Why Does The IRS Want To Tax Donations Raised For A Cancer Patient?

Have you heard of a website called GoFundMe?

We are talking crowdfunding, and the technology is a dozen or so years old. It is made possible by the internet. Think of a cause, a website and a means to process payments from interested parties. The cause can vary. It might be a business startup, unexpected medical expenses, a legal defense or even a wedding fund.

There are number of crowdfunding websites, bit today our story involves GoFundMe.

I am reading the story of Casey Charf, a young Omaha woman who in 2013 was involved in a bad car crash. She had broken her neck and back. While in the hospital the doctors discovered that she had cancer.

She was interviewed by local television and her story went viral. There were fundraisers for her medical expenses, and toward that end her sister set up a GoFundMe account.

More than a thousand people donated online, raising over $50,000.

Casey has spent the last two years on medical travel and receiving treatment. The cancer unfortunately is still there, but at least it does not appear to be spreading.

In March of this year the IRS dropped in. They sent a notice that the monies raised through GoFundMe should have been reported as taxable income, and to please remit over $19 thousand in taxes, penalties and interest.

Needless to say Casey Charf is contesting the matter.

And I think she will win.

I speculate, but I think I know what triggered the IRS notice. I suspect Casey received a Form 1099-K notice.

The IRS uses the Forms 1099 series to have a third party report amounts paid you and likely representing income. A bank would send you a Form 1099-INT for interest paid on your savings, for example.

The 1099-K follows in that spirit, but it is sent by payment processors. This immediately tells us that we are dealing with debit or credit cards. Why did this enter the tax Code? Think eBay. People were conducting business activities but not sending the government its due. Congress therefore mandated that the companies that processed the payments issue annual 1099s, and it delegated to the IRS how to handle further details.

The IRS published Form 1099-K and said that the payment processor was required to file the form if (1) gross payments to a person exceeded $20,000 or (2) there were more than 200 transactions with a given person.    

GoFundMe uses WePay as its payment processor. I am willing to bet nickels to dollars that WePay issued a 1099-K to Casey Charf.

And the IRS sent a notice.

Why?

Because the IRS presumes that 1099-Ks are for business activity.

I suspect the IRS was trying to find a “business” number on the tax return that matched or exceeded the 1099-K. Finding none it churned out a notice.

Can the IRS not tell that monies are being raised for a charitable cause?

In short, no, not really.

And there is the unfortunate, inside truth of today’s IRS: every year more and more functions are being automated. The practice started out innocently enough: have third parties send information to the IRS and then have IRS computers match that information to your tax return. 

That worked well enough years ago, when reporting requirements were much lighter. They are becoming – if they haven’t already become – onerous, as the IRS wants to know every creak in the economy so Congress can tax it. Many of these notices are wrong, but they still cause angst and cost taxpayers professional fees. The dirty secret is that the IRS is intentionally shifting the cost of administering tax law to taxpayers with all these notices. They can send out anything and force you to explain how they are wrong. Fail to explain and the IRS can (and likely will) assess you.

Back to our story.

I see no reasonable tax theory under which these payments are income to Casey. There is no business activity, nor is there an employment or contractor relationship providing a backdrop for earnings from personal services. I suppose one could argue that it is akin to a lottery or bag of money found on the street, but that seems a stretch.

There is a donative intent, although as structured the amounts raised do not appear to rise to the level of a tax-deductible donation. There are strict rules with deducting payments made directly to an individual, and for the most part they require the participation of a 501(c)(3).

From a tax perspective these payments most closely resemble a gift. Gifts are not taxable.

Which is why I believe Casey Charf will win on this issue.

More importantly, may Casey have a full and speedy medical recovery.

The NFL Is Giving Up Its (c)(6) Tax Status

So the NFL is going to relinquish its 501(c)(6) status, meaning that it will start filing as a regular, tax-paying corporation.

And I doubt it means much, unless someone simply has simply lost the plot when it comes to the NFL.

Let’s talk about it.

The gold-plate among tax-exempts is a 501(c)(3), which would include the March of Dimes, Doctors Without Borders and organizations of that type. The (c)(3) offers two key benefits:

(1)  Donations made are deductible, which is especially important to individuals.

(2)  Donations received are not taxable.

Point (1) is important because individuals are allowed only a limited plate of deductions, unless the individual is conducting a business activity. Point (1) is probably less important to a business, as the business could consider the donation to also be advertising, marketing, promotion or some other category of allowable deduction. An individual unfortunately does not have that liberty.

Point (2) represents the promised land. We would all like our income to be nontaxable.

The NFL is a (c)(6), which means that it does not receive benefit (1). It does not need benefit (1), however, as no one is trying to claim a donation.

Here is how the tax Code describes a (c)(6):

Business leagues, chambers of commerce, real-estate boards, boards of trade, or professional football leagues (whether or not administering a pension fund for football players), not organized for profit and no part of the net earnings of which inures to the benefit of any private shareholder or individual.

By the way, are you curious how the words “professional football leagues” got in there?

The NFL had been a nonprofit going back into the 1940s. During the 1960s it faced a challenge from the Al Davis and American Football League. An easy way to defuse an enemy is to recruit the enemy, and the NFL was talking to the AFL about merging. There was an issue, however, and that issue was antitrust. There were two leagues playing professional football, and there was a proposal on the table to combine them.

This made the proposed merger political.

It also meant that one had to go through Senator Russell Long, an extremely powerful senator from Louisiana.

Pete Rozelle, the then NFL commissioner, had an idea. What if the NFL “expanded” the league to include a team in Louisiana? Senator Long was quite interested in that turn of events.

And that is how we got the New Orleans Saints.

And, around that time, Congress amended the Code to include the words “professional football leagues.”

Back to our story.

So the NFL does not care about benefit (1). The reason is that the NFL does not receive monies from individuals like you and me. It receives money from its business members, which are the 32 NFL teams. Each team is a corporation, and payments by them to the NFL may be deducted a hundred ways, but none of those ways can be called a “donation.”

Notice that the “NFL” that is giving up its tax exempt status is NOT the individual teams. The “NFL” under discussion is the league office, the same office that organizes the draft, reviews and revises game rules, hires referees, and negotiates labor agreements with the players union. Each individual team in turn is a separate corporation and pays tax on its separate profits.

So is the league office a money-making machine, committing banditry by being tax-exempt?

Here I believe is the real reason for the NFL’s decision to relinquish its (c)(6): the NFL is tired of explaining itself. The NFL is an easy target, and the issue brings bad press when the NFL is trying to create good press, especially after recent issues with domestic violence and player concussions.  

But to give up the promised land of taxation…?!

Why would they do that?

What if there was no profit left once the league paid everything? You have to have a profit before there can be a tax.

That is, by the way, (c)(6)’s are supposed to work. They are not a piggybank. They are intended to promote the interests of their members, whatever that means in context. Years ago, for example, I worked on the tax filings for the Cincinnati Board of Realtors, a classic (c)(6). You can readily presume that its interests are to promote the recognition, status and earning power of realtors in the Cincinnati real estate market.

The same way the NFL promotes its teams in a sports universe including Major League Baseball, the NHL, NBA, NCAA sports, MMA and so on.

How about the $44 million salary to Commissioner Roger Goodell? Is it outrageous for a tax-exempt to pay a salary of this amount?

Outrage is a tricky thing. Someone might be outraged that a tag-a-long politician has become rich by having her ex-President husband steer – and then drain – donations to a family foundation while she was serving as secretary of state.

Let’s replace “outrage” with something less explosive: is it reasonable for the NFL to pay Goodell $44 million?

Well, let’s consider an alternative: each team pays Goodell 1/32nd of his salary directly.

The financial and tax effect is the same, although this structure may be more acceptable to some people.

So the NFL league office is going to be taxable.

And I am looking at the NFL’s Form 990 for its tax year ended March 31, 2013. For that year, the excess of its revenues over expenses was almost $9 million.

How I wish that were me. I would be blogging as the Travelling-Around-The-World Tax Guy.

Nine million dollars would trigger some serious tax, right?

Wait.

I also see on the Form 990 that the year before there was a loss of more than $77 million.

Ouch. That, in the lingo of a tax-paying corporation, is a net operating loss (NOL). It can be carried forward and deducted against profits for the next 20 years.

Let’s assume that $9 million or so profit for the NFL is a reasonably repetitive number.

Have we eliminated any tax payable by the NFL for the next eight or more years?

No, it will not work that way. The NOL incurred while the NFL was tax-exempt will not be allowed as a deduction when it becomes tax-paying. However, if it happened once, it can happen again – especially if the tax planners REALLY want it to happen.

Even if it doesn’t happen, the federal tax would be around $3 million, which is inconsequential money to billionaire team owners who are trying to maximize their good press and minimize their bad.

And remember: tax returns filed by a tax-paying corporation are confidential. There will be no more public disclosure of Goodell’s salary.

Although if I made $44 million, I would post my W-2 on Facebook.

Less-Than-10% Shareholders Responsible For Corporate Income Tax

I have a question for you:  if you and I work for a company and it goes bankrupt, might we have to pay back some of the money we were paid?

The answer – presumptively – is no, as long as we were employees and received payment as fair compensation for our services.

Let’s stir the pot a bit, though, and say that you and I are shareholders – albeit (very) minority shareholders. What if there were bonuses? What if we received dividends on our stock?

Let’s talk about Florida Engineered Construction Products Corp (FECP), also known as Cast Crete Corporation.

FECP had the luck of being a concrete company in Florida in the aughts when the housing market there was booming. FECP had four shareholders, but the two largest (John Stanton and Ralph Hughes) together owned over 90 percent. The balance was owned by William Kardash, who was an engineer, and Charles Robb, who headed sales.

FECP made madman-level money, although they reported no profits to the IRS.

CLUE: If one is thinking of scamming the IRS, one may want to leave a few dollars in the till. It does not take a fraud auditor to wonder how a company with revenues over $100 million uniformly fails to report a profit – any profit – year after year.

The numbers are impressive.  For example, FECP paid Messrs. Hughes and Stanton interest of the following amounts:

                                          Hughes                      Stanton

            2005                    $5,147,000              $4,250,000

            2006                    12,914,000             12,101,000

            2007                      6,468,000               9,046,000

FECP also paid hefty dividends, paying over $41 million from 2005 through 2007.

I am thinking this was a better investment than Apple stock when Steve Jobs came back.

What was their secret?

It started off by being in the right place at the right time. And then fraud. FECP had a loan with a bank, and the bank required an annual audit. FECP made big money quickly enough, however, that it repaid the bank.  Rest assured there were no further audits.

Mr. Stanton opened a bank account in FECP’s name. Problem is that the account did not appear on the company’s books. When the accountants asked what to do with the cash transfers, he told them to “mind their own business.” The accountants, having no recourse, booked them as loans. Eventually they just wrote the amounts off as an operating expense.

COMMENT:  Here is inside baseball: if you have questions about someone’s accounting, pay attention to the turnover in their accounting department, especially the higher-level personnel. If there is a different person every time you look, you may want to go skeptical.

Those massive interest payments to Messrs. Stanton and Hughes? There were no loans. That’s right: neither guy had loaned money to FECP.  I cannot help but wonder how the loans got on the books in the first place, but we are back to my COMMENT above.

Mind you, our two minority shareholders – Kardash and Robb – were making a couple of bucks also. They had nice salaries and bonuses, and they received a share of those dividends.

Proceed into the mid-aughts and there was a reversal in business fortune. The company was not doing so well. They cut back on the bonuses. The two principal owners however wanted to retain Kardash and Robb, so they decided to “loan” them money – to be paid out of future profits, of course. There were no loan papers signed, no interest was required, and Kardash and Robb were told they were not expected to ever “pay it back.” Other than that it was a routine loan.

Do you wonder where all this money was coming from?

FECP filed fraudulent tax returns for 2003 and 2004, reporting losses to Uncle Sam.

Ouch.

FECP tightened up its game in 2005, 2006 and 2007: they did not file tax returns at all.

Well, if you are going to commit tax fraud ….

But the IRS noticed.

After the mandatory audit, FECP owed the IRS more than $120 million. FECP agreed to pay back $70,000 per month. While impressive, it would still take a century-and-a-half to pay back the IRS.

Mr. Stanton went to jail. Mr. Hughes passed away. And the IRS wanted money from the two minority shareholders – Kardash and Robb. Not all of it, of course not. That would be draconian. The IRS only wanted $5 million or so from them.

There is no indication that Kardash and Robb knew what the other two shareholders were up to, but now they had to reach into their own wallets and give money back to the IRS.

On to Tax Court.  

And we are introduced to Code section 6901, which allows the IRS to assess taxes in the case of “transferee liability.”

NOTE: BTW if you wondered the difference between a tax attorney and a tax CPA, this Code section is an excellent example. We long ago left the land of accounting.

There is a hurdle, though: the IRS had to show fraud to get to transferee liability.

It is going to be challenging to show that Kardash and Robb knew what Stanton and Hughes were doing. They cashed the checks of course, but we would all do the same.

But the IRS could argue constructive fraud. In this context it meant that Kardash and Robb took from a bankrupt company without giving equal value in return.

The IRS argued that those “loans” were fraudulent, because they were, you know, “loans” and not “salary.” However the IRS had come in earlier and required both Kardash and Robb to report the loans as taxable income on their personal tax returns. Me thinketh the IRS was talking out of both sides of its mouth on this matter.

The Court decided that the “loans” were “compensation,” fair value was exchanged and Kardash and Robb did not have to repay any of it.

That left the dividends (only Stanton and Hughes had loans). Problem: almost by definition there is no “exchange” of fair value when it comes to dividends. FECP was not paying an employee, contractor or vendor. It was returning money to an owner, and that was a different matter.

The Court decided the dividends did rise to constructive fraud (that is, taking money from a bankrupt company) and had to be repaid. That cost Kardash and Robb about $4 million or so.

And thus the Court pierced the corporate veil.

But consider the extreme facts that it required. Stanton and Hughes drained the company so hard for so long that they bankrupted it. That might work if one left Duke Energy and the cleaning company behind as vendors, but it doesn’t work with Uncle Sam.  You knew the IRS was going to look in every corner for someone it could hold responsible.

Pilgrim's Pride, A Senator And Tax Complexity

The Democratic staff of the Senate Finance Committee published a report last month titled “How Tax Pros Make the Code Less Fair and Efficient: Several New Strategies and Solutions.”

I set it aside, because it was March, I am a tax CPA and I was, you know, working. I apparently did not have the time liberties of Congressional staffers. You know the type: those who do not have to go in when it snows. When I was younger I wanted one of those jobs. Heck, I still do.

There was a statement from Senator Wyden, the ranking Democrat senator from Oregon:

Those without access to fancy tax planning tools shouldn’t feel like the system is rigged against them. 

Sophisticated taxpayers are able to hire lawyers and accountants to take advantage of … dodges, but hearing about these loopholes make middle-class taxpayers want to pull their hair out.”

There is some interesting stuff in here, albeit it is quite out of my day-to-day practice. The inclusion of derivatives caught my eye, as that of course was the technique by which the presumptive Democratic presidential nominee transmuted $1,000 into $100,000 over the span of ten months once her husband became governor of Arkansas. It must have taken courage for the staffers to have included that one.

Problem is, of course, that tax advisors do not write the law.  

There are complex business transactions taking place all the time, with any number of moving parts. Sometimes those parts raise tax issues, and many times those issues are unresolved. A stable body of tax law allows both the IRS and the courts to fill in the blanks, allowing practitioners to know what the law intended, what certain words mean, whether those words retain their same meaning as one travels throughout the Code and whether the monster comes to life after one stitches together a tax transaction incorporating dozens if not hundreds of Code sections. And that is “IF” the tax Code remains stable, which is of course a joke.

Let’s take an example.

Pilgrim’s Pride is one of the largest chicken producers in the world. In the late 1990s it acquired almost $100 million in preferred stock from Southern States Cooperative. The deal went bad.  Southern gave Pilgrim an out: it would redeem the stock for approximately $20 million.

I would leap at a $20 million, but then again I am not a multinational corporation. There was a tax consideration … and it was gigantic.

You see, if Pilgrim sold then stock, it would have an $80 million capital loss. Realistically, current tax law would never allow it to use up that much loss. What did it do instead? Pilgrim abandoned the stock, meaning that it put it outside on the curb for big trash pick-up day.

Sound insane?

Well, the tax Code considered a redemption to be a “sale or exchange,” meaning that any loss would be capital loss. Abandoning the stock meant that there was no sale or exchange and thus no mandatory capital loss.

Pilgrim took its ordinary loss and the IRS took Pilgrim to Court.

Tax law was on Pilgrim’s side, however. Presaging the present era of law being whatever Oz says for the day, the IRS conscripted an unusual Code section – Section 1234A – to argue its position.

Section 1234A came into existence to address options and futures, more specifically a combination of options and futures called a straddle. . What options and futures have in common is that one is not buying an underlying asset but rather is buying a right to said underlying asset. A straddle involves both a sale and a purchase of that underlying asset, and you can be certain that the tax planners wanted one side to be capital (probably the gain) and the other side to be ordinary (probably the loss). Congress wanted both sides to be capital transactions (hence capital gains and losses) even though the underlying capital asset was never bought or sold – only the right to it was bought or sold.

This is not one of the easiest Code sections to work with, truthfully, but you get an idea of what Congress was after.

Reflect for a moment. Did Pilgrim have (A) a capital asset or (B) a right to a capital asset?

Pilgrim owned stock – the textbook example of a capital asset.

Still, what is stock but the right to participate in the profits and management of a company? The IRS argued that – when Pilgrim gave up its stock – it also gave up its rights to participate in the profits and management of Southern. Its relinquishment of these rights pulled the transaction into the ambit of Section 1234A.

You have to admit, there are some creative minds at the IRS. Still, it feels … wrong, doesn’t it? It is like saying that a sandwich and a right to a sandwich are the same thing. One you can eat and the other you cannot, and we instead are being wound in a string ball of legal verbiage.

The Tax Court agreed with the IRS.  Pilgrim appealed, of course. It had to; this was a $80 million issue. The Appeals Court has now overturned the Tax Court.

The Appeal Court’s reasoning?

A “right” is a claim to something one does not presently have. Pilgrim already owned all the rights it was ever going to have, which means that it could not have had a right as envisioned under Section 1234A.

The tax law changed after Pilgrim went into this transaction, by the way.

Do I blame the attorneys and accountants for arguing the issue? No, of course not. The fact that an Appeals Court agreed with Pilgrim means the tax advisors were right. The fact that the law was later changed means the IRS also had a point.

And none of the parties involved  – Pilgrim and its attorneys and accountants, the IRS , the Tax Court and the Appeals Court wrote the law, did they?

Although the way Congress works nowadays, they may have been the first ones to actually read the bill-become-law. There perhaps is the real disgrace.