Our case this time takes us to Louisville.
There is a
nonprofit called the Waterfront Development Corporation (WDC). It has existed
since 1986, and its mission is to development, redevelop and revitalize certain
industrial areas around the Ohio river downtown. I would probably shy away from
getting involved - anticipating unceasing headaches from the city, Jefferson
county and the Commonwealth of Kentucky - but I am glad that there are people who
will lift that load.
One of those
individuals was Clinton Deckard, who wanted to assist WDC financially, and to
that effect he formed Waterfront Fashion Week Inc. (WFWI) in 2012. WFWI was going
to organize and promote Waterfront Fashion Week – essentially a fundraiser for
WDC.
Seems
laudable.
Mr Deckard
had been advised to form a nonprofit, on the presumption that a nonprofit would
encourage people and businesses to contribute. He saw an attorney who organized
WFWI as a nonprofit corporation under Kentucky statute.
Unfortunately,
Waterfront Fashion Week failed to raise funds; in fact, it lost money. Mr
Deckard wound up putting in more than $275,000 of his own money into WFWI to
shore up the leaks. There was nothing to contribute to WDC. What remained was a financial crater-in-the-ground
of approximately $300 grand. Whereas WFWI had been organized as a nonprofit for
state law purposes, it had not obtained tax-exempt status from the IRS. If it
had, Mr Deckard could have gotten a tax-deductible donation for his generosity.
COMMENT: While we use the terms “nonprofit” and “tax-exempt” interchangeably at times, in this instance the technical difference is critical. WFWI was a nonprofit because it was a nonprofit corporation under state law. If it wanted to be tax-exempt, it had to keep going and obtain exempt status from the IRS. One has to be organized under as a nonprofit for the IRS to consider tax-exempt status, but there also many more requirements.
No doubt Mr
Deckard would have just written a check for $275 grand to WDC had he foreseen
how this was going to turn out. WDC was tax-exempt, so he could have gotten a
tax-deductible donation. As it was, he had ….
…. an idea. He
tried something. WFWI had never applied for tax-exempt status with the IRS.
WFWI filed instead
for S corporation status. Granted, it filed late, but there are procedures that
a knowledgeable tax advisor can use. Mr Deckard signed the election as
president of WFWI. An S election requires S corporation tax returns, which it filed.
Mind you, the returns were late – the tax advisor would have to face off
against near-certain IRS penalties - but it was better than nothing.
Why do this?
An S
corporation generally does not pay tax. Rather it passes its income (or deductions)
on to its shareholders who then include the income or deductions with their other
income and deductions and then pay tax personally on the amalgamation
It was a
clever move.
Except ….
Remember
that the attorney organized WFWI as a nonprofit corporation under Kentucky
statute.
So?
Under
Kentucky law, a nonprofit corporation does not have shareholders.
And what does
the tax Code require before electing S corporation status?
Mr Deckard has
to be a shareholder in the S corporation.
He tried, he
really did. He presented a number of arguments that he was the beneficial owner
of WFWI, and that beneficial status was sufficient to allow an S corporation election.
But a
shareholder by definition would get to share in the profits or losses of the S corporation.
Under Kentucky statute, Mr Deckard could NEVER participate in those profits or losses.
Since he could never participate, he could never be a shareholder as intended by
the tax Code. There was no shareholder, no S corporation election, no S
corporation – none of that.
He struck
out.
The sad thing
is that it is doubtful whether WFWI needed to have organized as a nonprofit in
the first place.
Why do I say
that?
If you or I
make a donation, we need a tax-exempt organization on the other side. The only
way we can get some tax pop is as a donation.
A business
has another option.
The payment
could just be a trade or business expense.
Say that you
have a restaurant downtown (obviously pre-COVID days). You send a check to a charitable
event that will fill-up downtown for a good portion of the weekend. Is it a
donation? Could be. It could also be just a promotion expense – there are going
to be crowds downtown, you are downtown, people have to eat, and you happen to be
conveniently located to the crowds. Is that payment more-than-50% promotion or
more-than-50-% donation?
I think of
generosity when I think of a donation. I think of return-on-investment when I
think of promotion or business expenses.
What
difference does it make? The more-than-50% promotion or business deduction does
not require a tax-exempt on the other side. It is a business expense on its own
power; it does not need an assist.
I cannot
help but suspect that WFWI was primarily recruiting money from Louisville
businesses. I also suspect that many if not most would have had a keen interest
in downtown development and revitalization. Are we closer to our promotion
example or our donation example?
Perhaps Mr
Deckard never needed a nonprofit corporation.
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