Those pesky earmarks. Everybody thought congressional rule changes would end one avenue on the road to congressional waste. However, the quest for campaign contributions appears to have simply brought about a change in the legal form that the recipients of earmarks take. Businesses can no longer receive earmarks, but nonprofits are still eligible. Smart business people and their lawyers are now using nonprofits to collect earmarks, according to a front page article by Eric Lipton and Ron Nixon in today’s New York Times. Companies Find Ways to Bypass on Earmarks. We admire the clever structuring, but we are not at...
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all convinced that the clever planning works.
As anybody who has ever formed a nonprofit corporation or obtained tax-exempt status for it as a charity quickly learns, it is easy to transfer assets to the entity, but getting them out is quite another thing.
Take the Great Lakes Research Center. According to the Times, Victoria Kurtz is the vice president of marketing for a small Ohio defense contractor. The ban on earmarks apparently was going to make it difficult for the contractor to obtain government funding. In an apparent response, Kurtz incorporated the Great Lakes Research Center as a nonprofit corporation. Enter Marcy Kaptur, a Democratic member of the House of Representatives, who has requested a $10.4 million earmark for the Great Lakes Research Center, according to the Times. The Center’s web site lists Kurtz as the Center’s executive director. And guess what? Kurtz contributed $5,800 to Kaptur’s campaign from October 26, 2006 through October 27, 2008., according to Federal Election Commission records. On October 29, 2008, she contributed another $2,300 to Kaptur’s campaign.
We wonder whether the strategy outlined in the Times article and used by Kurtz really passes muster. It apparently circumvents the Congressional limitations on earmarks. It appears that Kurtz and her associates didn't even have to seek legal counsel to develop this strategy. The Congresswoman instructed people how to circumvent the prohibition on earmarks, as evidenced by the following e-mail which accompanied the story in the Times.
Not clear who this was sent to, but it is clear that Representative Kaptur is quite helpful to her constituents. And you thought that the deaths of Senator Robert Byrd and Representatives John Murtha would put an end to this nonsense.
March 11, 2010
To Whom It May Concern:
Due to yesterday's announcement by the United States House of Representatives Committee on Appropriations your proposal for a Congressionally Directed Initiative is not eligible for consideration by the House Appropriations Committee, due to the recipient being a for-profit entity. As a result, your organization's proposal must be resubmitted through a not-for-profit institution or not considered by our office.
The question: If the venture turns out to be a profitable one (remember, we are dealing with nonprofits here), how do the interests behind the venture get the money out of the nonprofit if that is the endgame?
If the organization has obtained Section 501(c)(3) status, it is not at all clear how that would be accomplished without running afoul of tax law requirements. Section 501(c)(3) prohibits private inurement, which is a fancy way of saying the organization cannot pay “dividends” to insiders.
Of course, as long as we are talking about end runs around prohibitions, the obvious ones around the prohibition on private inurement are compensation and payments to related parties for goods and services. Neither Congress, nor the IRS are dumb, however. Congress has given the IRS tools to prevent charities from paying insiders amounts exceeding the fair value of the goods and services provided by the insiders—the intermediate sanctions. It also has given the IRS the power to revoke (or deny) charitable status if the organization is not organized and operated primarily for charitable purposes.
What is unclear to us is whether the Great Lakes Research Center is a charity or a tax=exempt entity. The Times article raises the possibility that the Center has or will apply for tax-exempt status, but it does not come out and say that this is the plan. We found no reference to it in the GuideStar database or in IRS Publication 78. Nor did the organization's articles of incorporation contain the language that we would have expected to find were it intending to apply for tax-exempt status. There is nothing that requires the Center to apply for tax-exempt status. If it doesn’t, presumably it is a corporation subject to the corporate income tax.
We have no evidence to suggest that the Center has done anything wrong. However, given the tone of the article and the apparent reasons the Center was created, we simply don’t see how the folks behind the Center will be able to remove profits if the Center is in fact a Section 501(c)(3) organization and that is their objective.
Even if a nonprofit has not received tax-exempt status from
the IRS, we still have trouble seeing how the insiders can receive
“dividends” given the fact that many
state nonprofit enabling statutes limit distributions to insiders, which could
pose roadblocks to removing profits from the corporation. The IRS would have no reason to
examine the reasonableness of compensation or payments for goods and
services if that were the case, but what about state
attorneys general? We are
not going to look at Ohio law, but we do note that the Revised Model Nonprofit
Corporation Act (1987) does prohibit unlawful distributions. We are curious whether the payment of
unreasonable compensation or other traditional ways of stripping earnings from
a corporation might be treated as distributions for purposes of the provisions
prohibiting certain distributions.
If so, would a state attorney general have authority to enforce the
limitation on distributions?
Normally, if an attorney general does intervene, the entity is a charity, so the attorney general usually is acting under statutory authority to protect charitable assets. But what is unclear to us is the extent that an attorney general would have jurisdiction if the organization is not a charity.
The Great Lakes Research Center is not the only organization mentioned in the Times article. There is also a reference to the Interactive Media Institute, which the reporters indicate is a nonprofit group controlled by executives at Virtual Reality Medical Center. Unlike the Great Lakes Research Center, the Interactive Media Institute clearly is a charity. It filed a Form 990-EZ for 2008. It apparently is seeking federal funding. Once again, we don’t know the motivations. However, these folks put themselves in the Section 501(c)(3) box, which means the IRS has jurisdiction to question expenditures if warranted.
As should be apparent, we find these end runs around prohibitions on earmarks to be offensive, particularly given the fact that the idea apparently was floated by a member of Congress. We don't know if that was where the idea first originated.
The United States is facing trillions of dollars of debt and deficits, with no obvious way to keep on the current path to what is already unsustainable spending. In that environment, earmarks are very troubling because they represent a way for politicians to use taxpayer funds to keep themselves in power. We hope the IRS and state attorneys general are curious, resulting in an examination of the nonprofits and charities seeking and receiving earmarks. If the profits remain in corporate solution and are used to further mission, there is no problem for the recipient entities. However, if the entities are being abused, regulators should crack down hard.
Kudos to Times reporters Lipton and Nixon for an excellent story. We hope you follow up.
Oh yes, and a bit of advice to potential recipients of earmarks: Fancy legal planning works best when it is undertaken stealthily.
Oh yes, and a bit of advice to potential recipients of earmarks: Fancy legal planning works best when it is undertaken stealthily.Fly like an eagle, just do it under the media's radar screen--Yes, we did see the Steve Miller Band this weekend.
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 NONPROFIT OR OTHER PARTY IN QUESTION SHOULD SEEK THE ADVICE OF QUALIFIED LEGAL COUNSEL.
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