1. Baylor Law School Nonprofit Organizations Spring 2005 Course Federal Standard of Care; Charitable Purpose; Social Welfare Organizations Prepared By: Darren B. Moore Bourland, Wall & Wenzel, A Professional Corporation Attorneys and Counselors City Center Tower II 301 Commerce Street, Suite 1500 Fort Worth, Texas 76102 (817) 877-1088 (817) 877-1636 (facsimile) E-mail: dmoore@bwwlaw.comdmoore@bwwlaw.com ©Bourland, Wall & Wenzel, P.C.

2. Federal Standard of Conduct Self-Dealing Excess Benefit Transactions

3. Private Foundation Per § 509(a): Organization described in § 501(c)(3) other than the following: –Traditional public charities –Publicly supported charities –Supporting organizations –Public safety testing organizations (i.e. § 501(c)(3) is a private foundation if it fails to qualify as a public charity)

4. Public Charity Traditional charities (hospitals, churches, etc.) Publicly supported (aka gross receipts) charities (receive substantial amount of support from public or governmental agencies) Supporting Organizations (take status from supported organization)

5. Self-Dealing (PF) § 4941 – Any conflict of interest transaction between an insider (disqualified person) and the organization –Fairness to organization irrelevant –Awareness by person involved that the acts constituted self-dealing irrelevant –Consequence is excise tax

6. Self-Dealing (Insiders) 1.Foundation Managers (officers, directors, trustees) 2.Substantial contributors (greater of 2% of total contributions for tax year or $5000) 3.20% Owners (owner of 20%+ power of organization that is a substantial contributor) 4.Family Member of (1), (2) or (3) (spouses, ancestors, children, grandchildren, great grandchildren) 5.35% owned entities (organizations more than 35% controlled by any of the above)

7. Self-Dealing Transactions 1.Sale, exchange or leasing of property (unless leased to PF free of rent) 2.Lending of $$ or extension of credit (unless lent to PF interest free) 3.Furnishing of goods, services or facilities (unless provided on same basis as to general public) 4.Payment of compensation or reimbursement of expenses that are not reasonable and necessary to accomplish an exempt purpose 5.Transfer to or use by or for the benefit of a DQP of any of the income or assets of PF 6.Certain agreements to pay a government official

8. Self-Dealing Consequences Two tier excise tax on DQP 1.5% of amount involved for each year (2.5% on foundation manager participating unless unaware act was self-dealing and not willful) - a DQP who is also a Foundation Manager can be subject to both 2. If not corrected in a timely manner, second- tier tax of 200% on DQP and 50% on foundation manager)

9. Self-Dealing Consequences “Amount involved”: the greater of the amount of money and the fair market value of the property given or the amount of money and fair market value of the other property received (§ 4941(e)(2)) First tier tax cannot be abated by IRS even for reasonable cause (§ 4962(b))

10. Self-Dealing (Estate of Reis) Courts have consistently held that statutory scheme of excise taxes is a valid legislative response to perceived abuse in use of PF’s Interest of PF in property of an estate (as a beneficiary of the estate) is an asset of the PF for self-dealing purposes (prohibits indirect self- dealing) Benefit to the DQP doesn’t have to be pecuniary but must be significant as opposed to tenuous

11. Excess Benefit Transactions Applies intermediate sanctions (excise taxes) on DQP’s who benefit improperly and on organization managers who participate in such transaction Applies to public charities and social welfare organizations Overlaps concepts of private inurement discussed later in course

12. Excess Benefit Transactions § 4958(c)(1): Any transaction in which an economic benefit is provided by an applicable tax-exempt organization directly or indirectly to or for the use of any DQP if the value of the economic benefit provided exceeds the value of the consideration (including the performance of services) received for providing such benefit.

13. EBT: Disqualified Persons 1.Any person who was in a position to exercise substantial influence over the affairs of the TE organization at any time during a 5 year period ending on the date of the transaction 2.A family member of a person of substantial influence 3.An entity that is 35% controlled by (1) or (2) **Beware: this is a different definition from PF DQP’s.**

14. Substantial Influence President, CEO, COO Treasurer, CFO Voting member of the governing body Persons with a material financial interest in a provider-sponsored organization (e.g. nonprofit hospitals)

15. Persons Deemed Not to Have Substantial Influence § 501(c)(3) organizations Certain § 501(c)(4) organizations Employees receiving economic benefits of less than a specified amount in a taxable year

16. Facts & Circumstances Tending to Show Substantial Influence Founder of organization Substantial contributor Compensation primarily based on revenues derived from activities of the organization Has or shares authority to control/determine substantial portion of the organization’s capital expenditures Managerial authority or key advisor to person with managerial authority Has controlling interest in a corporation, partnership or trust that is a DQP

17. Facts and Circumstances Tending to Show No Substantial Influence Person is an independent contractor Person has taken a vow of poverty Preferential treatment offered to all making comparable donations Direct supervisor of the person is not a DQP

18. Excess Benefit Transaction Consequences Two tier excise tax on DQP 1.First tier tax of 25% of the excess benefit - can be abated under certain circumstances 2.If not corrected in a timely manner, second-tier tax of 200% of the excess benefit Organization manager who knowingly participates pays a tax of 10% of the excess benefit not to exceed $10,000

19. Correcting an Excess Benefit Transaction An excess benefit transaction is corrected by undoing the excess benefit to the extent possible, and taking any additional measures necessary to place the applicable tax-exempt organization involved in the excess benefit transaction in a financial position not worse than that in which it would be if the DQP had been dealing under the highest fiduciary standards. (Treas. Reg. § 53.4958-7(a))

20. Practical Correction 1.Return the “correction amount” (the excess benefit plus interest) 2.Return the specific property where excess benefit was transfer of property (organization must agree) - DQP (and family members) cannot vote on whether to accept the property as correction

21. Caracci v. Commissioner Ouch!!!

22. Unreasonable Compensation as an Excess Benefit Compensation must be reasonable in relationship to the value of the services rendered –Compensation paid by similarly situated organizations for comparable positions –Availability of similar services in geographic area –Current compensation surveys by independents firms –Written offers from competitors for the employee

23. EBT: Compensation Organization must clearly indicate intent to treat the economic benefit as compensation when the benefit is paid –Written contemporaneous substantiation Employment contract W-2, 1099, 990 DQP reports on 1040 Exception: amounts excluded from gross income (e.g. employer-provided health benefits)

24. EBT Compensation: Rebuttable Presumption of Reasonableness Transaction approved by an authorized body of the organization composed of non- conflicted individuals Prior to making determination, authorized body obtained and relied upon appropriate comparability data Authorized body adequately documents basis for determination concurrently with making decision

25. Excess Benefit Transactions (Misc) Applies to churches (although IRS must still follow church audit act) Applies only to post-September-1995 transactions Does not replace revocation of exemption –Has organization been involved in repeated excess benefit transactions? –Size and scope of excess benefit transaction –Safeguards implemented following transaction –Compliance with other applicable laws

26. Registered Nonprofit Organizations by IRC Subsection (National)(2003) Source: National Center for Charitable Statistics, Urban Institute Doesn’t include most religious congregations.

27. Charitable Organizations § 501(c)(3) Why choose to be a 501(c)(3)? –Not required to pay income taxes –May elect not to pay federal unemployment taxes –Ability to attract deductible contributions –State tax exemptions

28. § 501(c)(3) Elements 1.Proper organizational structure 2.Organized exclusively for charitable purposes 3.Operated exclusively for charitable purposes 4.No part of net earnings inures to benefit of private individual 5.Not an action organization 6. > - not violative of public policy

29. Entitlement to Tax Exemption Should the government subsidize certain activities? –If so, what types? All types? Should the government provide a double subsidy for charitable, religious, educational organizations? Should there be limits on an organization’s ability to qualify as charitable, religious, educational? –What should the standard be for each? –Who should determine if the standard is met?

30. Organizational/Operational Tests Organizational Look to enabling documents Must be organized exclusively for charitable purpose(s) May be general or specific Operational Look at actual activities of organization Must be operated exclusively for charitable purpose(s) May not engage in substantial activities that fail to further charitable purposes More often the basis for revocation

31. Charitable Purpose “Primary” purpose must be charitable (“exclusive” doesn’t mean “sole”) Charitable purposes: –Relief of poverty –Advancement of education & religion –Promotion of health –Governmental purpose –Social welfare BBB v. United States

32. Social Welfare Organizations “[c]ivic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare...” “exclusively” again means “primarily”

33. Social Welfare Organizations: Can qualify as exempt under § 501(c)(3) or (c)(4) with purposes to further common good and benefit community § 501(c)(3) –Contributions are deductible –Cannot be involved in political campaigns –Cannot have a primary purpose of lobbying § 501(c)(4) –Contributions not deductible –Can have some involvement in political campaigns (not a primary purpose) –Can have as a primary purpose lobbying Regan v. Taxation with Representation

34. Social Welfare Organizations 1.Commensurate with the “common good and general welfare” of the community 2.Doesn’t include activities that primarily constitute “carrying on business with the general public in a manner similar to organizations operated for profit” 3.Must benefit community as a whole rather than merely benefiting the organization’s membership or other select group of individuals or organizations What is community???

35. Advocacy Groups Attempts to influence legislation May operate to inform public on controversial subjects even though advocating a particular viewpoint Q: Why is this beneficial to the community? Cannot have as a primary purpose intervention on behalf of or in opposition to a candidate for public office.

36. Next Week Federal Tax Exempt Status Read pp. 196-265