Showing posts with label Exempt Organizations. Show all posts
Showing posts with label Exempt Organizations. Show all posts

Wednesday, June 22, 2011

IRS Disses Doggie Diplomas and Other Developments

FISHER v. U.S., Cite as 107 AFTR 2d 2011-XXXX, 04/19/2011

There has already been a partial decision in this case which I mentioned in a previous post.  The government got summary judgement on whether a restrictions on transferability discount would apply to a single asset family limited partnership.  Apparently that was not the end of the story. After all there are still discounts for lack of marketability (even if they let you sell the damn thing nobody would want to buy it anyway) and minority interest.  This particular decision, which is also not the end of the story is about evidence.  The taxpayers want to bring into evidence what the IRS was originally willing to allow.  The IRS doesn't think that relevant.

The present Motion in Limine seeks to preclude Plaintiff from introducing evidence of the minority interest and lack of marketability discounts used by the IRS in arriving at the February 13, 2006 assessments. See generally dkt. no. 101. The United States contends that because this case involves a de novo review of the fair market value of the property at issue, the calculations of the IRS at the administrative stage are irrelevant. Id. at 4. Plaintiff contends that evidence should be allowed in rebuttal if Mark Mitchell, CPA (“Mitchell”), the United States' expert, testifies that the minority discount should be seven percent rather than the nineteen percent purportedly used by the IRS in the February 13, 2006 assessment. Dkt. No. 105 at 3.



In this case, introduction of evidence of the minority interest discount used by the IRS in the February 13, 2006 assessment is irrelevant. The issue is what the correct minority interest discount is, not what it was previously determined to be. Accord. Janis, 428 U.S. at 440; see also R.E. Dietz Corp. v. United States, 939 F.2d 1, 4 [68 AFTR 2d 91-5238] (2d Cir. 1991) (“The factual and legal analysis employed by the Commissioner is of no consequence to the district court.”). The previously used minority interest discount has no baring on factfinder's de novo determination of the property's fair market value. Because evidence of the previously used minority interest discount is irrelevant, it must be excluded.

This reminds me a little of the Levy case.  They were starting with a 30% discount and took it to a jury which allowed them 0%. (It was also a refund case so being stuck with the 30% was actually as bad as it could get.) In that case the taxpayers were trying to keep out the amount the family actually ultimately received.

Private Letter Ruling 201117036

This was an organization formed to provide credit counselling services that was denied exempt status.

Based on the information you provided in your application and supporting documentation, you are not operated for exempt purposes under section 501(c)(3) of the Code. An organization cannot be recognized as exempt under section 501(c)(3) unless it shows that it is both organized and operated exclusively for charitable, educational, or other exempt purpose. You failed to meet the operational test of section 1.501(c)(3)-1(a)(1) and section 1.501(c)(3)-1(c)(1) of the Regulations because you are organized for substantial private and commercial purposes, and operate in the same manner as a private commercial entity.



To qualify under IRC section 501(c)(3), an organization cannot have a non-exempt purpose that is more than insubstantial. Your primary activity is the provision of pre-bankruptcy certification and post-bankruptcy counseling for fees. You devote most of your time and activities to selling bankruptcy certifications to the general public under the guise of financial counseling. You have not shown that you are operated exclusively to educate individuals for the purpose of improving or developing their capabilities. Rather, the fact that no educational materials will be provided unless the client registers for a counseling session is an indication of operation for a primarily business purpose. Your primary focus is to expand your client base and to issue bankruptcy certificates as quickly as possible in order to generate revenue. Analogous to the organization described in Better Business Bureau of Washington D.C., Inc. v. United States supra, your activities appear to have an underlying commercial motive that distinguishes your educational activities from that carried out by a university or educational institution.

If you want to be recognized as a charity maybe you could kind of like do something charitable.

Private Letter Ruling 201117035

Here the IRS shows its narrow speciesism.  Among the possible purposes that qualify for exemption is "education".  It turns out, though, that it has to be human beings who are being educated.  Doggy University (the name I made up for the anonymous ORG in this ruling) does not qualify.

ORG holds dog obedience training classes, and awards the dogs a degree after completion of the course and also award, them prizes at the shows events. While the owners received some instruction as to the training of the dogs, it is the dog that is primary object of the training.





The nature of obedience training requires that the owner of the dog appear at the classes so that the dog is trained to respond to his owner's commands. While the owner receives some instruction in how to give commands to his dog, it is the dog that is the primary object of the training. The dog is also the primary object of the subsequent training in sporting and show events. Therefore, the organization's training program for dogs is not within the meaning of educational as defined in the regulations.


Dog training in the manner you describe is not exempt purposes as described in IRC section 501(c)(3), because the organization's training program for dogs as well as its dog shows is not within the meaning of educational as defined in the regulations . In fact, you primarily serve the private interests of the dog owners and thus not operated exclusively for 501(c)(3) purposes.



Private Letter Ruling 201117011

Taxpayer was granted 120-day extension from date this letter was issued, to make election under Code Sec. 469(c)(7)(A); to treat all of his interests in rental real estate as single rental real estate activity effective stated year.


Rental activities are "per se" passive.  There is an exception for people in real estate trades or businesses if they meet certain requirements.  They still have to materially participate in the properties.  Absent the election to aggregate the material participation standard can be challenging when there are multiple properties.  Taxpayers who have failed to make the election can sometimes get relief with a late election as the taxpayer in this ruling did.

Thursday, June 9, 2011

Looks Like a Duck -Walks Like a Duck - Talks Like a Duck - Not a Duck

See full size imageThomas F. Chambers, et ux. v. Commissioner, TC Memo 2011-114
U.S. v. MAGGERT, Cite as 107 AFTR 2d 2011-XXXX

For we are taking pains to do what is right,not only in the eyes of the Lord but also in the eyes of men.”2 Corinthians 8:21 From the Evangelical Center for Financial Accountability Seven Standards of Responsible Stewardship

He said he talked to Jesus all the time. Even when he was driving his car. That killed me. I just see the big phony bastard shifting into first gear and asking Jesus to send him a few more stiffs. From The Catcher in the Rye.

The First Amendment tells us that the government should not establish religion.  On the other hand, it also tells us that government is not supposed to interfere with the free exercise of religion.  People with a very secular perspective like the Freedom from Religion Foundation focus on the first aspect.  Deeply religious people might focus more on the second.  The tension shows up in the relationship that IRS has with churches. It is very hands off not requiring the level of reporting that other not for profits are subject to.  On the other hand it is put in the awkward position of having to decide what is and is not a church.  Although this seems to contradict the establishment clause it is necessary so that the sphere of religion where government is hands off does not become a gaping hole that tax cheats drive trucks through. The favorable tax treatment of churches, that in my view is mandated by the free exercise clause, is, quite predictably, a magnet for "phony bastards".  Two recent cases illustrate this problem.

U.S. v Maggert is an extreme case:

Maggert, a dentist, worked for several dental offices as an independent contractor. In 1998, Maggert and his wife attended a seminar by American Rights Litigators (“ARL”) and Eddie Kahn at which they were told they did not have to pay federal income tax. Maggert relayed this information to his accountant, who counseled Maggert against ARL's advice and ended their professional relationship when Maggert persisted. Maggert dissolved his professional association, Mark S. Maggert, D.D.S., P.A., and, from 1998 to 2005, did not file a federal tax return or pay federal income tax.

Eddie Kahn, by the way, was Wesley Snipes "tax adviser". I might have missed that if I wasn't following Joe Kristan's blog.  Joe frequently gets to the same cases I do, usually before I do.

Beginning in 2002, Maggert instructed the accountants for the dental offices where he worked to make his paychecks payable to Total Business Systems, LLC, a Florida corporation, or to Mark's Word of Faith International, a Nevada corporation. The accountants complied and issued Form 1099s, using the corporate identification numbers for these organizations rather than Maggert's social security number. Maggert deposited the paychecks into accounts he opened in these organization's names and withdrew money from the accounts on a regular basis (over $40,000 in 2002, over $52,000 in 2003, $178,000 in 2004 and $128,000 in 2005, for a total of $398,600).

The articles of organization for Total Business Systems, LLC identified the managing member as Geneva Holdings, Inc., in Australia and the registered agent as Ronald Saltzer. The articles of organization were signed by Saltzer and Alan R. Horne, the “Director” of Geneva Holdings, Inc. Saltzer admitted that he knew nothing about Total Business Systems, LLC or Geneva Holdings, Inc., and had never met Maggert or Horne. Saltzer had agreed to act as the registered agent and sign the articles of incorporation in exchange for a meal provided by Eddie Kahn.

Panhandlers are facing a generational problem right now.  I sometimes want to shake the guys to explain to them that they can't be Vietnam veterans if they are more than a couple of years younger than I am.  Offering to be registered agents could open up a whole new field.  Somebody once explained to me that one of the ways to get an individual to take on unlimited liability so you could have a partnership was to trade a bottle of Thunderbird for the signature.  I wonder if cheap wine sales went down when they put in the check the box regulations.  At any rate on to the religious patina of the plan.

The articles of incorporation for Mark's Word of Faith International listed Maggert as the “Presiding Patriarch (Overseer).” Maggert's wife signed the articles of incorporation as a witness and “Scribe.”

It can be the little things that screw up a plan.  If Dr. Maggert wanted to be Patriarch, why couldn't he have made his spouse "Chief Priestess" rather than something that sounds like the medieval version of secretary and reminds you of Pharisees ? Maybe she would have been more enthusiastic.

Maggert's wife admitted there was no such religious organization and that Maggert was not a spiritual leader or priest

We really don't want the IRS inquiring as to who is really a spiritual leader or a priest, but it is these type of shenanigans that makes it necessary.  Sadly, I think that the IRS agents who are tasked with dealing with this nonsense get a little jaded, which may have been part of the problem in the Chambers case.

The case of Thomas Chambers is much more troubling.  It was not being proposed that he be deprived of his liberty but the IRS was asserting a 75% fraud penalty, which is about as bad as it gets short of doing time.  It is pretty clear that Reverend Chambers (and I'm not being ironic with the Reverend) was not running a tax scam:

Mr. Chambers is an ordained minister who, during the years in issue, was the sole pastor of Biblical Church Ministries (sometimes also referred to as Biblical Church or Biblical Church and Global Ministries). Before he founded Biblical Church during 2003, Mr. Chambers had been the senior pastor of Pilgrim Bible Church since 1991. He resigned from his position at Pilgrim Bible Church because he wanted to concentrate more on global evangelism and planned to be out of the country for many weeks during the year. However, about a dozen of his former congregants at Pilgrim Bible Church asked him to continue leading them in studying the Bible on Sunday mornings. Mr. Chambers agreed to continue leading them in Sunday worship with the understanding that he would be ministering abroad a number of weeks during the year and that someone else would lead worship when he was absent.

On the other hand, if he had been endeavoring to make himself look like he was running a tax scam, he would have been hard pressed to find more effective means than what he stumbled on. It is fairly clear that in his choice of organizational structure Reverend Chambers made a mistake.

During 2003 Mr. Chambers organized Biblical Church as a “corporation sole” under Utah law. He designated himself as “overseer” of Biblical Church. As overseer, he had full control over the corporation sole, including the authority to amend its articles of corporation sole and appoint his successor. During 2006 petitioners transferred the ownership of their home from themselves as individuals to Mr. Chambers as overseer of Biblical Church, a corporation sole.

A corporation sole is a way to associate ownership of property with the holder of an office.  Who owns all those church buildings and schools that make up a Catholic diocese?  The bishop does as a corporation sole.  This can come as something of a shock to parishioners as a lengthy drama in Worcester Mass several years ago illustrates.  On the other hand you don't have to worry about your parish becoming affiliated with another denomination, which can happen with a congregational polity.  I suspect that Reverend Chambers chose corporation sole because it fit a "strong pastor" model of church governance that was consistent with his theology.  Then again, you can't rule out bad advice.

Unfortunately it is also a property ownership device that is part of one of the IRS's dirty dozen.  Unless the office holder is subject to removal by some higher authority (other than the highest authority that we are all ultimately subject to) corporation sole is an excellent scamming structure.  Too excellent.  I think that when he chose corporation sole Reverend Chambers painted a target on his back.



Here is a portion of Revenue Ruling 2004-27:

The Service is aware that some taxpayers are attempting to reduce their federal tax liability by taking the position that the taxpayer’s income belongs to a “corporation sole” created by the taxpayer for the purpose of avoiding taxes on the taxpayer’s income. The Service also is aware that promoters, including return preparers, are advising or recommending that taxpayers take frivolous positions based on this argument. Some promoters may be marketing a package, kit, or other materials that claim to show taxpayers how they can avoid paying income taxes based on this and other meritless arguments.

By choosing "corporation sole" Reverend Chambers made himself look like a duck.

Mr. Chambers followed through on his plans to participate in many overseas evangelism trips. In addition to his job as a pastor at Biblical Church, he is on the staff of e 3 Partners, 3 an organization that is exempt from tax pursuant to section 501(c)(3). Mr. Chambers' role with e 3 Partners is “church planter”, and his primary responsibility is to lead short-term mission trips to other countries, where he trains local pastors and other volunteers in evangelism.

e3 Partners Ministry is a substantial organization.  According to their most recent 990 they grossed over 18,000,000.  They have many hallmarks of legitimacy.  Not the least of which is having an accounting firm with a blogging partner.  I think the IRS phony church hit squad should have backed off when they saw that Reverend Thomas was affiliated with them.  When I looked at the board I saw a substantial business person I happen to know who is honest as the day is long and sharp as tack. 

The team members were responsible for raising their own funds for each trip, but e 3 Partners coordinated fundraising by receiving donations on behalf of individual team members and using those donations to pay trip expenses for those team members. Portions of the funds raised by all of the team members were directed to the team leaders, like Mr. Chambers, who were responsible for handling all of the day-to-day expenses the team would encounter on the trip. Before each trip, e 3 Partners deposited funds into a bank account provided by the team leader, who then withdrew the cash needed for the trip. All expenses incurred during the trip had to be documented by receipts, and the team leader was responsible for returning any unused funds to e 3 Partners at the end of the trip. During the years in issue Mr. Chambers received into his personal bank account numerous deposits to cover trip expenses from e 3 Partners, and the parties agree that such funds were properly excluded from petitioners' income.

So apparently if the Reverend Chambers had followed his first impulse and devoted all his time to foreign missions under the supervision of e3 Partners, he wouldn't have had any tax problems or at least not ones of the magnitude that he encountered.

During both 2005 and 2006 petitioners maintained a personal checking account at M and T Bank (M and T account). Petitioners also maintained checking accounts for Biblical Church at National Penn Bank (National Penn account) and the Bank of Lancaster County (Lancaster account) (collectively, the Biblical Church bank accounts or the church bank accounts). Petitioners were the only authorized signatories for the Biblical Church bank accounts. The name listed on the church bank accounts was “Biblical Church and Global Ministries”, but petitioners usually deposited checks made payable to “Biblical Church” into the National Penn account and checks made payable to “Global Ministries” into the Lancaster account. Biblical Church had two bank accounts because Mr. Chambers was trying to separate funds for the church itself from funds that were intended to support its overseas mission trips. He had originally planned to save some of the church funds to purchase a building; but because he was very passionate about the mission work, he put most of the money toward missions.


Petitioners opened the Lancaster account before they had obtained an employment identification number (EIN) from the Internal Revenue Service (IRS). They told the bank representative that they had applied for an EIN but had not yet received it. The bank representative nonetheless allowed them to open a bank account, and she typed all of the information required on the new deposit account coversheet but left blank the space for the EIN. She then printed out the new deposit account coversheet, had petitioners sign it, and instructed them to inform the bank as soon as they received the EIN from the IRS. The bank representative's actions in setting up the account, printing out the new account coversheet, and leaving blank the space for the EIN were consistent with protocol established by the Bank of Lancaster County at that time.

We have a saying that it is better to be lucky than good.  A corollary of that might be that it is worse to be unlucky than bad.  I suspect Reverend Chambers piece of bad luck with the EIN  might have been what really got the IRS swat team that was working him over excited.

At some point, a nine-digit number was handwritten in the space for the tax identification number on the new account coversheet. The nine-digit number written on the new account coversheet and subsequently associated with the Lancaster account is the Social Security number of a minor child unrelated to petitioners, not the EIN assigned to Biblical Church. The minor child who was assigned the Social Security number was not an account holder at the Bank of Lancaster County when petitioners created the Lancaster account.

His next misstep would appear to many of us to be the act of a godly man, who is also humble.

During the years in issue petitioners performed part-time janitorial work for Superior Walls of America, Ltd. (Superior Walls). Petitioners were paid $13 per hour for performing cleaning services about 15 hours each week. Mr. Chambers intended the compensation from Superior Walls as a fundraiser for his mission trips and for Biblical Church. He spoke with the financial controller at Superior Walls and explained his desire to perform janitorial services as a fundraiser for Biblical Church. Pursuant to an agreement with Superior Walls, instead of paying petitioners themselves for the work, Superior Walls paid Biblical Church directly. Mr. Chambers executed a Form W-9, Request for Taxpayer Identification Number and Certification, on behalf of Biblical Church, which he submitted to Superior Walls, claiming to be exempt from Federal tax withholding.

Unfortunately one of the things that scamsters do with phony churches is assign their income to them.  This would probably be the first instance of somebody doing it with the $13 per hour he was getting for mopping floors.  And lets not forget that Reverend Chambers actually did spread the Gospel in foreign places.  On the other hand by assigning his income, modest as it was, to the "corporation sole", Reverend Chambers was walking like a duck.

Petitioners later learned that the law required them to report the compensation from Superior Walls as taxable income, and they began to report the compensation as income during 2006.  Petitioners reported their income from Superior Walls during 2006 on a Schedule C attached to their Form 1040, U.S. Individual Income Tax Return.

That was a bit of unducklike behaviour that the Tax Court noted with approval.

Then there is the matter of the language in the governing document that to the IRS indicated  a “tax-hostile” entity

This Corporation Sole is a full-time Ministry and Spiritual Order which *** is mandatorily excepted by an “unrestricted” right, as referenced in United States law Title 26, §§ 6033(a)(2)(A)(i) and (iii), § 1341(a)(1) and § 508(c)(1)(A), from any form of taxation and from filing any returns or reports/documents ***

Although the Tax Court noted that the objectionable language was "largely a recitation of the tax law applicable to all churches", that is part of the style of tax protester rhetoric which frequently includes quotations from valid authority, ofter wildly out of context.  So Reverend Chambers with that governing document was talking like a duck.  (Although there is nothing to indicate that Reverend Chambers was constantly seen in the company of ducks, there is a chance that he purchased his paper work from one).  It is interesting to note that in the entire body of tax authority the term "tax-hostile" entity only appears in this case.  I wonder if it is a coinage by the agents who have to deal with this stuff. I used to have a third shift job in a hotel where a lot of cops would stop by to take their breaks.  They often referred to a crime that was not in the statute books called B and A, which stood for "being an asshole"

During the years in issue, the deposits into the Biblical Church bank accounts primarily consisted of numerous small checks written by individuals. Members and regular attendees of Biblical Church wrote checks that accounted for the largest number of deposits. Many of those individuals contributed a regular tithe or offering. Other checks were written by individuals who made only a few donations during the years in issue. Some checks were written by other churches. In total, about 50 individuals and three churches wrote at least one check to Biblical Church during the years in issue

The Tax Court was able to get Reverend Chambers out of a significant part of the trouble he had gotten into, primarily it appears from naivete.  First of all they determined that the Biblical Church was a church.


Biblical Church satisfies many of the criteria. Mr. Chambers is an ordained minister, the church has a distinct legal existence as a corporation sole, the church has been meeting regularly on Sundays since 2003, its worship services include a core group of 15 to 25 attendees who exclusively attend Biblical Church, its worship services are consistently held at the same place, and Mr. Chambers teaches recognized Christian doctrine. On the basis of the foregoing, we conclude that Biblical Church is a church.

That did not solve the problems entirely. Reverend Thomas had unfettered control of the various accounts.  Some of the expenditures went for personal purposes



The IRS reconstructed petitioners' income for the years in issue by examining the deposits to the M and T account, the Lancaster account, and the National Penn account. The IRS did not include deposits into the Northwest account when it reconstructed petitioners' income. However, the parties have included bank statements and canceled checks from the Northwest account among the stipulated exhibits before the Court. Those records show that petitioners used the debit card from the Northwest account to pay for numerous purchases at Wal-Mart, K-Mart, Staples, Dollar General, and a variety of other retailers, as well as many purchases at gas stations and restaurants. Petitioners wrote checks on the Northwest account to pay for many household expenses, including their gas bills, cable bills, and sewer bills. They also wrote checks to a tile company, a chimney sweep, a mattress store, a dentist, a newspaper, a mechanic, and a cement company.



Petitioners contend that even if some of the expenses paid from the Northwest account were personal, those amounts are not includable in petitioners' income because they were for the purpose of providing a home for Mr. Chambers, a minister of the gospel, and therefore are exempt from taxation under section 107. However, in order for a minister's housing allowance to be exempt from taxation under section 107, it must be designated as a housing allowance by an official action of the church in accordance with section 1.107-1(b), Income Tax Regs.

I think the Tax Court may have missed a chance to cut Reverend Chambers a break here.  They had recognized that the church was a church and he had transferred ownership of the house to the entity so this was arguably not a rental allowance situation.  They did prevent the IRS from piling it on to some extent.


The deposited checks in 2005 include federal income tax refund checks. In light of the circumstances and facts of this case, respondent is unwilling to concede that those refunds were correctly and properly made to petitioners. Therefore, respondent does not concede that those refunds are non-taxable in 2005. It appears that respondent is contending that petitioners are liable for deficiencies in income taxes from prior years and is attempting to recover some of those deficiencies by including petitioners' tax refunds from 2004 in their income for 2005. Respondent cites no authority that would permit such a determination, and we find none. Accordingly, we conclude that petitioners' Federal tax refunds should not be included in their income for 2005.

But there was only so much they could do.  The Chambers had sold gold coins inherited from Mrs. Chambers father to help with church expenses.  In their reconstruction of income the IRS treated these amounts as income and the Chambers did not have sufficient evidence to refute the presumption of correctness.



Respondent's contention is based on the premise that Mr. Chambers stated that Mrs. Chambers inherited the gold coins directly from her parents, which would contradict Mrs. Chambers' testimony that petitioners used cash they inherited from Mrs. Chambers' parents to purchase the coins. However, Mr. Chambers never clearly explained where the gold coins originated. In addition, he separately testified that petitioners had received cash from the inheritance. Although petitioners' testimony regarding the gold coins was somewhat difficult to follow, we do not find it contradictory. Nonetheless, because petitioners have the burden of proving that the $30,281 should not be included in their income and because petitioners failed to provide any evidence to corroborate their testimony, we conclude that petitioners have failed to carry their burden of proof that the income from the Surgical Resources Business Trust checks should be excluded from petitioners' gross income.

The big thing that the Tax Court did do for Reverend Chambers was making the 75% fraud penalty go away.  Acknowledging all the various things that Reverend Chambers had done to make himself appear like a duck, they could clearly see that he wasn't one.  Most important was the determination that there was an actual church there.

There are some other interesting aspects of the case that I have glossed over.  I recommend it as a good read.  I think it is worth commenting on how Reverend Chambers might have avoided these problems short of just working for organizations like e3 Partners, that have good infrastructure in place.  He might have looked at the ECFA Standards and Best Practices for Churches.  In the interest of full disclosure, I should probably say that the churches I have attended would not qualify for ECFA membership. Most Unitarian Universalists have a different theological perspecitve than that required by Standard 1.  Our principles do encourage us to heed "Wisdom from the world's religions which inspires us in our ethical and spiritual life" ECFA's standards and best practices clearly fall in that caterogy.  One excerpt from the standards might have been particularly apt for Reverend Chambers Biblical Church:

Every member shall be governed by a responsible board of not less than five individuals, a majority of whom shall be independent, which shall meet at least semiannually to establish policy and review its accomplishments.


If the group of people that asked Reverend Chambers to stay on as their preacher even while working on his evangelical missions did not include five people capable of seeing that mundane matters like setting a salary for him, most if not all of which could have been excluded as parsonage, then he really should have passed.

I have been sparing in my criticism of the IRS in this case.  I have often commented on how ill qualified I am to work for them.  If I was in charge of the team that was working on this I would have said "This guy is a real minister.  Let's leave him alone and go fight crime someplace else."  ignoring the laundry list of duck like characteristics that he was exhibiting.  What would be very sad is if this case ends up being viewed as an instance of the Satanic IRS persecuting the godly.  If you are of the mindset to look at it that way, I'd point you to ECFA who will teach you how to avoid even the appearance of impropriety.


I haven't seen a lot of commentary on this case.  At least one blogger has observed that it was quite a harsh result.  I've seen the identical commentary in more than one place, so I am not sure of the original source.

Friday, May 27, 2011

LGBT Advocacy Organization Denied Exempt Status

Private Letter Ruling 201120036

Nothing like a slightly sensational headline to grab their interest.  This is probably not the work of the vast right wing conspiracy.  I've made a desultory attempt to figure out the organization involved but haven't had any luck yet.  I've included a link to the full text so maybe you can figure it out.  The most frustrating part about private letter rulings is their anonymity.  Of course that is the fun part because you can try to figure out who it is or just make something up.  So here is the story.

Org X has been denied its application for exempt status.  X's members are for the most part employees of Y.  They are a little confused as to when they started :

Page 1 of the Form 1023 application states your organization, X, was formed as an unincorporated association on December 1, 1992, as this is when the Y Company formally recognized you as an employee caucus group. However, the document entitled "X Original Charter" indicates you were formed on July 20, 1995. visibility within the Y Company and beyond to its members, and to provide an official point of contact between its membership and Y, as well as with other gay, lesbian, bisexual, and transgender organizations external to the Y Company." You also indicate having the Y Company become the employer of choice for individuals of the lesbian, gay, bisexual, and transgender community where these individuals can work in a culture of equality and enjoy successful employment.

That type of institutional memory problem is common to membership organizations that evolve with different viewpoints on where it all began.  It's probably better if you can keep it consistent within the Form 1023, but I don't think that was there major problem.

The organization has some significant achievements:

Past achievements made by you and additionally listed in the activity narrative and in documentation included with the application include working with the Y Company to implement Extended Household Healthcare Benefits in 1995, assisting in adding "sexual orientation" into the company's anti- discrimination policy in 2004, the granting of Domestic Partner benefits to lesbian, gay, bisexual, and transgender and straight employees (in Canada in 1994 and the United States in 1997), creating and deploying workplace guidelines to aid employees and their managers and becoming an advocate for lesbian, gay, bisexual, and transgender employees who have experienced harassment in the workplace. And in 2006 you joined the Business Coalition for Domestic Partner Benefits Tax Equity. Your organizing document also lists documentation to support similar activities in your "Goals" section.

As a result of your efforts within the Y Company, you, as well as the Y Company, have received several forms of external recognition. These include the Y Company being placed on several best places to work list for lesbian, gay, bisexual, and transgender employees and have received several corporate leadership awards from your efforts, specifically in 1996, 2003, 2005 and 2007.

There are probably enough clues in there to figure out who the Y Company is, but I haven't been able to.

So what is the problem with X's application for exempt status ?

....you have stated in a "Performance Excellence Plan" submitted with your application, that your goals and objectives include increasing public awareness of the Y Company's commitment to member employees, grow awareness of the Y Company brand in the members community and assist the Y

Company in regaining a "leadership position" in the members market. You also stated that you took part in a job fair as representatives of the Y Company to enable the Y Company to demonstrate its diverse workforce. As this court case indicated, promotion of a for-profit industry and/or business is a substantial nonexempt purpose and, even as a secondary activity, precludes exemption under section 501(c)(3) of the Code. Furthermore, as with the case involving the Better Business Bureau of Washington, D.C., regardless of the number of truly exempt activities, the non-exempt purpose of your organization is too substantial to ignore, especially when considering you are primarily funded by the Y Company.

It would be a little tedious for me to list them all but in its denial of exemption under 501(c)(3), the IRS suggests numerous times that X consider 501(c)(5) "Labor, agricultural, or horticultural organizations". Besides continuing to maintain that they qualify under (c)(3) they refuse to do that because:

In your response you have stated that applying for exemption under section 501(c)(5) is not an option, as this would result in you and your members violating the policies of the Y Company, as the Y Company does not allow its employees to establish labor organizations.


So enlightened as the Y Company may be on LGBT issues, they don't want no union organizers hanging around the shop.

I still want to figure out who the Y Company is.  One other clue is that X indicated that it had joined the Business Coalition for Domestic Partners Benefits Tax Equity in 2006.  The membership list is pretty impressive.
 
I'm going to ask some of my leftist friends what they would think about the X organization that celebrates the LGBT friendly policies of the union busting Y company.

Monday, April 25, 2011

What is Nothing ?

                            What did you get, kid ?
                             I didn't get nothing. 
                            I had to pay $50 and pick up the garbage

Estate Of Axel O. Adler v. Commissioner, TC Memo 2011-28

I thought I'd be able to make more out of this, but there is really a very simple point.  If you want valuation discounts, don't rely on fractional interest in real estate.  Form a family limited partnership.

Private Letter Ruling 201104066

I find that the hardest things to go through are private letter rulings.  They come in fairly tedious batches of late S elections and IRA rollover mishaps.  It's rare that there is anything really interesting except denials of exempt status.  Nothing yet has risen to the level of comic masterpiece equivalent to the tax court decision in Free Fertility, but some of them are pretty good.  This one was about horses.  I think the IRS has something against horses:

The general purpose of this corporation shall be to identify, conserve, safeguard, and propagate the genetic integrity of the horse originally found in the possession of the Tr. in Country, and those bred in other countries by breeders whose foundation stock was drawn entirely from those tribes of the T



Your Articles further provide, "the purpose shall be accomplished through research of historical and genetic (scientific) data to add to the X or disqualify horses from the 'X', according to the standards as set down in said 'X'. The purpose shall be additionally accomplished through education of the international horse community, the general public, and youth (by publication), regarding historic, genetic and athletic value of these endangered genetic lines, and collection and sharing of historic artifacts, letters and documents."

I don't know.  Sounds pretty good to me.  IRS didn't like it:

You have not demonstrated that you do not inure to the benefit of private individuals. You, M, maintain a website, g, that contains links to private sellers of Q horses. Those breeders earn a profit, and private benefit, by being able to sell horses and/or stud services to interested persons. As a result, under section 1.501(c)(3)-d(1)(ii) of the regulations, you do not meet the requirements of section 501(c)(3) of the Code.

The Service did suggest that they might qualify under 501(c)(5):

You are similar to the organization described in Rev. Rul. 55-230. You are organized to guard the purity of the breed of Q horses; to promote interest therein; and to help fund research on the genetics of this breed of horses. You state that you are unlike this organization because you are not a horse registry. We disagree because you do maintain a partial horse registry, as you maintain listings of horses and their genetic parents in your newsletters. You are also similar to the organization described in Rev. Rul. 55-230 because you promote and fund research on the genetics of this particular breed of horse.


Michael P. Schwab, et ux. v. Commissioner, 136 T.C. No. 6

This is probably worth a full length post, but I'm not going to get to it.  In case you've been holding your breath, it's what ties in to the quotation from Alice's Restaurant.  The Schwabs had participated in something called an 'Advantage 419' plan, which then invested in variable life insurance policies.  When I was interviewed by The Wandering Tax Pro one of his questions was what is the best tax advice I could give to anyone.  Frankly, I lied.  I save my best advice for paying clients, but the best advice, which I can give for free is pretty good- Sometimes you should just pay the taxes. It's pretty clear that paying the taxes and stuffing the after tax income in a mattress would have been a better deal than this plan worked out to be.

 Because of IRS activity in the area, the Schwabs decided that their 419 plan wasn't such an advantage anymore.  The variable life insurance policies were distributed.  The taxpayers and the IRS were arguing about whether surrender charges should be considered in valuing the policies.  There was no net surrender value after considering surrender charges, so the taxpayers argued that like Arlo they didn't get nothing. The Court after grousing about the poor record it had to work with took a different approach.  It attempted to compute the fair market value of the policies, which as it turned out was something but not much.  Because of a no lapse provision the policies provided coverage for a short time before they expired.  The Court used standard valuation tables to come up with a value of about $2,000, which was more than 0, but a lot less than the $80,000 or so the IRS was arguing for.

Songie S. Milhouse, et vir., v. Commissioner, TC Summary Opinion 2009-012



This decision was dated 2/9/2011 so I suspect the number is wrong. That's what they have in RIA anyway and who am I to argue?  It is an innocent spouse case in which the spouse is found innocent.  Mrs. Milhouse had separated her finances from her husband because of a pattern of irresponsibility on his part.  She put money into a joint account that she had access to, but he ran.  The IRS thought that since she could have looked at the account, she should have known about his unreported income. 

Respondent did not offer any corroborating evidence at trial to support a finding that petitioner had actual knowledge of the items giving rise to the deficiency, nor did respondent substantively cross-examine petitioner or Mr. Todd on the scope of petitioner's knowledge. Petitioner, on the other hand, credibly disavowed any actual knowledge of the items giving rise to the deficiency and provided a vigorous cross-examination after Mr. Todd's direct testimony. Accordingly, we hold that petitioner did not have actual knowledge of the items giving rise to the deficiency that would preclude the granting of relief under section 6015(c)

It was good that Mrs. Milhouse won the case, but I think the lesson here is that if you think your spouse is not financially responsible, think very carefully before filing a joint return.  Just because the vast right wing conspiracy thinks civilization will end if gay people are allowed to file them doesn't mean they are always a good deal.





Friday, April 1, 2011

IRS Gets Mystical and Some Other Minor Developments

Since you folks seem to resist clicking on ads, I've been hanging on to my day job.  I'm going to try to get a little ahead this last weekend in March.  Right now the preparers are more swamped than the reviewers so I'll be taking Sunday off.  This post will be the first April one.  As usual I have quite a few interesting items that won't quite make it into full length posts that I want to share before they go stale.

I'd spent the first week in January pining for material from the Chief Counsel.  When it finally came out I started a post called "Happy New Year Chief Counsel", but as the year developed I couldn't really make much out of them.  It seems that the primary role of the Chief Counsel's office is to be confused about TEFRA.  I can't say I blame them.  Here's what you missed if you have been relying on me to screen the CCA's for you:

CCA 201101023

This one might be of practical use at some point if you are a partner and you can't convince the general partner to fix something.  You would probably include Form 8082 with the amended return.

The failure of a non-TEFRA partnership to file an amended return does not procedurally bar partners from amending their own return to reflect changes to partnership income.

CCA 201101020

This one borders on the mystical:

 The determination that a partnership is not a partnership is a partnership item if the partnership filed a Form 1065. See I.R.C. 6233(b) and Petaluma v. Commissioner (recent D.C. Circuit Opinion)

I think it means: "If it says its a partnership we must agree that it is a partnership in order to be able to say that it is not a partnership".

I think somebody was just back from a Zen retreat and was trying to work up a koan

CCA 201101012

Which brings us to the paradox of the partnership - the non tax paying taxpayer:

As long as the partnership had an obligation to disclose a listed or reportable transaction under section 6011 and the regulations, it is liable for the 6707A for failing to so disclose. You are correct that because a partnership is not a taxpaying entity there is no decrease in tax on which to compute the penalty. Instead, the penalty will be the maximum penalty permitted by the new law. ——————

So much for the Chief Counsel's meditations on partnerships.  Next comes

Asmark Institute, Incorporated v. Commissioner, TC Memo 2011-20

It was an appeal of a denial of exempt status.  Asmark was providing compliance services to agribusiness.  Appeals of exempt status denial sometimes have the makings of comic masterpieces like Free Fertility Foundation and this one had to do with fertilizer, so I thought there might be something there but overall it is pretty mundane.  Basically, there activities were too commercial:

First, the IRS argues that Asmark competed with commercial firms. Second, the IRS argues that providing services to agribusiness is not an inherently charitable activity. Third, the IRS argues that Asmark Institute offered the same services, charged the same prices, and employed the same workers as its for-profit predecessor, Asmark, Inc. Fourth, the IRS argues that the Asmark Institute's commercial nature is evinced by the fact that its clients were for-profit businesses. Fifth, the IRS observes that Asmark Institute's relationships with trade associations were designed to increase its client base. Sixth, the IRS argues that Asmark did not educate the public because its educational and compliance materials were available only for a fee.


The tax court agreed with the IRS.

Gary L. Greenberg, et ux. v. Commissioner, TC Memo 2011-18

This was a pigs get fed, hogs get slaughtered type of case.  Taxpayer had applied for disability benefits on an insurance policy that they purchased.  They were turned down and appealed.  They won and in addition to the disability benefits they dinged the Paul Revere Insurance for $2,400,000 in punitive damages.  Nice result.  Pay your taxes and go home happy.  Mr. Greenberg decided that he wanted to exclude the punitive damages just like he was allowed to exclude the disability payments.  Not surprisingly he lost.  The bad part is the penalty:

Petitioners do not separately address the penalty issue. Given the plain language of the statute and the applicable caselaw, the arguments they provide in support of their position on the deficiency itself do not amount to substantial authority or reasonable cause. Petitioners did not provide any evidence that they relied on professional advice, and they did not disclose their position on their return. See sec. 6662(d)(2)(B). Petitioners have therefore not met their burden of proof and are liable for the penalty.


So in addition to the tax deficiency of $1,161,134, there is a penalty of $232,227 and possibly six years of non-deductible interest.

U.S. v. DOVE, Cite as 107 AFTR 2d 2011-634

This was IRS looking for a permanent injunction to prevent someone from preparing returns.  It looks like they had a point:

Dove later described some of his tax preparation practices during a preliminary injunction hearing. Dove testified that he routinely deducted 10% of a client's income as a charitable contribution without determining whether his customer had documentation to support such a deduction. Dove also stated that he prepared a return for a customer in which he improperly reported various deductions for a piece of investment property that the customer never used as rental property.

The court agreed that Dove should take up another trade.  There was one comment that was a little troubling:

Dove also testified that he would report whatever information his customers told him without requesting any documents to support their oral representations.


There seems to be an implication that preparers are supposed to be auditors.  We in fact provide that level of service to many of our clients so that when they do get audited we can walk in with a book that documents every number on the return, but that is a step beyond preparation.  Also as a practical matter, we will have all the W-2's, 1099's and K-1's since it is more efficient for us to interpret them.  The comment is perhaps less disturbing in context.

Well that will do to start April off anyway.

Wednesday, March 23, 2011

Some More Randomness

Here are a few developments that don't seem to merit a full treatement and are starting to get a little stale.

Richard H. Franke v. Commissioner, TC Memo 2011-10

I really thought I could make something of this.  It was about whether somebody who had fallen for a tax protester type package was liable for fraud penalties.  He was only arguing about money.  The people who created the package are doing time. The scheme was based on creating a "Corporation Sole", which is a legal form used generally by religious groups to associate title to property with whoever holds a particular office.

What was really interesting was that Mr. Franke was an enrolled agent and he was using the scheme to shelter his tax preparation income.  He was continuing to insist to the Tax Court that he believed the scheme worked as they found him liable for the penalty.  I generally think that enrolled agents don't get enough respect so I was kind of disappointed.

TRC, INC. v. U.S., Cite as 107 AFTR 2d 2011-XXXX

The company was trying for a refund of penalties for failure to timely pay over payroll withholdings.  They were not successful.  The decision emphasized that withholings are special in that the money was never yours in the first place :

In determining if the taxpayer exercised ordinary business care and prudence in providing for the payment of his tax liability, consideration will be given to the nature of the tax which the taxpayer has failed to pay. Thus, for example, facts and circumstances which, because of the taxpayer's efforts to conserve assets in marketable form, may constitute reasonable cause for nonpayment of income taxes may not constitute reasonable cause for failure to pay over taxes described in section 7501 that are collected or withheld from any other person.


Although it is the duty of the court to weigh all of the factors identified in the regulations, “it will be the rare case where the government is made “the unwilling partner in a floundering business” without the employer incurring the duty to pay a penalty for having made such a choice” to fail to pay trust fund taxes over to the government on a timely basis.

The best thing for small businesses is to use a service like Paychex.  If you don't have the money to pay over the withholdings, it really means that you don't have the money to make payroll.

Private Letter Ruling 201101028, 01/07/2011

This was a withdrawal of exempt status,  The organization was supposed to be raising funds for charities.  It's only activity was gambling, apparently Bingo, and contributions from other organizations controlled by the same person.  It may be that they applied for exempt status in the first place in order to be able to get licensed for the gambling.  It seems like many organizations apply for exempt status more to get some sort of state law privilege or creditability with actual exempt organizations or local and state governments.  The IRS probably has enough to do collecting federal revenue without being used as vehicle for liquor licenses and gambling permits.  But as I often say "It is what it is.  Deal with it."

Private Letter Ruling 201101027, 01/07/2011

This one is another revocation of exempt status, this time for "inurement".  It was pretty convoluted.  I'll just give you a taste of what ORG (The not really not for profit) was up to:

Given the facts, it appears that CO-2, DIR-6 as president, purchased the land in January 19XX from LAND order to build a golf course; which was also on or around the time the land was discovered to contain toxins, which would have certainly devalued the land at that point in time Not able to build a golf course due the toxins, CO-2 then only held the land for an 8-month period who would then sell the land to CO-1 who would also only hold it for an 8-month period before selling it to ORG at a value that may or may not have been the fair market value given the discovery of the toxins in the land. Without contemporaneous certified appraisals the value of the land during each sale remains unknown. To state that no appraisals were ever conducted for any of these transactions is unlikely since most land and property sales are accompanied by a certified appraisal.


ORG has not demonstrated that the transaction with DIR-6 was in fact at arms-length. Without a certified appraisal at the time the land was sold to ORG and in light of value of land recorded by the county, the facts indicate that ORG purchased land that was grossly overvalued. This transaction allowed the FAMILY to divest ORG of several hundred thousand dollars as illustrated below:

Few things trouble me more than people using exempt organizations to enrich themselves.

Valarie N. Stephenson v. Commissioner, TC Memo 2011-16

This was an innocent spouse case.  It is one where the taxpayer won for a change.  That she had to go to Tax Court is indicative of how hard it is for people to win these cases.  There are 8 factors that are considered, one of which is abuse by non-requesting spouse.  Here is what she had on that one:

Mr. Stephenson abused petitioner throughout their marriage. During trial petitioner provided specific examples of abuse, including a time when Mr. Stephenson threatened to kill her or himself if she left him and times when Mr. Stephenson threw items at her. Mr. Stephenson regularly humiliated petitioner in front of his family and their friends and demeaned her when she asked questions. Mr. Thomas corroborated some of petitioner's testimony by credibly testifying that petitioner had bruises on her body and told him that she was in an abusive relationship.


I know it is more a matter of principle, but the denial of joint filing to same sex couples is probably not quite the hardship they think it is.  Joint and several liability is the dark side of joint return filing that most planners, even divorce attorneys, who should know better, ignore.

Unless something really huge happens, there will be quite a few posts like this in the next couple of weeks as I have a pretty big backlog and not much time to give things the full treatment.

Monday, February 21, 2011

OK 2010 This is Really Goodbye

In  a previous post,  I explained the need for occasional purges of material that does not transform itself into a full length post.  Now I'll explain the Amazon ads.  All hope of them being a means of monetizing has vanished.  They are purely decorative.  The only thing my readers, who apparently now number in the scores (If you have trouble remembering what a score is here is a little trick.  Remember "Four score and seven years ago".  Now subtract the year of the Declaration of Independence from the year of the Battle of Gettysburg.  Then subtract seven.  Then divide by four.  Piece of cake.). do is come to the site.  I have a little gadget next to where I type the blog and I can search Amazon and then click to move the link and image into the blog.  I thought I would see what I got with Goodbye and up comes one of my favorite books.  It's very short and I read it from time to time to cheer myself up. 

As the title indicates this is the last of the 2010 material.  I would have gotten it in sooner, but it got pushed aside by two much more interesting recent developments.  One was about mercenaries and the other was about breasts.  So how was blog housekeeping going to compete? With no further fanfare here is the last of 2010:

Private Letter Ruling 201051024

This was a ruling on exempt status.  Exempt status ruling are a fairly rich source of tax humor, although it will be a while before somebody tops Free Fertility Foundation.  I'm not inclined to mock this particular effort, although it does provide a slighly heightened reading on my bs detector.

You were incorporated under the nonprofit laws of the state of M on x. According to your Articles of Incorporation your purpose is to advance the religious beliefs, cultural traditions and lifestyles of four N churches (the "churches") by providing loans and other assistance for real estate purchases and other farm and business related purchases to members of the churches; to encourage savings and thrift and continue to be committed to Christian principles of operation by providing investment and borrowing opportunities to enhance economic social and spiritual well being of the N Brotherhood; and to operate exclusively for charitable, religious or educational purposes.

Investors are limited to residents of M who are members of the churches. Eligible individuals meeting the minimum-investment requirement ($10,000), up to a maximum of 25 new investors annually (to comply with the requirements for exemption from the security laws of the state of M), will be accepted on a first-come, first-serve basis. 



You state that both your lending and borrowing activities will support your exempt purpose of advancing your religious beliefs, cultural traditions and lifestyles of the churches. You represent that central to your religious doctrine is a belief (i) in Biblical financial truths, including brotherly financial aid, responsibility for stability in family finances, the collective responsibility for all members of the church for each other's well being and personal stewardship and (ii) that deacons of your churches are called by God to oversee and, where applicable, alleviate the financial hardship of their church's members. You state that all of these principles lead to the rejection of laws that permit or facilitate the avoidance of responsibility, such as bankruptcy and insolvency laws.

Although you were initially funded by contributions from founding board members and received a church offering from each of the churches, you do not plan to engage in further fundraising activities. Your primary method of raising capital will be interest bearing loans from investors. Your sole source of income will be interest charged to borrowers. You plan to use the spread between the interest rates paid to investors and those charged to borrowers to pay all necessary future expenses.

The organization did not qualify for exempt status.

Articles 4(a) and (b) of your Articles of Incorporation states that you were formed to provide investment and borrowing opportunities. Providing investment and borrowing opportunities to members is not an exempt purpose described in section 501(c)(3).



Your primary purpose is to operate a trade or business, a lending institution which directly competes with commercial lending institutions. Your business practices are consistent with those of the industry in general. You will be funded by capital from investors. Your method of determining fees is similar to the method used by commercial lending institutions.

The minor mystery in this is what the organization expected to gain by its exempt status since it was planning on just breaking even and would not be getting charitable contributions.  It may be there was some state law benefit.  In my recent post on exempt organizations I note one that was trying to qualify so it could get a liquor license.  Presumably that was not the plan with this one.

I'm not much of a scriptural scholar, but I'd like to know where the stuff about bankruptcy comes from.  I think there is more in there about forgiving debts.

Humphrey E. Igberaese v. Commissioner, TC Memo 2010-284

This is really a run of the mill substantiation case. It concerns a host of deductions including charity.

Cash Charitable Contributions Igberaese asserts that he contributed $200 to his church in cash every week of the year, for a total of $10,400. He said that when he was in town, he would attend church and would personally donate the $200 to the church. He said that when he would be out of town, he would provide the cash to other church members in sealed envelopes to take to the church for him. He said he did not recall, even approximately, how often he provided the cash to other church members to donate for him. Nor did he remember the names of any of these members. He presented a printout of a computer spreadsheet consisting of the name of the church, the date of each contribution (each Sunday of the year), the amount of each contribution ($200), and the yearly total ($10,400). He testified that he made each entry around the time of that week's contribution.

Putting aside the formal substantiation requirements for charitable contributions, I'd advise people like Mr.Igberaeseke to work on their stories a little better.  I don't have personal acquaintance with tax court judges, but I believe I've learned a bit about them from reading their opinions for the last thirty years.  Among the things that I have surmised is that they are not idiots and that they live in the same world that I do.  Some of them probably go to church and will therefore know that people who drop cash in the collection plate mostly still think that George Washington is our holiest president.  If the ushers know who's face is on a C note, it is not from experience gained counting the collection

We do not find the evidence Igberaese introduced to be credible. As we discuss in connection with each deduction, Igberaese presented little beyond his own unpersuasive testimony and self-created documentation to corroborate his series of implausible deductions. Several of his explanations for the absence of further corroboration were also implausible.

We are similarly skeptical of Igberaese's documentary evidence, which shows little more than that he has written down his implausible assertions

Trout Ranch, LLC, et al. v. Commissioner, TC Memo 2010-283

This was a dueling expert case.  The Trout Ranch had donated a conservation easement.  The partnerships expert indicated that it was worth 2.1 million.  He based the valuation on other easements sold in the area. The Tax Court was not greatly impressed :

 In essence, in all three cases the conservation easements all but eliminated residential development. In stark contrast, the Trout Ranch CE restricted development from at least 40 residential lots to 22 lots (a reduction in potential development of 45 percent). We are simply not convinced that the value of a conservation easement that restricts development to at most one residential lot sheds any light on the value of a conservation easement that allows as many as 22 residential lots.

The Service had originally wanted to allow $485,000, but when it came to trial they decided to reduce that to 0.  I mean, what the heck, why not say the property was worth more with the easement and have them pick up income ?  The switch led to some fancy burden of proof discussion, which the Court indicated didn't matter because they were able to determine the true value.

The Tax Court came in at $560,000.  We know that is the right answer, because its what the Tax Court said.  The case is worth reading if you are interested in valuation issues.  It's not great for my purposes as I couldn't find any good quotes.

Richard A. Frimml, et ux. v. Commissioner, TC Summary Opinion 2010-176


My tentative title for this was "Paint Your Horses".  It is a hobby loss (Section 183) case.  The IRS seems to be firmly convinced that people take care of animals much larger than themselves that appear to defecate copiously for fun.  Go figure.  The couple was raising American Paint Horses.  The Tax Court ruled that they were in fact trying to make money.

Petitioners' knowledge at trial was extensive as it related to breeding and artificially inseminating Paint horses. Their knowledge included the genetics, the mechanics and the financial aspects of breeding.  Even the horses aren't having any fun.

The worst thing about people who win hobby loss cases around horse breeding is that the Tax Court gives them extra points for heartlessness.

Petitioners made many business decisions regarding the purchase, care and sale of a number of Paint horses for their horse activity. Petitioners paid extensive amounts to care for Special when he was injured. On the other hand, petitioners decided to put down a 2-year-old foal that hurt her leg in a fence accident because the cost to heal her exceeded the projected price in selling her.

In case you are wondering what was so special about "Special".

They have identified semen production by Special as a potential future source of revenue.

This case is similar to that of Johnny L. Dennis TCM 2010-216 which I gave a brief mention.  Besides doing a cost benefit analysis on the vet bills, the other thing that they have in common was not riding the horses themselves.

U.S. v. RUTH, JR., Cite as 106 AFTR 2d 2010-7443

The decision itself is about criminal procedural issues which are not of great interest to me.  If you have an interest in such things check out Jack Townsend's blog.  I read cases like this because the story behind the story is often interesting.

The conduct at issue began while Ruth and Pilkey were incarcerated at the Federal Correctional Institution in Fort Dix, New Jersey. The defendants submitted tax returns to the IRS claiming refunds in the names of fellow inmates for wages never earned and giving addresses where the inmates never lived. These inmates fell into three groups: (1) those who were aware of the fraud, (2) those who were not aware of the fraud and had instead provided their personal information in order to receive legal assistance from Ruth and Pilkey, and (3) those who testified they did not know the defendants. Ruth and Pilkey were able to avoid having to submit W-2 forms by misrepresenting that fellow prisoners were working at companies that had gone bankrupt. As part of the scheme, defendants obtained employer identification numbers for these bankrupt companies. To avoid detection by prison authorities, defendants enclosed envelopes addressed to the IRS within large envelopes sent to collaborators outside of prison. Defendants had the tax returns sent to mail-forwarding services who would then deliver the returns to their collaborators.

I became interested in accounting in part from reading stories about epic frauds.  I doubt anybody will ever top Alfredo Reis.  Read the book about him if you don't believe me.  He convinced the British bank note printing company that printed the money issued by the Bank of Portugal that he worked for the bank and got them to print money for him.  He used the money to buy stock in the Bank of Portugal which was the only entity that could prosecute counterfeiting.  These fellow aren't in the same league, but given the adverse conditions they were working under (being in prison and all), they really achieved a lot.  Of course you might expect that the IRS computers would catch them eventually.  That's not exactly the way it turned out.

Defendants' scheme resulted in the IRS issuing refunds of tens of thousands of dollars. Eventually the IRS became suspicious of returns filed by persons in federal custody using the same type of form and listing the same employers and addresses. In May 2004, an inmate came forward who informed prison officials about the fraudulent tax scheme. Based on this information, prison officials searched the lockers of several inmates, including Ruth and Pilkey, and recovered records and material used to file the fraudulent tax returns.

So that is it for 2010.  Goodbye 2010.






















Monday, January 24, 2011

So You Want to be an Exempt Organization ?

Of all the areas I look for material in I find private letter rulings the most challenging.  They tend to come in blocks on particular subjects and there will frequently be several virtually identical ones in a row.  The most typical probably concern late S elections.  I've yet to see one of those that could make a good story.  My eyes light up, however, when I see a batch that have 501 as the relevant code section.  They are frequently about organizations having their exempt status revoked, which is quite often a good story. The post I consider most amusing was a Tax Court decision on exempt status. I've still got a fairly large backlog of material to share with you, so I am going to give you a few of those rulings.  I think I could make a whole post out of a couple of them, but I'm not going to get to them and they are starting to get a little stale.

Private Letter Ruling 201050041

My tentative title for this was "Sober House".  It's great when you can mix business and pleasure, but its not so great to mix a business you own with a not for profit that you run.  That was the problem with this group.  Their mission was to provide substance abuse recovery services.  The clients, however, lived in real estate owned by the people running the not for profit.  If you are going to do something like that, which I don't recommend, you need to be scrupulous in your record keeping.  They were less than perfect.

RA-1. There appears to much overlap in the activities of the two entities. In reviewing the expenses of the organization, it appears that expenses for the for-profit entity were paid by the non-profit entity. There were a great deal of checks paid and referenced to the Intensive OutPatient Program (TOP) which is a program of the CO-1.

There were several rental properties located in City, City, City and City which were acquired and owned by RA-1, members of his family and an employee of the organization. The employee was a Counselor of ORG and it was stated that RA-1 and Counselor, Counselor acquired the real estate together. According to RA-1, these properties were bought, maintained and used for the purpose for providing housing services to the clients of ORG.

The organization was unable to substantiate amount reported on its Form 990. In particular, it reported grants to individuals, but was unable to provide records showing who received grants, how much was received by each individual or how the recipients were determined. The organization was unable to provide client records which would detail services provided. Amounts paid to workers were often paid to relatives of RA-1 and no verification of work done for the exempt organization were provided.

The organization did not establish that the rent paid by ORG for the rental properties owned by RA-1 and his relatives was a fair market value rate. Furthermore, there were no documentation which detailed out who occupied the rental properties, how much was paid for rent and the time period of occupancy.

There were other indications of a lack of internal control. Accountant had a difficult time providing documents that were clear and understandable. There were a great deal of commingling of the revenue and expenses with the for-profit entity, as well as, expenses that could not be substantiated. .

There were Board of Directors listed on the Form 990, however, during the initial interview. VP stated "there were no Board of Directors officially, however decisions regarding the organization were made by himself and RA-1. According to him, the reason for this was that people didn't want to make time to participate.

So it could have all worked out if we were just a little more civic minded.  I have to say that if you are a young CPA and somebody asks you to volunteer to be treasurer of something like this, run for the hills. 

Private Letter Ruling 201050036

I thought there must be something serendipitous in this ruling being so close to the previous one.  My tentative title for it was "Barroom Buddies".  There is a lot more to Section 501 than 501(c)(3).  You hear the most about 501(c)(3) because those are the ones that you can make deductible contributions to.  There are, however, a plethora of 501 organizations that are just themselves exempt from tax to some greater or lesser extent.  Among these are 501(c)(10) organizations which are :

Domestic fraternal societies, orders, or associations, operating under the lodge system—
(A) the net earnings of which are devoted exclusively to religious, charitable, scientific, literary, educational, and fraternal purposes, and
(B) which do not provide for the payment of life, sick, accident, or other benefits.

A real life example of a qualified 501(c)(10) organization is The Grand Lodge of Ancient Free and Accepted Mason of North Carolina.  The get the benefit of being featured here by the luck of the draw in my poking around in GuideStar.  I have little doubt that they are an example of the right way to qualify for 501(c)(10) status.

The subject of this PLR known as ORG is another matter entirely.  Here is an interesting little sidelight on exempt status.  Sometimes the motive for obtaining exempt status has little to do with the direct federal tax benefits.  In the case of ORG there was the matter of a state law that held:

"in order for a licensee to sell intoxicating liquor outside city limits, a licensee must meet certain provisions such as having obtained an exemption from the payment of federal income taxes as provided in IRC sections 501(c)(3), 501(c)(4), 501(c)(5), 501(c)(7), 501(c)(8), 501(c)(10), 501(c)(19), or 501(d) of the United States Internal Revenue Code of 19XX,

Since DIR-1 inception with the ORG she has been able to sell liquor by the drink because of his organization's exemption from Federal income tax under IRC 501(c)(10).

During our interview on July 30, 20XX I asked DIR-1 why she joined the ORG, and her response was, "it allowed us to obtain a liquor license."
 
"The neighborhood tavern has been owned and operated by my family since 19XX DIR-1 took over the family business in 19XX." DIR-1 never transferred ownership of the building or any other assets to the parent organization. Instead, she pays the ORG Headquarters $ per year to lease the building and its contents.


ORG consists of 32 members, and all of them were asked to join by DIR-1. There are no requirements for membership, and there's only one class of membership. To become a member, each individual pays $, then fills out a card, providing such information as their address and phone number, and in return, the parent organization sends them an identification card indicating what post the member belongs to and the name of the member. New cards are issued every year. Upon becoming a member of ORG the individual receives their first drink for free, and ct off each additional drink. In July, dues are collected and remitted to the parent, ORG #1 in City, State. Additional members are recruited by current members or word of mouth.


The ruling has a fairly extensive discussion of how much of a fraternal bond is required for the organization to qualify. Part of the discussion goes as follows:

In National Union v. Marlow, 374 F. 775, 778 (1896): the court summed up the nature of a fraternal beneficiary society as follows: ".... a fraternal-beneficial society ... would be one whose members have adopted the same, or a very similar calling, avocation, or profession or who are working in union to accomplish some worthy object, and who for that reason have banded themselves together as an association or society to aid and assist one another, and to promote the common cause. The term "fraternal" can properly be applied to such an association, for the reason that the pursuit of a common object, calling or profession usually has a tendency to create a brotherly feeling among those who are thus engaged. As a general rule, such associations have been formed for the purpose of promoting the social, moral, and intellectual welfare of the members of such associations and their families, as well as for advancing their interests in other ways and in other respects...

The IRS found that ORG was not quite up to snuff:

ORG does not meet the requirements of an organization described in IRC section 501(c) (10). Members of ORG do not have a common fraternal bond. The members do not adopt the same or very similar calling, avocation, profession, or are working in unison to accomplish any worthy objective or common cause. ORG has not been operating for religious, charitable, scientific, literary, educational and fraternal purposes, nor has ORG devoted its net earnings exclusively to religious, charitable, scientific, literary, educational, and fraternal purposes. ORG is operating in a commercial manner which is not an exempt activity described under Internal Revenue Code section 501(c) (10).

In this circumstance, Merle Haggard not withstanding, barroom buddies are not the best kind.


Private Letter Ruling 201050033

Moving on to more salubrious pursuits we come to an "org' that was formed to support gymnastic activities.  Perhaps it is consistent with the ethos of that sport (if that's what it is) to discourage slacking :

Your Bylaws state that to accomplish your purpose, "each family must fulfill their financial requirements and work their assigned number of hours at each fundraiser." Fundraising activities are held throughout the year, on almost a quarterly basis. Non-compliance results in a fee charge of $


Your Bylaws further provide that membership is open to "those persons who are parents or guardians of gymnasts who are members of the competitive teams and pre-teams at Gym" (the "members" or "member-parents"). The children of two of your directors participate in Gym and receive financial assistance from you to the extent they participate in fundraising activities.

In your application for exemption, you indicate that Gym is a for-profit organization. According to your Bylaws, the owner of Gym (the "owner") takes part in all meetings and "has a say" in your decision making. You are required to inform the owner of all pending major decisions, and the owner may be invited to submit input.

If a gymnast's family does not raise enough funds through the various fundraising activities to cover the costs of its portion of the block fees, the family must pay the difference in cash or not participate in the Gym competitive program. If payment is not received promptly, the gymnast is not allowed to compete at the following meet. You are entitled to any surplus funds on a gymnast's block fee account if the gymnast leaves the competitive program before the end of the competition season. Any surplus funds are used at your members' discretion.



In addition to the private benefit conferred to your member-parents through your fundraising activities, the equipment you own and loan to Gym for no charge results in more than incidental private benefit to the gym and its owner, because the for-profit gym gets the benefit of the use of the equipment for free. Purchasing such equipment for use by a non-exempt entity is not an exempt purpose.



Your primary purpose is raising funds to offset the costs of participation in the competitive program of Gym, a for-profit organization, for children of your member-parents. Members are credited with funds raised based upon participation in fundraising events. If members do not raise sufficient funds through fundraising activities, the parents pay the balance of the fees required for their child to participate in Gym's competitive program. You state that you do not provide financial or any other assistance to gymnasts outside of the Gym's competitive program.

Because of the direct financial benefits that your member-parents receive, your activities violate the prohibition against inurement, thereby preventing you from qualifying for exemption as an organization described in section 501(c)(3) of the Code. The requirement that each parent-member participate in your fundraising activities in direct proportion to the benefits they expect to receive causes a direct benefit to flow to these member-parents. Consequently, your earnings are being used to pay for benefits to specific individuals rather than to a charitable class, which allows your earnings to inure to the benefit of specific insiders, namely the parents of Gym's participants.


In addition, the owner of Gym sits on your board of directors and is also considered an insider. You have purchased equipment that is used for no charge by Gym, a commercial business. This transfer of your financial resources to the owners of Gym is in violation of the inurement proscription and is also sufficient to defeat exemption under section 501(c)(3) of the Code.

This bunch applying for exempt status could motivate me to launch a jeremiad about selfish narcissism but what do you expect from people who think subjectively judging kids running around and jumping constitutes a sport ?