IRS Rejects A Religious Organization’s Tax-Exempt Application

 

We have a nonprofit application for exempt status that has gone off the rails.  

The reviewing (IRS) officer wanted them, for example, to recharter under a different category of nonprofit status.

I considered it arbitrary, but if it made him happy….

He called this week threatening to terminate his review altogether. I called him back immediately.

What happened, I asked

You have not forwarded all the information I asked for, he explained.

I faxed you several documents in early June. I said. I am unaware of having omitted anything.

I need state certification of the amendment to the charter, he replied.

Which he had not requested previously.

Fine. I called the secretary of state’s office, explaining my situation. They were very helpful and by the end of the day I received a verification that I could forward to the IRS.

The nonprofit, by the way, is a high school booster club. The IRS is treating them like they were Amazon. Folks, these are parents selling pop and snacks at high school games. All they are trying to do is buy bleachers and build restrooms nearer the athletic fields. The IRS overkill here is ridiculous.

My previous exempt application, on the other hand, went smoothly. I had one conversation with the reviewing officer and that was it.

Yes, one’s experience with the IRS can vary greatly depending on whom one is working with.

I am looking at IRS response to an application by an organization called Christians Engaged. It caught my attention for two reasons: first, the response came out of Cincinnati; second, the organization got turned down. I get curious when an application is rejected. I remember, for example, an application rejected for being little more than a masquerade for sending family members to college on a tax-deductible basis.

Let’s set this up:

(1)  The organization was organized in Texas in 2019.

(2)  The founder and president is a former Republican Congressional candidate and a preacher.

(3)  The vice president is a former Promise Keepers prayer coordinator and a homeschool mom.

(4)  The secretary is a millennial managing Republican field teams in Collins county, Texas.

Sounds 2021-ish.

The organization’s mission statement includes the following:

a.    Regular prayer for the nation

b.    Impact culture by voting every election

c.    Encourage political education and activism

d.    Educate Christians on the importance of prayer, voting and nonpartisan political engagement

Got it. There is noticeable call-to-action here.

So what are the activities of Christians Engaged?

(1)  Hold weekly prayer meetings for state and federal leaders, including distribution of program outlines to participating churches.

(2)  Maintain a website and social media providing educational materials and connections for Christians to become politically active.

(3)  Educate believers on issues central to biblical faith, such as the sanctity of life, the meaning of marriage, private versus governmental ethics, religious liberty, and so on.

(4)  Conduct educational activities, including a course in political activism, with a basis in Biblical and Christian value systems.

(5)  Educate on how to select between imperfect candidates as well as political party impact on elected officials.

Tax-exempts have to be careful when they approach political activities.  The type of exempt we are discussing here is the (c)(3) - the most favorable tax status, as contributions to a (c)(3) are tax-deductible.

As a generalization, a tax-exempt is permitted to advocate on issues affecting them, the community, society and the nation. Think environmental protection or domestic abuse, for example, and you will get a feel for it.

What it cannot do is lobby (at least, not to any significant extent).

What is lobbying?

An obvious example is direct lobbying: contacting an elected or government official with the intent of influencing new or existing legislation.

Less obvious is indirect lobbying, sometimes referred to as grassroots lobbying. Rather than contacting an elected or government official directly, the goal is to influence and motivate the public to do so.

To me this definition is soapy water. A tax exempt is allowed to advocate, and obviously it will advocate on behalf of its mission statement. An early education (c)(3) will, for example, advocate with the goal of getting someone to leave the couch and take action on early education matters.  

We have to tighten-up the definition of grassroots lobbying to make it workable.

How about this:

Attempt to influence the general public through communications that:

·      Refer to specific legislation

·      Reflect a point of view on said legislation, and

·      Include a call to action

Better. It seems that a general education or exhortation mission – and leaving specific legislation or candidates alone - will fit into this definition.

What did the IRS reviewing officer see in the Christians Engaged application?

(1)  The activities approach that of an action organization, involving itself with political campaigns and candidates.

How, me asks?

The organization involves itself on issues prominent in political campaigns, instructing what the Bible says about the issue and how the public should vote.

(2)  The issues discussed are more commonly affiliated with certain candidates of one political party rather than candidates of another party, meaning the organization’s activities are not neutral.

(3)  The organization itself is not neutral, as it instructs people on using and voting the Bible. 

(4)  The organization serves the interest of the Republican party more than incidentally, meaning it serves a substantial nonexempt purpose.

 Huh?

Let’s just quote the IRS: 

Specifically, you educate Christians on what the Bible says in areas where they can be instrumental including the areas of sanctity of life, the definition of marriage, biblical justice, freedom of speech, defense, and borders and immigration, U.S. and Israel relations. The bible teachings are typically affiliated with the [Republican] party and candidates.”

That took a turn I did not expect.

I expected an analysis of applying soapy-water standards of grassroots lobbying to societal reality in the 21^st century.  

We got something … else.

The matter is being appealed, of course.

“Destination-Based” “Border Adjustment” “Indirect Tax” … What?

The destination-based border adjustment tax.

I  have been reading about it recently.

If you cannot distinguish it from a value-added tax, a national sales tax, a tariff or all-you-can eat Wednesdays at Ruby Tuesday, you are in good company.

Let’s talk about it. We need an example company and exemplary numbers. Here is one. Let’s call it Mortimer. Mortimer’s most recent (and highly compressed) income statement numbers are as follows:

Sales			10,000,000
Cost of sales			(3,500,000)
Operating expenses			(4,000,000)
Net profit			2,500,000

How much federal tax is Mortimer going to pay? Using a 34% federal rate, Mortimer will pay $850,000 ($2,500,000 * 34%).

Cue the crazy stuff….

A new tax will bring its own homeboy tax definitions. One is “WTO,” or World Trade Organization, of which the U.S. is a part and whose purpose is to liberalize world trade. The WTO is a fan of “indirect taxes,” such as excise taxes and the Value Added Tax (VAT). The WTO is not so much a fan of “direct taxes,” such as the U.S. corporate tax. To get some of their ideas to pass WTO muster, Congressional Republicans and think-tankers have to reconfigure our corporate income tax to mimic the look and feel of an indirect tax.

One way to do that is to disallow deductions for Operating Expenses. An example of an operating expense would be wages.

As a CPA by training and experience, hearing that wages are not a deductible business expense strikes me as ludicrous. Let us nonetheless continue.

Our tax base becomes $6,500,000 (that is, $10,000,000 – 3,500,000) once we leave out operating expenses.

Not feeling so good about this development, are we?

Well, to have a prayer of ever getting out of the Congressional sub-subcommittee dungeon of everlasting fuhgett-about-it, the tax rate is going to have to come down substantially. What if the rate drops from 35% to 20%?

I see $6,500,000 times 20% = $1,300,000.

Well, this is stinking up the joint.

VATs normally allow one to deduct capital expenditures. We did not adjust for that. Say that Mortimer spent $1,500,000 on machinery, equipment and what-not during the year, What do the numbers now look like? 

• Sales                                       10,000,000
• Cost of Sales                            3,500,000
• Operating Expenses                 4,000,000
• Capital Additions                       1,500,000 

I am seeing $5,000,000 ($10,000,000 – 3,500,000 – 1,500,000) times 20% =  $1,000,000 tax.

Still not in like with this thing.

Let’s jump on the sofa a bit. What if we not tax the sale if it is an export? We want to encourage exports, with the goal of improving the trade deficit and diminishing any incentive for companies to invert or just leave the U.S. altogether.

Here are some updated numbers:

• Sales                                        10,000,000 (export $3,000,000)
• Cost of Sales                             3,500,000
• Operating Expenses                  4,000,000
• Capital Additions                        1,500,000 

I see a tax of: (($10,000,000 – 3,000,000) – (3,500,000 + 1,500,000) * 20% = 2,000,000 * 20% = $400,000 federal tax.

Looks like Mortimer does OK in this scenario.

What if Mortimer buys some of its products from overseas?

Oh oh.

Here are some updated, updated numbers:

• Sales                                       10,000,000
• Cost of Sales                            3,500,000 (import $875,000)
• Operating Expenses                 4,000,000
• Capital Additions                       1,500,000 

This border thing is a two-edged blade. The adjustment likes it when you export, but it doesn’t like it when you import. It may even dislike it enough to disallow a deduction for what you import.

I see a tax of: ($10,000,000 – (3,500,000 - 875,000) – 1,500,000) * 20% = 5,875,000 * 20% = $1,175,000 federal tax.

Mortimer is not doing so fine under this scenario. In fact, Mortimer would be happy to just leave things as they are.

Substitute “Target” or “Ford” for “Mortimer” and you have a better understanding of recent headlines. It all depends on whether you import or export, it seems, and to what degree.

By the way, the “border adjustment” part means the exclusion of export income and no deduction for import cost of sales. The “destination” part means dividing Mortimer’s income statement into imports and exports to begin with.

We’ll be hearing about this – probably to ad nauseum – in the coming months.

And the elephant in the room will be clearing any change through the appropriate international organizations. The idea that business expenses – such as labor, for example – will be nondeductible will ring very odd to an American audience.