Dateline: January 2, 2007, Chicago
Many will recall the tragic events of October 26, 2006, when five firefighters were killed by a sudden burst of flames from a brush fire that had been set by an arsonist. The event received widespread coverage around the nation. It is therefore not surprising that someone decided to set up a fund for the firefighters’ survivors. It is also not surprising that funds poured in, eventually exceeding $1 million. The fund was handled by the United Way of Central County, California. According to an article in the L.A. Times, at the half million mark, United Way official Bob Duistermars decided to place what the Times characterizes as a “cautionary call” to the IRS. Maeve Reston, Donations to Firefighters’ Survivors Put at Risk, L.A. Times, Dec. 8, 2006. And guess what?
The IRS told Duistermars that the United Ways’ actions could cost the United Way...
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its tax-exempt status (we assume this was more of a theoretical warning than an actual possibility). As stunning as that might seem, it is the right answer. The law is clear: A charitable organization can only expend its funds for the benefit of a charitable class. The IRS defines a charitable class as follows:
The group of individuals that may properly receive assistance from a charitable organization is called a charitable class. A charitable class must be large or indefinite enough that providing aid to members of the class benefits the community as a whole. Because of this requirement, a tax-exempt disaster relief or emergency hardship organization cannot target and limit its assistance to specific individuals, such as a few persons injured in a particular fire. Similarly, donors cannot earmark contributions to a charitable organization for a particular individual or family.When a disaster or emergency hardship occurs, a charitable organization may help individuals who are needy or otherwise distressed because they are part of a general class of charitable beneficiaries, provided the organization selects who gets the assistance.
The families of five fighters might be worthy, but this group is too small to constitute a charitable class. That means a charity who provides them with funding, barring special legislation, is arguably not operated in accordance with Section 501(c)(3). Moreover, individuals who make a gift directly to those individuals or a fund earmarking the gift for those individuals are not entitled to a charitable contribution or other deduction.
We are a bit surprised that the United Way was unaware of this fact. In the wake of 9/11, the IRS issued a plain language publication (Publication 3833) to address this issue. There was no need to bother anyone at the IRS. The publication is quite clear. Moreover, it is simply a restatement of longstanding tax concepts. In a particularly noteworthy statement, Duistermars told the Times that much of the confusion stemmed “from the fact that Congress passed a special law exempting the families of the Sept. 11 terrorist attacks from most those IRS regulations”—quotation is the paraphrase by the Times of the interview, not Duistermars's specific comment. Why there is any confusion is totally beyond us. If Congress had to pass a special law that effectively redefined the concept of “charitable class” for a particular case, then there should be no confusion. By negative implication, those who aren't the beneficiaries of a special exemption are subject to the basic rule.
Riverside County Supervisor Marion Ashley told the Times, “This was a spontaneous effort—there wasn’t time to go to a bunch of tax attorneys and CPAs...We feel like the IRS is the Grinch that stole Christmas.” "Wrong," in our best John McLaughlin voice. Supervisor Ashley, like many others, believes that people who do good are entitled to a free pass. Moreover, he views compliance with the law as burdensome regulation. Finally, he believes the IRS makes the law. He is dead wrong on all accounts.
First, there are countless laws that regulate non-profits, tax-exempt entities, charitable solicitation, and the use of charitable dollars. These laws are on the books to make sure that members of the public who give money to charitable causes aren’t defrauded. That means everyone raising money, no matter how noble the cause, must comply with the laws. Self-selection does not work when it comes to compliance with laws designed to prevent fraud. "We don't have to comply, we are the good guys." Moreover, the laws of tax-exemption are designed to assure that only certain activities are subsidized by taxpayers. That means line drawing. You might not like where the line is drawn, but that is a problem with any law.
Second, there are administrative costs in operating a charity so that it complies with the law. Stop blaming CPAs and attorneys for helping charities to comply with the law. Third, and finally, it is not the IRS that makes the law and draws the lines. If anyone is the Grinch, it is Congress. The IRS is an administrative agency charged with enforcing the law that Congress passed.
Of course, once Congress got wind of the problem, they decided to help out by passing H.R. 6429 in the final hours of the 109th Congress. The bill provides as follows:
SECTION 1. SHORT TITLE. This Act may be cited as the ''Fallen Firefighters Assistance Tax Clarification Act of 2006''.
SEC. 2. PAYMENTS BY CHARITABLE ORGANIZATIONS WITH RESPECT TO CERTAIN FIREFIGHTERS TREATED AS EXEMPT PAYMENTS. (a) IN GENERAL. -- For purposes of the Internal Revenue Code of 1986, payments made on behalf of any firefighter who died as the result of the October 2006 Esperanza Incident fire in southern California to any family member of such firefighter by an organization described in paragraph (1) or (2) of section 509(a) of such Code shall be treated as related to the purpose or function constituting the basis for such organization's exemption under section 501 of such Code if such payments are made in good faith using a reasonable and objective formula which is consistently applied.
(b) APPLICATION. -- Subsection (a) shall apply only to payments made on or after October 26, 2006, and before June 1, 2007.
President Bush signed the bill into law on December 21, 2006. Public Law 109-445.
As you can see, Congress bailed out the United Way of Central County, California. This was a very big mistake on the part of the Congress. The United Way of Central County, California should have been forced to return the money to the donors. There are a number of charities that provide certain benefits to the families of fallen firefighters and police officers. These benefits often taken the form of scholarships for children. Properly organized and operated, these charities can overcome the problems posed by the charitable class requirement. Those who received the return of their contributions could have then made charitable contributions to those organizations. As we said at the outset, this was a good cause and clearly well-intentioned effort. However, those five firefighters were not the only fire fighters or worthy public servants to die in the line of the duty. The five firefighters did receive national media coverage, unlike many others. In our view, the level of media coverage should not be the basis for public subsidy. Yet, that is exactly the basis on which Congress has allocated a tax subsidy.
Congress could have acted far more responsibly by taking a considered and detailed look at the definition of charitable class and its relation to fallen public servants. The United Way of Central County, California is not the first organization to make a mistake with respect to charitable class and it surely won’t be the last. We frequently see funds set up to aid the families of fallen fire fighters, police officers, and other worthy individuals. Often, the public is told to send their funds to a fund being administered by a bank or other financial institution. No doubt many of those sending funds are claiming the contribution as a charitable contribution for tax purposes. No doubt, nobody is paying taxes on the fund. Rather than dealing with this problem on an ad hoc basis, Congress would serve the tax system by coming up with a comprehensive solution to the issues raised by the United Way of Central County, California’s actions. Senator Grassley would better serve the public by focusing on this issues than by conducting a Senate Finance Committee audit of the Museum of Modern Art, something that is best left to our friends at the IRS.
Internal Revenue Service - Circular 230 Disclosure: As provided for in Treasury regulations, any advice (but none is intended) relating to federal taxes that is contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.
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.
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