But in a case like the one described in Technical Advice Memorandum 200435020, we have trouble understanding why the organization’s exempt status was not challenged outright. We would be willing to bet that the IRS’s reticent is due to the fact that organization in question is a religious one.
|
THE FOREGOING IS NOT AND SHOULD NOT BE TAKEN AS LEGAL ADVICE. IF LEGAL ADVICE IS REQUIRED, THE NON-PROFIT OR OTHER PARTY IN QUESTION SHOULD SEEK THE ADVICE OF QUALIFIED LEGAL COUNSEL.
If you liked this post, please visit http://www.charitygovernance.com for a description of our Guide/Tutorial for non-profit directors and officers entitled “Avoiding Trouble While Doing Good: A Guide for the Non-Profit Director and Officer.” Copyright 2004, Auto Didactix LLC. All Rights Reserved. You may not copy any portion of this post to a computer "clipboard" for reposting anywhere or e-mailing, or otherwise reproduce this post. If you want others to review this post, you may provide them with a link to this web blog. Any use of the material or ideas in this post by reporters or other publishers shall make reference to Jack Siegel, author of "Avoiding Trouble While Doing Good, A Guide for the Non-Profit Director and Officer" and this web blog. |
Comments