I am looking at a tax-exempt case that went off the rails.
There are rules in the tax-exempt area to encourage one
to keep their nose clean. The rules can be different depending on whether the
entity is a private foundation or not. The reason is that a foundation is
generally considered more susceptible to influence than a “classic” tax-exempt,
such as a 501(c)(3), as a foundation generally has a smaller pool of donors.
A doctor (Dr O) organized a 501(c)(3) called American
Medical Missionary Care, Inc (AMMC) in 1998. In 2000 it applied for and
received tax-exempt status from the IRS. Its exempt purpose was to operate a
clinic in Michigan providing medical examination and treatment for individuals
unable to afford such services.
Sounds like a great cause to me.
Dr O served as president. His spouse (Mrs O) served on
the board of directors as well as secretary and treasurer over the years.
In 2013 AMMC filed its Form 990 reporting compensation
of $26,000 paid Dr O and $21,000 paid Mrs O.
AMMC however issued W-2s of $26,000 apiece.
There is a mistake here, but it is not necessarily a
big deal. They should tighten down the numbers going forward, though.
On its 2014 Form 990 AMMC reported no compensation to Dr
or Mrs O.
Seems odd. Compensation does not tend to turn off and
on like a spigot.
Meanwhile, Dr O had gotten in trouble with the
Michigan Board of Medicine in 2014. He was required to pay a significant amount
of money and also relinquished his medical license. Dr O eventually returned to
Nigeria in 2017, leaving his wife in the United States.
The IRS selected the nonprofit for examination.
The revenue agent dug around the AMMC’s various bank
accounts for 2014 and found biweekly checks to Mrs O of $1,000 each. There were
also certified checks ranging from $6,000 to $10,000. In all, Dr and Mrs O had
received cash, checks and money orders from AMMC totaling approximately $130
thousand.
The 990 showed the $130 grand as a loan receivable
from Dr O.
Oh please.
Dr O got into trouble and needed cash. He turned to AMMC because that is where the money was. A loan implies an ability to
repay and intent to collect, all within the normal course and conduct of
business. I seriously doubt that is what we had here.
Dr O and Mrs O had outsized influence over the (c)(3).
Who was going to tell them no, much less point out that making loans to officers
and board members is minefield territory in the tax Code?
The IRS revenue agent felt the same way and assessed a
tier-one penalty.
Penalties in the nonprofit area can be a bit
different. There can be penalties on an individual or on the entity itself, for
example. The more severe penalties revolve around “excess benefit” transactions
and “disqualified persons,” which are – as you might suspect – people with substantial
authority or influence over the tax-exempt. Dr O organized AMMC years before
and served as its president. He was a poster child for a disqualified person.
The IRS assessed a tier-one penalty of $32,500. It also revoked the exempt status of AMMC.
Let’s walk through the tiered penalty.
The IRS assessed a tier-one penalty of $32,500 on the O's. This
is 25% of the $130,000 that Dr and Mrs O drew in 2014. The reason I call it a
“tier-one” is that there is a possible “tier two.” To avoid a tier-two, one has
to return the money to the tax-exempt.
What happens if one fails to return the money?
The penalty goes to 200%.
This is one of the severest penalties in the tax Code,
and Congress intended it that way. Years ago, the only recourse the IRS had was
to revoke the entity’s exempt status. Congress felt that this response was a
sledgehammer, and it instead created a set of “intermediate” penalties,
shifting the burden to the person benefiting from the transaction. With that as
background, Congress did not consider 200 percent as excessive.
So the O’s now had another penalty of $230,000.
COMMENT: 200 percent of
$130,000 is $260,000, not $230,000. The Court made some tweaks which need not concern
us here.
You may be wondering why Dr O would care, if he was
safely ensconced in Nigeria.
For one, his wife was still in the United States.
And she was on the Board. She had served as secretary
and treasurer. She was a disqualified person in her own right. She was also
considered to be a disqualified person by being married to a disqualified
person. She was not getting out of this snare.
Mrs O was going to get hammered.
She fielded a last stand:
(1) She
argued that much of the money was distributed to needy people to help with rent
and utilities, after-school programs for the kids and so forth.
Problem was: she had no
records to substantiate any of this. She had not drawn checks in a manner
commensurate with this storyline, although she testified that she would hold
and re-deposit the certified checks back into the (c)(3) if and as needed. The
Court was – by this point – quite skeptical of anything she had to say.
(2) She argued that much of the money represented
compensation to either her or both Dr O and her.
This was her best argument, but unfortunately this route was closed to her.
You see, AMMC should have issued W-2s if it intended for the monies to represent compensation. The tax-exempt did not issue W-2s for 2014. It did not even authorize compensation in its minutes. Some things have to be done currently, and this is one of those things.
A W-2 (or 1099) would have saved a penalty equal to twice its face amount. That is, a $26,000 W-2 to Dr O would have saved a penalty of $52,000 ($26,000 times 200%).
It was a worst-case scenario for the O’s.
Then again, they abused AMCC. That money did
not belong to the O’s. It belonged to the (c)(3). The exempt purpose of AMMC was to assist the poor with access to medical care, not to enrich its founding
family after the loss of a medical license.
Our case this time was Ononuju v Commissioner,
T.C. Memo 2021-94.
