Dateline: May 31, 2007, Chicago
Last week we wrote an article about two $50 million gifts made by T. Boone Pickens to two institutions. Each gift carried the stipulation that the money could not be spent until the $50 million gift and the income thereon had grown to $500 million. Pickens clearly exhibited a preference to help future generations rather than the one that is currently alive.
Today, the Chicago Sun Times devoted a full page article to an anonymous University of Chicago alum's $100 million gift to the U of C. The article, by reporter Dave Newbart, is headlined "$100 Million Loan-Killer." The alum's gift can be viewed as the antithesis to T. Boone Pickens' gift. The Sun Times reports that the funds are to be used...
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to provide financial aid through grants to students who otherwise would have to incur debt to attend the U of C or couldn't even afford to attend because they don't qualify for loans. It is not entirely clear whether it is only the income on the $100 million that will fund the aid. The Chronicle of Philanthropy is reporting that the gift will provide financial aid for roughly 1,200 students, suggesting that not just the income on the assets will be spent. In any event, this donor is likely receiving a charitable contribution deduction today in exchange for addressing immediate societal needs.
That brings us to Tuesday's press release from Senators Baucus and Grassley. In a letter encouraging Treasury Secretary Henry Paulson to speed the revision of the Form 990, the two senators decided to digress, writing:
We want to digress for a moment and raise an aspect of endowments of public charities that is not directly related to reporting. The former Commissioner of the IRS spoke a few weeks ago, prior to his departure, that charities needed to provide charitable work commensurate with their resources. The Commissioner's statement is much in keeping with the commonsense view of the American taxpayer who subsidizes by billions of dollars a year the work of charities – that the point of giving is to help the community and those in need and not to help a charity build an even bigger bankroll. The commensurate test is an important part of assessing whether an entity is acting as a charity. The commensurate test is traditionally stated as: "where [a charity] is shown to be carrying on through such contributions and grants a charitable program commensurate in scope with its financial resources." The new Form 990 should allow the IRS and the public to easily identify how the commensurate test is being met. Please also inform us of what guidance Treasury and IRS are planning to put forward that will put more teeth into the commensurate test and what is the audit plan and results so far in this area.
As far as we know, neither Senator Baucus, nor Senator Grassley have LLMs in Taxation--we aren't suggesting that they should. Consequently, we were very surprised to see reference to the "commensurate test" in this letter. Pick up virtually any tax guide on Section 501(c)(3) status. You will see references to the organizational and operational tests, the prohibition on political interventions, private inurement, and private benefit, and several other requirements that must be satisfied before an organization qualifies for tax-exempt status as a public charity. You are unlikely to see any reference to the commensurate test, or as it is sometimes known, the "commensurate-in–scope" test. In all likelihood, some diligent staff member of the Senate Finance Committee has been doing some heavy duty legal research to provide support for what may be broader policy concerns expressed by Senators Baucus and Grassley. We don't know for sure, but the tea leaves are pointing in that direction.
In a 1999 law review, Professor Evelyn Brody observed that the IRS "showed little stomach for applying [the commensurate test] aggressively." See A Taxing Time for the Bishop Estate: What is the I.R.S. Role in Charity Governance?, 21 University of Hawai'i Law Review 537 (1999). In fact, she notes that the IRS issued a field service memorandum (FSA 1999-530) calling into question the IRS's confidence in the test as an independent requirement for exemption. Brody's article was focused on the infamous Bishop Estate litigation. There the state law issue was whether the Bishop Estate was accumulating assets as a means to increase fees to its trustees, who were statutorily entitled to fees. Brody was asking whether the tax law had anything to say about the issue. Her vehicle for expressing her thoughts was a hypothetical Tax Court opinion. She suggested that the IRS probably did not have had authority to revoke exemption under the commensurate test. Respected authority Bruce R. Hopkins has also noted the absence of significant IRS reliance on the commensurate test, indicating at one point that the test had been largely dormant for some period of time. See Hopkins, The Law of Tax-Exempt Organizations (Wiley 2003).
We can only ask: Why something so obscure is suddenly worth a digression, particularly in a letter to the Secretary of the Treasury, who hopefully is more focused on trade deficits with China and the value of the dollar? Could it be the
commonsense view of the American taxpayer who subsidizes by billions of dollars a year the work of charities – that the point of giving is to help the community and those in need and not to help a charity build an even bigger bankroll
is the right view in the minds of Senators Baucus and Grassley?
That is not language that endorses the accumulation of large endowments. That leads us to wonder whether Senators Baucus and Grassley might be thinking about legislation that might curb the accumulation of large pools of assets when there are no specific plans for the use of those assets. Such legislation could take one of the following three forms:
- A requirement that public charities distribute or spend a portion of investment income or pay an excise tax on a failure to meet the minimum distribution or spending rate. Section 4942 contains just such an excise tax applicable to private foundations.
- A tax on unreasonable accumulations similar to the one in Section 535 imposed on the unreasonable accumulation of corporate earnings.
- A present value reduction in the charitable contribution deduction for contributions structured like the one made by T. Boone Pickens.
Once again, Professor Brody, often ahead of her time, offers commentary and insight on the arguements for mandatory distributions or spending rates for public charities in Charities in Tax Reform: Threat to Subsidies Overt and Covert, 66 Tennessee Law Review 687 (1999), one of her many articles.
To be clear, the press release and letter says nothing the three possible remedies or any other specific proposals, but much of the language in the Baucus/Grassley digression could easily find its way into and would be appropriate as an introductory statement that might accompany a subsequent legislative proposal.
Is such legislation a good or bad idea? We won't take a stand on that until we see the legislation. We do know that it will prove highly controversial. Many would like to see such legislation, but those sitting on gigantic endowments would likely be adamantly opposed to it. We can only wonder how major universities, cultural institutions, and other institutions with large endowments might be gearing up for what could be a very interesting battle should Senators Baucus and Grassley decide to take more concrete action.
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