Seeking Tax Exempt Status By Lessening The Burden Of Government

Let’s introduce Captain Obvious: if you want charitable tax-exempt status from the IRS, you need to have a charitable purpose.

Let’s look at New World Infrastructure Organization’s application for tax-exempt status.

It starts with two individuals: Scott and Pam Johnston.

They owned a business called The Pipe Man Corp (TPMC). Scott was the president and Pam the vice-president

TPMC was organized to develop a portable pipe manufacturing system, working and shaping pipe in larger-than-usual sizes. Combine these pipes with road infrastructure and a business opportunity was created.

TPMC never got started. I guess it needed angel investors, and the investors never appeared.

The Johnstons then organized a nonprofit corporation called New World Infrastructure Organization (New World).  Scott and Pam were its only officers and directors. TPMC granted New World permission to use its copyrights and patents, whatever that meant, given that Scott and Pam were the only two officers and were on both sides of the equation.

New World submitted an application for tax-exempt status, stating that its …

… ultimate purpose and core focus will be charitable, with … [its] main beneficiary being Federal, State and Local Government Agencies.

OK, its purpose has something to do with government.

… our research will result in encouraging Economic Development throughout the United States. It will save time, money and lessen the burden of government. The prototype machinery, after testing, will be placed into service making very large corrugated metal pipe. The pipes need to make a Highway Overpass can be made and arched in less than a week. The cost of these pipes represent a fraction of the cost of traditional methods.”

Lessening the burden of government can be a charitable mission. For tax-exempts, this generally means that a governmental unit considers the organization to be acting on its behalf. The organization is freeing up resources – people, material, money – that the governmental unit would have to devote were it to conduct the activity itself.   

It would be helpful to present a prearranged understanding with one or more government units, especially since New World was hanging so much of its hopes on the lessening-the-burden-of-government hook.

Helpful but not happening.

I am not clear how New World was lessening anything.

According to the narrative description, … [New World] intends to fulfill its charitable purpose by working with governmental agencies, engineering firms, and businesses to reduce the cost of infrastructure projects to ‘as little as one fourth current costs.’”

Wait a second. Is New World saying that its exempt purpose was to reduce the cost of projects to the government? That is not really an exempt purpose, methinks. Let’s say that you start a business and guarantee the government that you will beat a competitor’s price by 10%. That may or may not be a good business model, but you are still in business and still for-profit. Maybe a little less profit, but still for-profit.

How about if New World provided its services at cost?

… while petitioner has suggested … that it would be willing to enter into an exclusivity agreement … to sell its product at cost, it has not established through its bylaws or otherwise that it would in fact do so.”

Seems that New World wanted a profit. It is not clear what it would do with a profit, although there is the old reliable saw of paying-out profits via salaries and bonuses to its two officers and directors.

The Court saw a failed business effort slapped into a tax-exempt application. The supposed charitable purpose was to offer a lower price on infrastructure projects, which was not quite as inspiring as clothing the poor or feeding the hungry. It appeared that no governmental unit had asked to have its burdens reduced. It further appeared that there was a more-than-zero possibility of personal benefit and private inurement to the Johnstons.

Why even go to all this effort?    

I suppose the (c)(3) status would have allowed New World to obtain the funding that its predecessor – TPMC – was unable to obtain. TPMC would have issued stock or borrowed money. New World would have raised capital via tax-deductible charitable contributions.   

The Tax Court said no dice.

Our case this time was New World Infrastructure Organization v Commissioner, T.C. Memo 2021-91. 

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.

Trust Fund Penalty When Your Boss Is The U.S. Government

You may be aware that bad things can happen if an employer fails to remit payroll taxes withheld from employees’ paychecks. There are generally three federal payroll taxes involved when discussing payroll and withholding:

(1)  Federal income taxes withheld

(2)  FICA taxes withheld

(3)  Employer’s share of FICA taxes

The first two are considered “trust fund” taxes. They are paid by the employee, and the employer is merely acting as agent in their eventual remittance to the IRS. The third is the employer’s own money, so it is not considered “trust fund.”

Let’s say that the employer is having a temporary (hopefully) cash crunch. It can be tempting to borrow these monies for more urgent needs, like meeting next week’s payroll (sans the taxes), paying rent and keeping the lights on.  Hopefully the company can catch-up before too long and that any damage is minimal.

I get it.

The IRS does not.

There is an excellent reason: the trust fund money does not belong to the employer. It is the employees’ money.  The IRS considers it theft.

Triggering one the biggest penalties in the Code: the trust fund penalty.

We have in the past referred to it as the “big boy” penalty, and you want nothing to do with it. It brings two nasty traits:

(1)  The rate is 100%. Yep, the penalty is equal to the trust fund taxes themselves.

(2)  The IRS can go after whoever is responsible, jointly or severally.

Let’s expand on the second point. Let’s say that there are three people at the company who can sign checks and decide who gets paid. The IRS will – as a generalization – consider all three responsible persons for purposes of the penalty. The IRS can go after one, two, or all three. Whoever they go after can be held responsible for all of the trust fund taxes – 100% - not just their 1/3 share. The IRS wants its money, and the person who just ponied 100% is going to have to separately sue the other two for their share. The IRS does not care about that part of the story.

How do you defend against this penalty?

It is tough if you have check-signing authority and can prioritize who gets paid. The IRS will want to know why you did not prioritize them, and there are very few acceptable responses to that question.

Let’s take a look at the Myers case.

Steven Myers was the CFO and co-president of two companies. The two were in turn owned by another company which was licensed by the Small Business Administration as a Small Business Investment Company (SBIC).  The downside to this structure is that the SBA can place the SBIC into receivership (think bankruptcy). The SBA did just that.

In 2009 the two companies Myers worked for failed to remit payroll taxes.

Oh oh.

However, it was an SBA representative – remember, the SBA is running the parent company – who told Myers to prioritize vendors other than the IRS.

Meyers did so.

And the IRS slapped him with the big boy penalty.

QUESTION: Do you think Myers has an escape, especially since he was following the orders of the SBA?

At first it seems that there is an argument, since it wasn’t just any boss who was telling him not to pay. It was a government agency.

However, precedence is a mile long where the Court has slapped down the my-boss-told-me-not-to-pay argument. Could there be a different answer when the boss is the government itself?

The Court did not take long in reaching its decision:

So, the narrow question before us is whether …. applies with equal force when a government agency receiver tells a taxpayer not to pay trust fund taxes. We hold that it does. We cannot apply different substantive law simply because the receiver in this case was the SBA."

Myers owed the penalty.

What do you do if you are in this position?

One possibility is to terminate your check-signing authority and relinquish decision-making authority over who gets paid.

And if you cannot?

You have to quit.

I am not being flippant. You really have to quit. Unless you are making crazy money, you are not making enough to take on the big-boy penalty.

The Nick Saban Tax

Have you heard about the “Nick Saban” tax?

Let’s set it up.

There has been a longstanding tax provision limiting the deduction for public company executive compensation to $1 million. Mind you, this is not a restriction on how much you can pay an executive; the restriction only applies to how much you can deduct on a tax return. The restriction does not apply to all executives, either; it applies to the CEO, CFO and three other most-highly-paids.

But there was an exception large enough for the Fortune 500 to drive through. The exception was for “performance.” Magically and almost overnight, virtually all executive compensation packages became based on “performance.” Options were considered performance-based, and eventually options came to be passed around like candy. Realistically, one had to refuse to do any tax planning for this provision to actually apply.

This changed with the Tax Cuts and Jobs Act passed in December, 2017. Congress tightened up this code Section (162(m)) by taking away the performance exception. The $1 million cap now has a real bite.

But Congress was still looking for money.

Congress decided to put the same $1 million compensation limit on nonprofits.

This creates a quandary, as nonprofits (generally) do not pay tax. If I were a nonprofit executive and Congress threatened to disallow my deduction, I would not be feeling the tremulous fear of my for-profit peers.

Congress thought of that. They decided that the nonprofit would pay a 21% tax on my behalf.

Whoa. Now you have my attention. Granted, the tax is not on me, but we all know how this works in the real world. Only small children and Congress believes in free. The rest of us have to pay.

Congress passed a tax provision applying the $1 million cap to the five highest- paid employees of a 501(a), which includes a 501(c)(3). Think nonprofits, certain hospitals, colleges and universities and the like.

BTW medical professors were excluded from this, so it appears clear that Congress was trying to reach the athletics programs and their coaches.

But there is a problem.

Here is Code section 4960 imposing the tax:

       (c)  Definitions and special rules.

For purposes of this section-

(1)  Applicable tax-exempt organization.

The term "applicable tax-exempt organization" means any organization which for the taxable year-

(A)  is exempt from taxation under section 501(a) ,

(B)  is a farmers' cooperative organization described in section 521(b)(1) ,

(C)  has income excluded from taxation under section 115(1) , or

(D)  is a political organization described in section 527(e)(1) .

What is that Section 115(1)?

         § 115 Income of states, municipalities, etc.

Gross income does not include-

(1)  income derived from any public utility or the exercise of any essential governmental function and accruing to a State or any political subdivision thereof, or the District of Columbia; or …

What does this mean?

Congress thought that – by extending Section 4960 to reference Section 115(1) – it would reach those entities exempt via Section 115(1).

Entities such as Alabama.

Or the University of Alabama.

Why?

Because the University of Alabama is an instrumentality of the state of Alabama.

And here the tax law goes wonky.

The Courts have looked at the interaction of Sections 115(1) and 511(which is the unrelated business income tax which applies to a nonprofit). Can a state instrumentality (say a university) run a business – say a farm-to-table restaurant chain – and avoid the unrelated business income tax because of Section 115(1)? If that were the case, then Illinois could start a chain called Outfront Steakhouse, make a zillion dollars and never pay tax because of Section 115(1).

The Courts have clarified that is not the case. There is a limit to Section 115(1).

According to that reasoning, it seems to me that Congress should be able to tax those university salaries.

But there is another argument – the doctrine of implied statutory immunity. This arises from our federalist system of government: the federal government has to respect the state government. Under this theory, if the federal government wants to tax a state, it has to say so in an unambiguous manner – that is, it cannot be “implied.”

Continuing our example, if the federal government wanted to tax Illinois for opening a steakhouse chain and locating them adjacent to every Outback Steakhouse location throughout the land, it would have to say something like:

… the [] tax will apply to an entity relying upon Section 115(1) for nontaxability of their [] business activity should that activity be the same or substantially similar to a business activity conducted by a for-profit restaurant chain.”

That is explicit. That breaches implied statutory immunity. The tax would then stick.

Is that what Congress did with the new Section 4960(c) tax?

Nowhere close, it appears.

Under that reasoning the University of Alabama will not pay the Nick Saban tax, as the tax does not reach the University of Alabama.

There are universities clearly affected by this new law: Duke, for example, or Northwestern. They have to pay up. Think of it as the difference between a “public” university and a “tax-exempt” university.

But having the state name in the university’s name, however, does not mean that the university is exempt as “public.” It depends on how the university was organized and chartered. Texas A&M will be affected by the new tax provision, but the University of Texas - Austin will not. It is enough to give one a headache.

What happens next?

The easiest path is for Congress to revise Code section 4960 and clean up the language. Without Congressional action, you can be certain the “public” universities will litigate this matter. They have to.

But the likelihood of the present Congress accomplishing anything seems unlikely, at best.

Tax Break For Wealthy (Federal Government) People

Let's talk about a tax break; some may even call it a gimmick. It will never affect your or me, unless we go into the federal government.

Here is Code section 1043:

Sale of property to comply with conflict-of-interest requirements 

(a) Nonrecognition of gain

If an eligible person sells any property pursuant to a certificate of divestiture, at the election of the taxpayer, gain from such sale shall be recognized only to the extent that the amount realized on such sale exceeds the cost (to the extent not previously taken into account under this subsection) of any permitted property purchased by the taxpayer during the 60-day period beginning on the date of such sale.

(b) Definitions

For purposes of this section -

(1) Eligible person

The term "eligible person" means -

(A) an officer or employee of the executive branch, or a judicial officer, of the Federal Government, but does not mean a special Government employee as defined in section 202 of title 18, United States Code, and

(B) any spouse or minor or dependent child whose ownership of any property is attributable under statute, regulation, rule, judicial canon, or executive order referred to in paragraph (2) t a person referred to in subparagraph (A).

Let's say that you are pulling down several million dollars a year from your day job. You have the opportunity to head-up the EPA or the National Park Service. It is almost certain that your paycheck will shrink, and the Congressional committee investigating you may request you sell certain investments or other holdings to avoid conflict of interest concerns.

Folks, this is an uber-elite tax problem.

To ease your decision, the tax Code will allow you to sell your investments without paying any tax. To do so you are required to buy replacement securities within 60 days, and the non-taxed gain will reduce your basis in the new securities.

OBFUSCATION ALERT: To say it differently, your "basis" in the old securities sold will carry-over as your basis in the new securities.

By way, it is not necessary to have Congress to tell you to unload your investments. There is a more lenient "reasonably necessary" standard that might work for you. I am reasonably certain I could come up with some necessary argument so I would not pay tax.

While sweet, Section 1043 is not a complete escape clause. If you think about it, all you have done is delay the taxable gain until you sell the new securities. I suppose an escape clause is to die without selling, but I generally do not consider dying to be a viable tax strategy.

The numbers can add-up, though. It is estimated that Paul O'Neill, a former Treasury Secretary, sold approximately $100 million of Alcoa stock when he took the position. I do not know what the gain would have been (as we do not know the cost), but the tax he deferred must have been eye-opening.

By the way, you can get the same break by drawing a judicial appointment.

I do have a question: do you wonder why the politicos never mention Section 1043 whenever they rail against "tax breaks" used by wealthy people?

Nah, there is no wonder at all.

Sequestration And IRS Furloughs

Last Friday the IRS sent an e-mail alerting its employees that furlough notices are looming, beginning today.

           

Everyone is covered by this furlough, and that means everyone from the acting commissioner and executives to managers and employees,” said acting IRS Commissioner Steven Miller.

For your planning purposes, the first furlough days will be May 24, June 14, July 5, July 22 and August 30, with another two days possible in August or September.”

The National Treasury Employees Union President Colleen M. Kelley added her penetrating economic insight with the following:

Furloughing IRS employees is further evidence of the ongoing damage sequestration is causing across the country.”

Sure. It’s virtually post-apocalyptic out there.

You may remember that sequestration cuts kicked-in upon failure to arrive at a federal budget. Sequestration amounts to approximately 2 pennies per federal dollar – hardly an intimidating amount to almost anyone not drawing a government check. On the flip side, so may programs are excluded – social security, Medicare, Obama’s vacations – that the unprotected programs are facing much more than 2% average cuts.

Furlough means that IRS employees will be taking days off without pay. The financial effect will vary from family to family, of course, but it is unwelcome news.

Kudos to the IRS for not proceeding with furloughs during the filing season. It was already a difficult season, with a tax bill signed in January and a corresponding delay in the IRS accepting certain tax schedules and forms.